Week Ahead: Can the US CPI Do What Payrolls Didn’t and Persuade the Market that the Fed Will Deliver a 50 bp Cut ?

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Marc Chandler
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After the US jobs report and Fed speak, the market scaled back the odds of a 50 bp cut at the September 17-18 FOMC meeting. It settled last week slightly below a 30% chance. The odds were shaved for the second consecutive week. Fed officials have indicated that the full employment mandate is now of greater significance given its growing confidence that inflation is heading back toward its 2% target. Next week's August CPI and PPI are likely to be consistent with that narrative. Ahead of the weekend, the two-year yield posted its lowest settlement since September 2022 (~3.65%). The 10-year yield settled near 3.71%, its lowest level since mid-2023. And, yes, for the first time since July 2022, the 2-10-year yield curve settled with a positive slope. Major equity indices (MSCI Asia Pacific Index, Europe's Stoxx 600, the US S&P 500 and NASDAQ) fell more last week than during the turmoil from mid-July through early August as carry-trades were unwound.

After falling sharply in August, the dollar was correcting higher and position-adjusting ahead of the jobs data saw it pullback. What is the state of the dollar's upside correction. The dollar's retreat around the jobs report exceeded technical retracement levels, but it came back and its appears that the correction can continue. In addition to the US inflation gauges, the other highlight of the week ahead is the ECB meeting. There is nearly universal agreement that the ECB will deliver its second cut in the cycle. The US 2-year premium over Germany is hovering around 140 bp, last seen in May 2023. It peaked this year in April around 205 bp. China begins the new week with its August CPI and PPI reports and finishes the week with a spate of real sector reports. The yuan slipped last week for the first time in seven weeks, and it was touch and go until the very end. State-owned banks that were selling dollar in July above CNY7.25 were seen buying them back in recent days. Profit-taking? And if they were doing the state's bidding, will the banks have to turn the profits over the Beijing? 

United States:  With last week's modest acceleration of jobs growth and the first decline in the unemployment rate since March, attention turns toward prices. August CPI is due September 11, the morning after the first debate between Harris and Trump. Pricing in the Fed funds futures market is consistent with about 28% chance of a 50 bp cut on September 18. In the frantic activity after the jobs report, the odds went up to nearly 75%. Nevertheless, the futures market is pricing in better than a 50% chance of two half-point hikes at the last two meetings of the year. The yield curve finished the week with a positive slope (~6 bp) for the first time since July 2022. Economists look for a 0.2% rise in core and headline CPI. Due to the base effect, the year-over-year headline pace may slow to 2.6% from 2.9%, while the core may hold steady at 3.2%. At three-month annualized rate, a 0.2% rise translates into 1.2% at the headline level and 2.0% at the core. Producer prices, released September 12, coupled with the CPI, will allow economists to fine-tune forecast for PCE deflator, which the Fed targets. 

Ahead of the weekend, the Dollar Index held the low since July 2023 set in late August near 100.50 and recovered to around 101.40. Last week's high was set on Tuesday (after the Monday holiday) near 101.90 and slightly below the 20-day moving average. The pullback was deeper than we envisioned but the upside correction may not be over. A move above 101.50 would suggest that indeed the correction or consolidative phase is intact. 

Eurozone: The ECB delivered its first cut in the cycle in June, and since then, there has been little doubt that it would cut rates again this month (September 12). The decline in the preliminary estimate for August CPI (2.2%), the lowest print since July 2021, had little impact on expectations. The 0.2% increase means that over the past four months, eurozone CPI has risen at an annualized rate of 1.8%. The core rate is stickier at 2.8% (from 2.9%). It was at 5.3% in August 2023. A quarter-point cut will bring the deposit rate to 3.50%. The swaps market has it at between 2.25% and 2.50% by the middle of next year. The ECB is expected to make a technical adjustment and reduce the spread between the deposit rate and the main refinancing rate from 50 bp to 15 bp. The central bank will also update its macro-economic forecasts. In June, it projected 0.9% growth this year picking up to 1.4% in 2025 and 1.6% in 2026. It had CPI finishing the year at 2.5% and falling to 2.2% at the end of 2025 and 1.9% at the end of 2026. 

The euro traded higher last week and set a seven-day high near $1.1155 after the US jobs report. The momentum was not sustained, and the euro surrendered its gains. It settled lower on the day but inside Thursday's range. Last week's low was set near $1.1025, but it did not settle below $1.1040, which is the (38.2%) retracement of the August rally. The (50%) retracement is about $1.0990 and the (61.8%) target around $1.0940. The short-term speculative market still may have euros to pare ahead of the ECB's meeting, Near-term consolidation seems likely. 

China:  China's consumer prices have gradually emerged from the deflation experienced from October 2023 through January 2024. The 0.5% year-over-year increase in July was the most since February. The main narrative is that the weakness in consumer prices reflect poor demand. Yet, a key driver of the CPI are food prices and demand are more inelastic that supply. Also, the hyper-competitiveness of some sectors, like autos, which is other side of "excess capacity" is supply-driven. In addition, most observers recognize the inconsistencies and internal contradictions of Chinese data, but they are willing to accept relatively low level of consumption at face value, primarily it seems because it supports priors, while some Chinese economists have argued that consumption is understated. The last monthly Bloomberg survey produced a median forecast of 0.5% CPI this year and 1.5% next year. Producer prices have been falling on a year-over-year basis since October 2022. The 0.8% decline reported in June and July matches the low from 2023. It has been recovering since the -5.4% print in June 2023. After Monday's price data, attention will turn to the lending and real sector data for August. The general sense is that the economy continues to struggle, and more stimulative efforts are needed. 

The dollar's recovery after the jobs data allowed the greenback to snap a six-week decline against the Chinese yuan. It eked out a minor gain of less than 0.1%. Still, with the yen firm and US rates softer, it is not clear that there is much upside scope for the dollar against the yuan. Last week's high was near CNY7.1250. In the coming days, the CNY7.1050-CNYCNY7.1100 may provide a cap. The dollar approached the 15-month low set against the offshore yuan in late August slightly ahead of CNH7.07. If that represents the lower end of the range, the CNH7.12-CNH7.14 may offer the near-term cap. Also, the three-month implied offshore vol remains elevated (~5.50%-6.1%) since early August. In the previous several months, implied vol was mostly 3.50%-4.0%. 

Japan: Revisions to Q2 GDP will start the new week and there is scope for a small upward revision from 3.1% annualized pace initially reported. Yet, with 2/3 of Q3 behind us, Q2 data, unless significant, is unlikely to be impactful. The highlight of the week is July's current account figures and capital flows that are reported alongside it. Net exports have been a drag on Japanese growth for three of the past four quarters. In theory one might expect the yen's weakness to have improved Japan's trade balance. Yet, the deficit averaged almost JPY405 bln a month in Q2 24 and JPY340 bln in Q2 23. In Q2 19, Japan's average monthly trade deficit was slightly less than JPY40 bln a month. The weekly MOF portfolio flow report shows Japanese investors were net sellers of foreign bonds and stocks before going on strong buying spree in August, with the benefit of a stronger yen. 

The dollar was sold to within a few hundredths of a yen of the spike low made last month against the yen near JPY141.70. The continued decline in US yields, with the 10-year rate falling to levels not seen since the middle of last year (~3.65%) weighed on the greenback. The yen was the strongest G10 currencies last week, rising 2.7%. The Swiss franc was in second place with a 0.75% gain. If US yield continues to trend lower, the risk is so does the dollar against the yen. The JPY138.75-JPY140 area may be the next important technical target. 

United Kingdom:  The UK economy recovered in H1 24 after contracting in H2 23, and the economic momentum appears to be carrying into Q3. This may see a stronger labor market report (September 10) and a solid July GDP report (September 11). The swaps market continued to downgrade the chances of a cut at the September 19 BOE meeting but remains confident of at least one cut before the end of the year and favors two by a slight margin. 

Sterling surged after the US jobs data to nearly reach $1.3240, stopping short of the two-year high set in late August around a quarter-of-a-cent higher. It was quickly sold and by the end of the European session set a new session low near $1.3110. It traded on both sides of Thursday's range and settled below its low (~$1.3135), ga bearish outside down day. The momentum indicators are still falling. The key now may be last Tuesday's low slightly below $1.3090. A break of that would signal the continuation of the downside correction after last month's six-cent rally. 

Canada:  After last week's Bank of Canada rate cut, and rhetoric that validated market expectations for additional rate cuts, and the poor August jobs report, this week pales in comparison. Building permits are a notoriously volatile time series, and the July report follows May-June, when on a combined basis, permits fell by over a quarter. The Q2 capacity utilization report is due September 13. It has eased for the past four quarters. There have been other periods in which capacity utilization rate have fallen for four quarters, but there is no precedent for a five-quarter contraction in at least the past 30 years. 

Even after the Bank of Canada's dovish cut, and NDP's withdrawal of support from the government, the US still fell to almost CAD1.3465 (five-month low set in last August was about CAD1.3440) before the employment reports. The US dollar jumped to a new two-week high a little above CAD1.3580. There may be a band of resistance between CAD1.3585-CAD1.3620, which houses the 200-day moving average, a retracement objective of last month's sharp drop, and some congestion (past highs and lows). The momentum indicators have turned up, and the greenback's outside up day before the weekend adds to the bullish technical tone. 

Australia:  The Bullock-led Reserve Bank of Australia has repeatedly said that a rate cut remains unlikely. The market has resisted, and still strongly anticipates a cut, though it is not fully discounted any more. Melbourne Institute's survey of consumer expectations may reinforce the central bank's caution. The survey warns that expectations may have bottomed in May at 4.1% and in August stood at 4.5%, the same as in December 2023. Moreover, the July print put the trimmed mean at 3.8% and the Q2 CPI had the trimmed mean at 3.9%. That said, with some puzzlement we note that the strongest G10 currency last month was the New Zealand dollar. It rose 5% compared with the Aussie's 3.40% gain, though the Reserve Bank of New Zealand is expected to begin its easing cycle next month. The swaps market has almost 80 bp of cuts this year with two meetings left.

The Australian dollar recorded a big bearish outside down day ahead of the weekend. After making a three-day high near $0.6765, the Aussie was greeted with a wall of sellers that pushed it to $0.6660. Among the G10 currencies, the Australian dollar's 1.4% decline was the largest last week. The momentum indicators are accelerating to the downside, and the five-day moving average looks set to cross below the 20-day moving average early next week. The $0.6645 area is the (38.2%) retracement of last month's rally. Near-term targets include the 200-day moving average, near $0.6620 and the (50%) retracement, close to $0.6585. 

Mexico: Mexico is in a sort of pressure cooker. A lame duck president and his strong legislative majority are  pursuing controversial judicial reform that are spooking investors. The economy is slowing, and economists have cut this year and next year's GDP forecast, according to latest central bank survey. The unemployment rate has risen for four consecutive months through July. Inflation, on the other hand, is rising. Headline CPI peaked two years ago this month at 8.7%. It fell to 4.26% last October. That is where it bottomed. Rising for five months through July, it stands at 5.57%. The bi-weekly report gives some hope of a pullback, but it most likely will remain well above 5%, which was the annualized rate in the three months through July. Mexico's core rate has continued to trend lower. It peaked in January 2023 at 8.45%. It has fallen every month since to stand at 4.05% in July. The reading for the first half of August showed a further decline below 4%, for the first time since 2020. Still, the fall appears to be moderating. 

The peso was the worst performing emerging market currency last month, depreciating by nearly 5.65%. Three-month implied volatility reached 17.8% in late August and softened slightly last week to about 16.8%. It finished Q1 below 9% and the 200-day moving average is approaching 12%. Last week, the peso fell by about 1.35% against. It was the 12th consecutive week that the net change was more than 1%. Despite the intraweek penetration the MXN20.00 level held on a closing basis. The greenback has not settled above MXN20.00 for nearly two years. Still, the momentum indicators are stalling in overbought territory, but the high may not be in place. The next immediate target is the early August spike high near MXN20.2180.