Yuji Sakai
The consolidative phase for the dollar, we anticipated last week, after its recent drop, is evolving into a proper upside correction. We expect the dollar to trade broadly firmer over the next week or so. It is also part of a larger picture, where US interest rates also look to have put in a near-term bottom and are set to recover. Ideas that the next US administration may favor a weaker dollar has become a talking point. Yet, of all the forces that drive the $7.5 trillion a day foreign exchange market, official preferences are not among the most salient. Nor is it simply a question of asymmetry, where it is thought easier to “talk down” a currency than to talk it up. That was not the case in the run-up to the Plaza Agreement in 1985 or the period before the coordinated material intervention in 2000, marking the end of the Clinton-Rubin-Tech Bubble dollar bull market. That said, the end of the dollar’s cyclical rally and the change in the US policy mix could push the dollar in the “desired” direction.
There are three highlights in the weekend ahead: the flash July PMI, the Bank of Canada meeting, and the Q2 US GDP estimate. Other observers may add the PCE deflator, which the Fed targets. Yet, the CPI (and PPI) data already has provided the signal. Recall that during the tightening cycle that ended a year ago, the Fed often cited CPI in its rationale for hikes. The swaps market is highly confident that the Bank of Canada will cut rates at its July 24 meeting. After this week’s meeting, there are three left this year, and the swaps market is pricing in one cut fully and about a 50% chance of another. The preliminary PMIs seem to have little impact in Australia, Japan, and the US, but appear to be more impactful for the eurozone and UK. And while, not exactly a data/event highlight, we note that the US equity market appears to have begun a corrective phase. The S&P 500 (SPX) and NASDAQ rallied more than 22% off their mid-April lows. A modest “technical correction” could see a decline toward 5400 in the S&P 500 (~5505 close) and 17355 in the NASDAQ (~17727 close).
United States: The upcoming data may be more for economists than markets. Most of the reports will contain little new information. The one that, the preliminary estimate of the July PMI, has lost some of its gravitas, as many participants seem to prefer the ISM in recent months. That said, the compo-composite June PMI stood at 54.8, the highest since April 2022. The US will release its first estimate of Q2 GDP. The Atlanta Fed GDP tracker stands at 2.7%. The median in Bloomberg’s monthly survey is 1.9% It does not matter that it is stronger than the 1.4% pace seen in Q1. GDP math notwithstanding, job growth is slowing, and the American consumer is pulling back. Consumption rose at an annualized rate of 3.2% in H2 23 and may have slowed to almost half of that in H1 24. Government spending surged at an annual pace of 5.2% in H2 23 and has slowed markedly in H1 24 to around 1.8%. Private investment grew slightly faster than government spending in H2 23 at about a 5.3% pace and looks to have slowed too. A 2.4% quarterly annualized increase in Q2 would put the H1 24 private investment on about 3.4% annualized pace. The GDP report out on July 25 will incorporate the following day’s monthly personal income and consumption figures. The deflators may draw some attention, but the fact of the matter is that the CPI and PPI reports already sent the signal. However, because of the drag in the non-housing service components of CPI (e.g., airfares and medical services), which are not used to calculate the core deflator, and the firmer PPI components that do, warns that the PCE deflator may be a little stickier. The headline may rise by about 0.1% (rounded) for a 2.5% year-over-year pace (2.6% in May). The core rate may rise by almost 0.2% (rounded) and that will keep the year-over-year rate steady at 2.6%. A move above 104.50 lifts the tone for the Dollar Index. The oversold momentum indicators are set to turn higher, and DXY could recover toward the 105.00-105.20 area.
Japan: Japan’s economy appears to have recovered in Q2 from the contraction in Q1. Japanese consumers have been pulling back for the last four quarters but appear to have returned. Net exports also appear to have contributed. The June composite PMI fell below the 50 boom/bust level. This week’s estimate will help determine if it was a fluke or a signal of soft economic activity as last November’s sub-50 reading, the only one in the year (despite the Q3 contraction). More importantly, at the end of the week, Tokyo’s July CPI will be reported. It offers investors and the Bank of Japan robust insight into the national price pressures ahead of the central bank meeting on July 31, several hours before the FOMC meeting concludes. The BOJ will update its economic forecasts. It may also raise rates and announce a reduction in bond purchases that will signal quantitative tightening (the new buying will be less than the maturing amount).
The push to JPY155.40 on July 18 may have completed the dollar’s downside correction. The momentum indicators, oversold, have not turned up, but likely will in the coming days. The initial upside target is near JPY158.60, but potential may extend back toward JPY159.00-JPY159.50. Despite the dollar rising in four of last week’s five sessions, the greenback finished a fraction lower. It was the third consecutive week the dollar fell against the yen, its longest losing streak of the year.
Eurozone: After last week’s ECB meeting, which gave the market little reason to second-guess its confidence that another rate cut will be delivered in September, the swaps market had assigned about an 85% probability to it before the ECB meeting. The eurozone’s June PMI fell (50.9 vs. 52.2) for the first time since last October. Growth is seen to be steady, even if slow. The US two-year premium over Germany trended lower. Since mid-June, it narrowed by around 30 bp but found support ahead of 160 bp and finished the week above 170 bp. A further compression be necessary for the euro to extend its rally. Instead, a deeper pullback from the late-June to July 17 rally that took the single currency from around $1.0665 to $1.0950 seems more likely. Initially, the $1.0840-50 area offers a reasonable target, and below there, more important support is near $1.08.
Canada: The Bank of Canada meets on July 24. Economists in Bloomberg’s survey are more evenly divided than the swaps market, which is pricing in more than a 90% chance of a rate cut, and that was even before the disappointing May retail sales report at the end of last week (-0.8% vs. 0.6% gain in April). A cut would be the second for the Bank of Canada. The market is pricing is a third cut fully and has about a 50% chance of a fourth. Recall the greenback’s false break below CAD1.36 in response to the soft US CPI on July 11. That was the lower end of the three-month range. It looks poised to challenge the upper end of the range (~CAD1.38). The momentum indicators have turned up and the five-day moving average crossed above the 20-day moving average.
UK: May’s composite PMI, which declined from 54.1 to 53.0, gave little inkling of the upside surprise to May’s GDP (0.4% after a flat April). The composite PMI fell further in June (to 52.3), and last week’s reports showed payrolls fell for the third consecutive month and retail sales softened. While the swaps market has two rate cuts fully discounted in the remainder of the year, the market is evenly divided over the outlook for the August 1 Bank of England meeting. Sterling set the high for the year (~$1.3045) in the middle of last week in response to a slightly firmer than expected CPI report. That seemed to have completed the rally that began in early July from about $1.2615. The momentum indicators are rolling over from overbought territory. A break of the $1.2880 area could signal a move toward $1.2830, and possibly $1.2780.
Australia: Last week’s employment report had little impact on rate expectations. The futures market has largely abandoned dally with a rate hike. At the end of June, the market had nearly an 80% chance of a hike this year, and that has been downgraded to less than 25%. Meanwhile, Australia’s composite PMI fell every month in Q2, and improving every month in Q1. The Australian dollar was turned back on July 11 from $0.6800, its best level since January. It consolidated for a couple of sessions but broke down last week and ended a five-week rally, matching its longest rally since the end of 2020. It finished the week below its 20-day moving average and settled below $0.6700 for the time since July 2. The momentum indicators have turned lower. The Aussie had been in a $0.6600-0.6700 trading range from mid-May through early July (with one settlement outside of that range). It is now returning to that range. Before reaching the bottom, there may be support in the $0.6630-50 area.
China: The Third Plenary session has come and gone. It is a quiet week for Chinese data. After the one-year Medium-Term Funding Rate was left unchanged at 2.50%, there seems to be little incentive to induce the banks to cut the loan prime rates. They will set early Monday. The poor performance in Q2 bolsters speculation of more stimulus. Fiscal spending appears to be less than last year, and some see the yuan’s weakness as deterring lower rates, perhaps until the Federal Reserve cuts. For the past two weeks, the dollar has traded in about a CNH7.26-CNH7.2950 range against the offshore yuan. Given our view of the dollar more broadly, including against the Japanese yen, and without making any claims about why and how Beijing manages its currency, we suspect the dollar can return to the CNH7.30 area. The peak from earlier this month was a little above CNH7.31.
Mexico: The dollar fell by about 5.3% against the peso in the first half of July. The peso’s steep carry proved too much. The greenback found support near MXN17.60 and tested MXN18.10 before the weekend. Ideas that the US-Mexico tensions will escalate in a second Trump term, and new concessions will be wrought in the 2026 USMC weighed on the peso. The dollar approached the down trendline drawn off the June 12 and June 28 highs. It is around MXN18.1150 at the start of the new week. Mexico reports CPI for the first half of July. There is potential toward MXN18.30 and then MXN18.50 in the coming days. The whole month’s inflation data will be available shortly before Banxico meets on August 8. Officials do not have much conviction, as the headline rate has been rising even as the core extends its decline. At the end of the week, Mexico reports June trade figures. Mexico’s trade deficit has fallen to about $4.46 bln in the first five months of 2024, compared with a $6.56 bln deficit in the same 2023 period.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
