Daily Market Notes Tickmill UK

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347

Fears of energy crisis may drive Euro to parity against USD

Despite sharp strengthening of the dollar on Tuesday and growing pessimism on European equity markets, the S&P 500 managed to neutralize selling pressure closing in green, Nasdaq rose 1.68%, the Dow Industrial Index fell 0.42%. The strength of the US currency extended into Wednesday, DXY aims to probe 107 level. The collapse of EURUSD to 1.0250 saw little headwinds and the pair looks set to continue to explore fresh lows, a probe below 1.02 looks very likely. Investors await release of the US services PMI in June and the Minutes of the June Fed meeting to assess the possibility that the Fed will soften the rhetoric and choose a less hawkish pace of policy normalization in response to increased risks of a global economic recession.

The term structure of US bond rates indicates rising expectations that a short period of rate increases will be followed by a cycle of rate cuts. Inversion of the yield curve deepened as both 10Y/2Y and 5Y/2Y bond yield spreads dipped below 0:

Such behavior of the yield curve often precedes negative returns of Asian and European currencies, such as the pound sterling and the euro, and increase in the demand for the dollar, the Japanese yen and the Swiss franc.

In the commodities market, the price of copper, a metal widely used in manufacturing and construction, is an indicator of concerns about a future slowdown in the economy. Its price has fallen by 28% since the beginning of June, reflecting fears that demand for it will decline rapidly in the second half of 2022:

The key question for investors is the magnitude of economic slowdown (aka demand destruction) that the Fed expects in its forecasts for which current plans of policy tightening will remain unchanged. It should be noted that despite the surge of risk aversion in financial markets, money markets investors only slightly revised their expectations for policy tightening towards a slower pace: by only 6 bp for the Fed and by 12 bp for the Bank of England and the ECB. Underlying this difference are likely the risks of a larger economic blow to the EU due to a torn trade ties with Russia and the fact that the US economy approached the tightening cycle in a more “overheated” condition than opponents.

Today, the Fed minutes are due, given significant strengthening of the dollar, the “sell on the facts” scenario is likely to materialize. EURUSD and GBPUSD are likely to experience a short bounce up. Also, market attention will be riveted to the ISM report in the service sector, which accounts for 70% of the US economy. The focus is on the hiring component, which should help to clarify expectations for Friday NFP report.

The European currency continues to price in rapid growth of anxiety that the economy may face an energy crisis. German authorities are taking measures to stabilize the situation, including calls to ration gas consumption and preparing a plan to take a stake in the country’s largest utility provider, Uniper. Earlier it was reported that the load on the NordStream 1 pipeline was significantly reduced, investors fear that the situation could worsen. The seriousness of the situation is also evidenced by the fact that the EU is going to hold a meeting of energy ministers of the countries included in the bloc on July 26. EURUSD will most likely continue to decline up to 1.00, while the dollar index may rise to 109-110. The reversal of the pair will have to be preceded by news about the restoration of gas supplies from Russia, which will reduce the risks of an energy crisis in the bloc.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

348

US labor market reports can extend relief rally in risk-assets as investors are desperate for positive growth signals

The dollar remains close to fresh highs on Thursday, the minor retracement was also reflected in revived modest demand for risk, the key Asian and European markets gain more than 1%. Demand for safe assets came pressure, investors dump long-term bonds of matured economies. Yield on 10-year Treasuries is once again targeting the 3% mark.

Commodity markets saw surplus of buyers as well, key proxies for market fears of a future recession – oil and copper prices are up 1% and 3.5% today, respectively.

The rally of risk assets today was basically sponsored by the minutes of the FOMC meeting released yesterday. There were lots of mentions about the need to lower inflation and little about possible costs of an aggressive policy, which prompted investors to revise the odds of a recession to the downside and began to roll back the emotional reaction of recent days. The minutes showed that the Fed is ready to hike interest rate above the neutral level if inflation proves to be persistent and that the commitment to the idea of suppressing inflation outweighs fears that this could significantly harm the economy.

Another important source of information about the state of the US economy was the PMI in the services sector from ISM released yesterday. The headline figure was better than expected thanks to rebound in business activity sub-index, but other components of the report pointed to a decrease in hiring compared to the previous month, a slowdown in the growth of new orders and some slowdown in inflation:

Given these data, there is a growing risk of disappointment with tomorrow’s NFP report, in particular, the payrolls figure could again miss estimates. As the Fed signaled it won’t be easily spooked with deterioration in the key macro data, worse than expected jobs growth will likely result in a new round of risk-off in the market, as this may rekindle worries about a policy mistake, i.e., policy tightening into economic slowdown.

The strong dollar forces US trading partners to keep up with the hawkish Fed in order to contain further devaluation of their currencies, which is fraught with inflationary pressure coming from expensive imports. The European currency is moving towards parity against the dollar and it is likely that the ECB will soon have to hint at a more aggressive pace of rate hikes, as the risks of higher inflation figures in the coming months may begin to outweigh the risks of lack of monetary stimulus due to monetary tightening. However, EURUSD move towards 1.00 is likely to resume soon and the best candidates to trigger sales are this Friday’s labor market report and next week’s US inflation report.

Today, the release of the ADP report is dye, to which the market is often very sensitive. Job growth is expected to be around 200K, an upside surprise will likely extend current rebound in risk-assets, while weaker-than-expected print may increase bearish sentiment in equities.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

349

Strong NFP report will likely fuel EURUSD drop to parity

The dollar continued to strengthen on Monday after release of US labor market report on Friday, which did not confirm market pessimism about the US economy, reinforcing the view that the US is now an “island of stability” for large capital. The key measures of the US labor market remained in June at the level, which give the Fed grounds to confidently hike interest rate by 0.75% in July. Ahead is the release of the June CPI, which should point to a new high in inflation in the current business cycle (forecast 8.8% YoY), leaving no doubt that the Fed will continue to tighten policy at a galloping pace.

The US economy created 372K jobs in June, well above the consensus estimate of 265K. The number of jobs in the private sector increased by 381K against the forecast of 233K. The revised estimate for the previous two months was lower by 74K, however, the upside surprise in June Payrolls overshadowed that weak spot of the report. Along with upcoming June CPI release, the labor market report should lay the groundwork for a 75 bp Fed rate hike second time in a row.

The total number of jobs in the US thus rose to a level that is only 524K below the pre-pandemic level. By sector, tourism and leisure lag behind the most in terms of job growth, with 1.3 million jobs below February 2020 levels. However, the problem is not the low demand for labor, but the shortage of labor supply. The second weakest sector in terms of hiring is the civil service sector, however, along with the growth of government tax collections, the situation in 2023 will change for the better. The level of employment in other sectors is close to historical highs.

As for the rest of the report, the unemployment rate remained at 3.6%, wages rose by 0.3% m/m and 5.1% y/y, which was in line with consensus. Somewhat disappointing was the labor force participation rate, which dropped from 62.3% to 62.2%. Given quite low unemployment rate, LFPR recovery is necessary to ease the imbalance between strong demand and weak supply in the labor market, but so far this has not happened. There was hope that the decline in the stock market would hit wealth, primarily pension savings, and force some of the workers to start looking for work, but the market correction did not produce the desired effect, and this means that companies continued to experience difficulty in hiring and are likely to be forced to raise wages further, which speaks in favor of unfavorable inflation outlook.

Some other employment reports, such as the JOLTS report or the NFIB Small Business Survey, have shown that there are nearly two jobs for every unemployed American, and that 50% of small businesses have jobs that cannot be filled yet:

The NFP report turned out to be one of the few positive macro reports that came against other weak indicators of activity. Despite market pessimism, US companies’ demand for labor remains strong. Against this background, the Fed is likely to raise rates by 75 bp in July, the odds of such an outcome according to rate futures is already 93% against 86.2% last week:

Further pace of Fed rate hikes is likely to slow down to 50 bp in September and November and up to 25 bp in December.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

350

Greenback may stay in the uptrend for a while as key drivers are set to remain intact

The bullish momentum in the dollar remains intact at the start of the week with EURUSD testing the round 1.00 level followed by a technical rebound to 1.006. Given ongoing risks of an energy crisis in the EU (restart of the NordStream 1 pipeline after maintenance), as well as fresh round of escalation of the economic confrontation with the Russian Federation (seventh package of sanctions), the probability of falling below 1.00 remains high. The FX options market suggests that the next major support zone could be around 0.98.

The overbought in the dollar is swelling and along with this extremely long bias in positioning, the odds and size of a potential bearish correction are increasing as well. However, for a long squeeze in the dollar, we may need to see weakening or the appearance of counter-signals in the key drivers of the recent rally of the US currency – slowdown in global growth momentum and aggressive policy of the Fed. However, in the near future, such a development of the situation is not to be expected - the Fed, based on incoming data, is increasingly inclined to raise the rate by 75 bp for the second time in a row while macro reports outside the US are full of negative surprises. Take the dismal report from ZEW today, which showed that German economic sentiment plummeted from -28 to -53.8 (forecast -38.3 points):

In addition, a potential positive surprise in the US CPI report on Wednesday (e.g., annual inflation above 9%) could trigger speculation that there may not be a slowdown in the pace of Fed tightening at the September meeting.

Reporting season in the US started this week, and short sellers in USD hope that positive surprises in the reports will draw investors into equities which should add to dollar supply and trigger some sell-off. However, given the current state of the global economy, the chances of actually seeing strong earnings figures seem low. Despite overstretched rally, the dollar is more likely to remain in an uptrend than a correction in the short term. From a technical standpoint, the dollar index (DXY) may find meaningful resistance at 110 level:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

351

Minor upside surprise in US CPI is likely priced as fuel prices continued to rise in June

Today is a special day for financial markets as the US Bureau of Labor Statistics releases CPI for June. It’s no secret that the Fed tied monetary policy to developments in inflation, so its acceleration will mean that the Fed’s lead in the policy tightening race will only increase, and vice versa, an inflation print below consensus should promote expectations that the gap in the pace of policy normalization between the Fed and other central banks will narrow somewhat. In fact, this will be the driver of price changes in almost all asset classes.
Headline inflation is expected to hit a new high of this business cycle (8.8%) and core inflation to slow from 6% to 5.7%. The expected acceleration in headline inflation is due to the jump in US fuel prices in June from $1.17 to $1.3 per liter:

Given this circumstance, a small positive inflation surprise will unlikely trigger sizeable shift in tightening expectations; much more unexpected will be inflation below the forecast of 8.8%, as well as a stronger slowdown in core inflation which is less volatile and characterizes key consumer trends.
If headline inflation accelerates above 9.0%, a bearish breakout of the EURUSD level of 1.00 can be expected while inflation reading in line with the forecast will likely lead to a false breakout and there is a risk that “sell on the facts” scenario will happen in the US dollar, given the significant overbought dollar in the medium term (RSI on the daily timeframe above 74 points).
Currencies showing high sensitivity to expectations of global business cycle - the Norwegian Krone, the Australian dollar, the New Zealand dollar, are rising today, the Japanese yen is consolidating near highs against the dollar (level 137). Futures for US indices show a slight increase, European stock indices are in the red.
Oil prices are trying to recover, but reports that China may be facing a fresh outbreak of covid vases (400 new cases in Shanghai) and risk of tightening of sanitary measures increase concerns about demand from the key consumer. OPEC said yesterday that demand for oil will exceed supply by 1 million barrels this year, but events in China have likely overshadowed that message. There is a risk of further decline in prices, as the threat of a new lockdown in China’s major industrial and financial center grows.
Leading survey-based indicators of investor and business sentiment deteriorated in June. Shortly after the publication of investor confidence in Germany on Tuesday, which fell to the lowest level since the debt crisis in the EU in 2011 (-53 points), in the US, the index of small business optimism came out, the fall of which also markedly exceeded expectations as inflation climbed to the first the place of uncertainty factors among US small firm owners:

The risk of a new wave of risk aversion is rising, and a policy tightening by central banks will only reduce risk appetite in equity markets and increase demand for safety plays. The RBNZ raised the rate by 50 bp, the Bank of Canada is expected to raise the rate by 75 bp today. If US inflation jumps above 9.0%, risk assets are likely to come under serious pressure, and the dollar will continue to rally.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

352

Markets brace for 100 bp July rate hike and the room for dovish surprise grows

EURUSD volatility around the round 1.00 level remains elevated which creates ripple waves in other USD cross-pairs. After yesterday’s “shocking” CPI release, markets shifted expectations of the upcoming July rate hike from 75bp to 100bp. Earlier, the Bank of Canada surprised markets with a front-loaded 100 bp rate hike, highlighting seriousness of the inflation threat and the need for decisive response. European currencies are set to remain in the shadow of a strong dollar for a while as the factor of interest rate differential, until the Fed’s policy stance is clarified on July 27, should keep these currencies under pressure. EURUSD consolidation near the 1.00 level with very weak attempts to rebound indicates a growing risk of a bearish breakout with a target of 0.98-0.99.

At least one Fed official signaled that a 100 bp rate hike at the upcoming meeting is on the table. Speaking yesterday, Atlanta Fed chief Rafael Bostic said that “everything is at play”. Bank Nomura made a 100 bp outcome as a baseline scenario for the upcoming FOMC meeting.

However, there is a risk that the market reaction to the upside surprise in the CPI report was excessive and may be prone to correction. Looking at the details, one can see a strong heterogeneity of inflation by components: prices in two categories, gasoline and utility gas, rose significantly more than others:

In other categories, monthly price growth in most cases did not exceed 1%.

The fact that gasoline prices jumped in June was known long before the release of the inflation report, so the surprise on the upside, in truth, does not look so unexpected. Due to the high dispersion in component price increases and the fact that the prices of goods known for their high volatility were the main contributors to the “shocking” June figure, a decline in inflation in subsequent months could be quite rapid. There is already information that gasoline price inflation began to slow down in July, so from this point of view, too sharp Fed tightening, and even more so a 100 bp step may be unreasonable and do more harm to the economy than good. It is also important to keep in mind that inflation generated by fuel prices growth is not the kind of inflation that can be effectively regulated by raising interest rate (via demand destruction), moreover, the pass-through effect of gasoline inflation into other categories, judging by the numbers, is not so strong.

Considering that futures on the Fed rate price in the 100 bp outcome at the upcoming meeting with an 84% chance, the decision to raise the rate by 75 bp may be regarded as dovish surprise and eventually lead to an overdue downward correction of USD.


Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

353

Dollar can extend pullback as markets price out 100 bp rate hike in July

Last week was marked by highly volatile expectations regarding the FOMC July decision: after release of the CPI for June, which showed inflation accelerating to 9.1%, the chances of a 100 bp rate hike soared to 84%, but already on Friday, the retail sales report and inflation expectations from U. Michigan again made 75 bp a baseline scenario. The overbought dollar turned lower, while risk assets rebounded on optimism about the short-term inflation outlook.

Despite a new inflation record in June (in the current business cycle), US retail sales rose 1% in June, beating the 0.8% forecast. More surprisingly, growth in core retail sales, which is less volatile from month to month, almost doubled the forecast - 1% vs. 0.6% expected. The growth of import and export prices sharply slowed down, the dynamics was also better than expected.

The U. Michigan Sentiment Index moved up for the first time in several months, from 50 points in June to 51.1 points in July. The uptick is still minor, but what is more important is the fact of recovery as markets expected a fall to a new low. Inflation expectations of households for the next five years also brought some relief to market expectations, the figure fell from 3.1% to 2.8%. Easing gasoline prices in July have made a major contribution to the drop in household inflation expectations.

Retail sales data and a report from U. Michigan formed a counterbalance to the inflation report for June, indicating, firstly, that consumers could still bear the burden of inflation and continue to spend at quite a solid pace, and secondly, that the upside inflation trend could finally reach a tipping point in June. With the market starting to price in extreme Fed tightening scenarios (a 100bp rate hike in July), Friday’s data triggered a significant correction in those expectations, leading to a sharp pullback in the USD index from 109 to 107.50 points and rebound in Asian and European equities. US futures were also up more than 1% on Monday.

Two Fed officials, Bullard and Waller, said last week that while all options for tightening policy in July, including extreme ones, are being considered, they would like to see clear signals in the data that more than a 75 bp is needed. It is clear that the data on retail sales and inflation expectations did not contain such signals. On Monday, the odds of a 100bp rate hike, according to interest rate futures, dropped from 84% to 35.6%. The “blackout period” of the Fed officials this week ahead of next week’s meeting and the absence of key US economic reports this week make it unlikely that the market will make a 100bp rate hike as its base case. In this regard, consider extreme long positioning, the risks for the dollar appear to be skewed towards deeper pullback, the dollar index may test the previous consolidation area of 107-106.75:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

354

Gas shortages, risks of cautious ECB decision suggest downside risks for Euro remain high

The long squeeze in greenback continues on Tuesday, the dollar index (DXY) sank by almost 1%, Euro, Swiss franc and Australian dollar scored the largest gains among the major currency pairs against the dollar. EURUSD is trying to gain a foothold above 1.0250 ahead of the meeting of the European regulator on Thursday. The ECB could lift interest by 50 basis points and although this is not the baseline scenario, central banks have been often making unexpected rate decisions recently, and EURUSD gains seems to be driven by technical rebound and expectations of an upside surprise in rate decision.

The macroeconomic background of the European economies slightly improved after release of data on employment in the UK, job growth in June significantly exceeded the forecast (296K against the forecast of 170K), unemployment remained at the same level of 3.8%, contrary to expectations of growth to 3.9%. The final estimate of annual inflation in the Eurozone was adjusted downward to 3.7%, in line with the forecast.

Despite swift rebound in EURUSD in the first two days of this week, the risks around the ECB meeting remain high, as can be seen from the parabolic increase in volatility in the derivatives market, which pricing depends on rate of the ECB rate (swaptions):


Source: Bloomberg

Adding to the uncertainty is the prospect of resuming gas supplies via the Nord Stream 1 pipeline to the EU after maintenance is completed on July 22. Earlier, Russia’s gas monopoly Gazprom sent a force majeure letter to several European customers, which markets took as a signal that gas supplies would not resume after the maintenance is completed. The IMF warned about strong recessionary risks for EU in the event of a gas embargo from the Russian Federation, in particular to countries most heavily dependent on Russian gas (the Czech Republic, Hungary, Slovakia and Italy), while the EU said a 1.5% decline in the economy is possible in case of an embargo in the worst-case scenario.

The risks of worsening of the EU gas shortages and prospects of unsatisfactory policy stance of the ECB in the fight against inflation on Thursday maintain significant downside risks for the Euro, so EURUSD rally should likely be interpreted as a relief rebound in the ongoing bearish trend. If the ECB does not raise the rate by 50 b.p. and will act according to the base scenario (25 bp rate hike), and if there are no convincing details on the normalization of spreads in the EU government bond market (aka anti-fragmentation tool), EURUSD may resume moving towards parity and potentially stage a breakout below the level.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

355

Despite the rally, the risks for EURUSD, GBPUSD are skewed to the downside

Rising optimism about returns in risk assets and narrowing gap in the expected pace of tightening between the Fed and other central banks were the main drivers of broad USD sell-off on Tuesday. The dollar index (DXY) dropped to 106.40, however, selling pressure in the second half of the day eased yesterday, the price entered short-term consolidation and today it rebounded to the area of 107 at the start of European session. Risk assets came under selling pressure as well, major equity indices declined by 0.5% on average.

The idea that the gap between the Fed and other central banks gained traction after reports that the ECB could still raise rates by 50 bp on Thursday. In addition, strong UK employment data increased the chances that the Bank of England will also deliver a 50 bp rate hike at the meeting in August. The EU and UK money markets price in nearly 200 bp tightening by the ECB by May 2023, the same for the Bank of England. However, there is a substantial risk that markets will scale back their expectations of ECB and BoE tightening, given fragile growth forecasts for the European and British economies. At the same time, the prospect of a 200bp Fed rate hikes confirmed by the official opinion of the FOMC (Dot Plot) looks more reliable due to the fact that the US economy is better protected from global challenges, such as reduced gas supplies from Russia. For this reason, the risks for EURUSD, GBPUSD are skewed to the downside.

The UK inflation report released today increased the odds that the Bank of England’s current tightening course will send the economy into stagflation. Annual inflation exceeded the forecast and amounted to 9.4%. Monthly inflation accelerated to 0.8%. The rise in import prices, which is also ahead of forecasts, indicates that either retailers will have to put up with further margin cuts or raise prices, so a 10% year-on-year increase in food prices is likely not to be the limit and accelerate towards the end of the year.

At the same time, core inflation seems to have peaked and started to slow down to 0.4% vs. 0.5% forecast. There are other signs that inflationary pressures in supply chains, which were one of the key drivers of inflation in 2021, have begun to ease - used car prices have continued to decline and are now 8% lower than their peak in January.

GBPUSD reacted negatively to the report bouncing off from the short-term resistance area:

EURUSD rose above 1.02 yesterday after reports that the ECB considers a 50bp rate hike on Thursday. ECB Chief Economist Lane will reportedly make a formal proposal at the meeting, and markets are now trying to estimate the number of members of the Governing Council who will support this proposal. At the moment, it is known that only three officials spoke in favor of raising the rate by 50 bp, the markets estimate the probability of such an outcome at 50%.

Even with a hawkish outcome of the meeting, the ECB will have to try to support the European currency, given the worsening growth forecasts for the EU economy. EURUSD strengthening potential tomorrow may be limited by the level of 1.0350 as part of a rebound from the 1.00 level, after which the price will test the upper limit of the short-term downtrend:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

356

Despite Dollar correction the risk of EURUSD retesting parity is high

The Fed week is unlikely to be as turbulent as the last week featured with ECB meeting as the risk of surprising policy decisions at Wednesday meeting appears to be low. Chances of a “super-aggressive” 100bp rate hike decline as incoming data for July point to both increased preconditions for a slowdown in headline inflation (lower gasoline prices) and a smaller-than-expected damaging effect of high inflation on consumption (retail sales +1% MoM in June). The consensus forecast suggests that the Fed will raise rates by 75 bp. The decision of the ECB to limit forecast horizon of its policy actions to one meeting (moving away from forward guidance), means that EURUSD will now be more sensitive to incoming data and this week’s EU CPI may cause higher-than-usual volatility.

After consolidating in the 106.50-107 range last week, the dollar index (DXY) drifts towards 106 points on Monday thanks to increased demand for risk. European indices trade in positive territory, US bond yields rise across all maturities, German and British bonds are moderately declining in price. Market optimism rose on the news that Gazprom will supply gas to European customers in “corresponding volumes”, which, firstly, became a signal of reduced geopolitical risks, and secondly, helped investors to revise EU growth outlook towards a more optimistic one.

Despite the low potential for surprises, the fact that the Fed intends to raise rates proactively should provide support for the dollar in August-September. In addition, the odds that the ECB and the Bank of England will revise the interest rate path towards fewer rate hikes are higher than those of the Fed.

Recession fears are likely to further curb the rally in risk assets and also offer support to the dollar. Other potential drivers of the currency market this week include releases such as US GDP for the second quarter (consensus forecast 0.5%). The report is likely to have a short-term impact on the market, as it is unlikely to change the stance of the Fed, which is ready to pay a high price to return inflation to a comfortable path.

The heightened reaction of the EURUSD to the PMI reports on Friday (which proved to be quite pessimistic, especially for the German economy) indicates increasing sensitivity of the Euro to incoming data as the ECB decided to abandon forward guidance, shifting focus of investors to other data sources such as macro and corporate reports. Today the report on business climate in Germany from the IFO agency was released, which did not live up to expectations - the main reading was 88.6 points against 90.2 forecast. On Friday, data on inflation in the Eurozone is due, headline inflation is expected to accelerate from 8.6% to 8.7%, core inflation - from 3.7% to 3.8%.

Market expectations on the ECB policy appear too hawkish and incoming macro data on the Eurozone economy creates the risk of correction of these expectations in favor of more moderate ones. The consequence of this is higher risk for EURUSD to test parity again than to rise to 1.04-1.05:


Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

357

Preview of the FOMC meeting: hints on interest rate path in 4Q could be the key thing to watch

Greenback index continues to consolidate in a tight range on Wednesday in the run-up to FOMC meeting. The range has been forming for about a week and indicates short-term equilibrium in USD supply and demand before release of the key market information. The presence of the pattern suggests that a breakout on Fed information will indicate the direction of a fresh trend leg. From a technical perspective, market looks poised to test lower edge of the channel (105.70-106) before possible resumption of the upside:

The risk of surprise in the policy today is quite low, according to Fed funds rate futures, the chance of a 75 bp rate hike is more than 90%. At least two Fed speakers stated unequivocally that they will vote for 75bp, leaning towards the idea that US inflation spike in June above 9% was transitory. In addition, data from U. Michigan showed that inflation expectations declined in July, which in fact is one of the key goals of Fed’s monetary tightening. It’s also important to note that the Fed rarely goes against market consensus, so most likely today we will see a rate hike of 75 bp and lack of significant market reaction to this outcome.

Instead, market participants can focus on hints that may help to assess the size of rate hikes in 4Q meetings. Current consensus market estimate of the rate path suggests that the Fed will deliver 50 bp in September and 25 bp in November and December. Any surprises in this direction will likely determine short-term demand for USD and US Treasuries of shorter maturity.

The Fed will not release updated economic forecasts and Dot Plot at today’s meeting, so keep in mind that Powell’s press conference and FOMC statement will be the main sources of information.

The Conference Board’s report on consumer confidence, released yesterday, pointed to a weakening US expansion in the third quarter. The key indicator has been declining for the third month in a row, although not as fast as in June. The current conditions index, based on consumer assessments of business prospects and the state of the labor market, fell from 147.2 to 141.3 points. The expectations index also moved lower, but the decline turned out to be insignificant - from 65.8 to 65.3 points:

Inflation expectations, according to the CB report, fell to 7.6% from 7.9% in June.

The moderately weak report and the signal of easing inflation expectations have become another argument in favor of the fact that the Fed will be cautious today, raising the rate by 75 bp and will likely hint at slowdown in the pace of policy tightening in line with current expectations.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

358

Fed signals increasing policy flexibility, Euro takes dovish clues from persistent inflation

US equities rose and the near end of the yield curve fell following the Fed meeting (2-year Notes 3.1% → 2.99%), as the Fed rhetoric began to shift from high inflation to a potential economic slowdown due to policy tightening. Recall that in May and June, the comments of the Fed officials, including chair Powell, tried to convince the markets that the Fed was throwing all its efforts into fighting inflation and unfortunately the US economy will have to pay the high price in terms of slowing growth rates. At the time, equity and dollar markets traded the idea that the Fed was tightening when the US expansion started to show first cracks, which could potentially exacerbate downturn. However, data on June retail sales (+1% MoM), U. Michigan inflation expectations (7.9% → 7.6%), US gasoline prices in July showed that a favorable mix of still decent growth rates and slowing inflation is emerging in the economy, which should in theory increase Fed flexibility and help the central bank to slow down costly tightening process. The Fed’s vague forward guidance outlined yesterday and the move away from a front-loaded tightening approach in favor of data oriented one (the ECB did the same at the last meeting) had two important consequences: the dollar and markets in general should become more sensitive to incoming data that will pave the way for the next Fed decision, and the risks of a dovish Fed tweak at the upcoming meetings, increased.

Analyzing the probability distribution of how much the Fed rate will rise by the end of the year, it can be seen that the 100 bp outcome still has the highest probability, but the probability of 75 bp outcome increased while the odds of 125 bp and higher decreased, signaling dovish market interpretation of the yesterday FOMC meeting:

Today’s release of US GDP data will be the first test of the dollar’s reaction function to incoming data. Consensus forecast is 0.5% QoQ in the second quarter, but data on firm inventories and foreign trade point to downside risks.

The release of the Durable Goods Orders report yesterday underpinned demand for risk, as the figure was well above the forecast - growth in June was 1.9% MoM, against the forecast of -0.5%. Apparently, good dynamics was ensured by the growth of orders in the defense sector, excluding orders in this sector, the gain was 0.5% against the forecast of 0.2%. Orders for durable goods is the function of consumer expectations, as they are expensive purchases, so the better-than-expected print provided additional positive information on household expectations.

Inflation data in Germany disappointed, the report showed today that inflation slowed down from 7.6% to 7.5%, missing forecast of 7.4%. At the same time, the price level increased by 0.9% MoM, falling short of 0.6%. Considering that the ECB at the last meeting signaled that the significance of incoming data in policy is increasing, the initial negative reaction of EURUSD to the report is likely to gain momentum.

From a technical point of view, the potential reversal of EURUSD after the parity test began to fade - the price, after the rebound to 1.025, fluctuates in the range of 1.02-1.01, slowly sliding down against the backdrop of negative news on inflation and growing risks of an energy crisis, especially in light of news about falling gas flows from the Russian Federation via the Nord Stream 1. As I wrote in the previous article, the risks in this story are skewed towards further escalation, and therefore there should definitely be bearish bias due to concerns of slowing activity on the back of lower gas consumption and likely higher inflation in the coming months. The pair is in a clear bearish trend and, as we know, without meeting resistance, the trend tends to continue. There are no resistance factors yet, so the downward movement should rather be considered as a continuation of the bearish trend:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

359

Was market reaction to US GDP number too emotional? Looking under the hood, it may seem so

Demand for risk increased markedly, greenback declined and US bond yields took out recent lows (2.8% for 10-year bonds, 2.9% for 2-year bonds), finding an equilibrium at the lowest levels since April, as the US economy unexpectedly for many, including doomsayers, showed negative growth rate in the second quarter. Nominal output fell by 0.9% QoQ, missing estimate of 0.5%, which formally means that US entered recession. The release of the report made a strong impression on the dollar, as earlier at the meeting the Fed made it clear that after hiking interest rate by 75 bp two times in a row, further rate hikes will be much more dependent on incoming data i.e., adjustment of the path of tightening in either direction is now more likely. After the release, the dollar index fell from 107 to 106.50, and then continued its gradual decline to 105.50, from where it was able to rebound:

The contraction in US GDP has cast a shadow over the investment thesis that US assets provide the best risk/reward ratio in the face of a global slowdown, high inflation, geopolitical risks and a cycle of central bank tightening. In addition, the weak report spurred a revision of the Fed’s policy tightening forecasts: the expected aggregate size of the rate increase by the end of the year was reduced from 100 bp to 90 bp.

However, looking at the details of the report, one can find arguments in favor of the fact that the market reaction to the weak report was excessive and, in fact, the US economy did not enter a recession. If we look at the contribution of each component of GDP, we can see that growth was pulled down by volatile components - firms’ investment in inventories (-2% of the total) and investment in fixed assets (-0.7% of the total). Consumer spending growth in the second quarter was positive at +1%:

The downturn phase of the business cycle is usually characterized by contraction in consumer spending and rising unemployment, but so far in the US, these two indicators do not give cause for concern. In the labor market, initial jobless claims have risen for the fourth week in a row, but the Fed has warned that tightening policy will have some costs, so the deterioration in individual indicators is not much of a surprise.

The Fed officials’ argument that recession risks are exaggerated also continues to be based on the fact that the classic signs of lower consumer spending and rising unemployment are absent. Raphael Bostic said in an interview yesterday that the economy is far from recession, but he shares concerns that a “self-fulfilling prophecy” effect could actually make matters worse.

In general, in my opinion, the effect of a weak report on GDP should come to naught next week and the dollar index will be able to resume growth. From a technical point of view, the dollar index completed bearish pullback to the lower edge of the main trend channel, which creates conditions for a rebound:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

360

Despite risk of slowing Fed tightening, Dollar correction may be over and here is why

The planned visit of US House speaker Nancy Pelosi to Taiwan has the potential to exacerbate relations between the US and China, which in the foreign exchange market will be expressed in the strengthening of the dollar, increased demand for safe heavens, weakening of the CNY and currencies that get clues from the moves of the Chinese currency (AUD, NZD). AUDUSD upward momentum is under additional threat as the RBA signaled that inflation peak is finally in sight. EURUSD may slide towards 1.02.

Rumors that the Fed will slow down the pace of tightening after a series of weak US reports since last week (in particular, downbeat GDP figure in 2Q) kept dollar pressured at the start of the week. However, betting on the continuation of the long squeeze becomes risky, as by correcting expectations for tightening, the markets are unlikely to drift away much from the Fed’s guidance, risking making a mistake. Geopolitical and economic uncertainty outside the US persists, so the idea that the dollar will be in demand as a defensive asset for some time remains justified.

Reports that the speaker of the lower house of Congress Nancy Pelosi will visit Taiwan and the sharp reaction of the Chinese authorities, who promised a military response, keep investors in suspense, risk assets are in the red and the dollar attempts to gain foothold on Tuesday, pricing in escalation. Among the G10 currencies, the most vulnerable to the escalation are the AUD and NZD, which have already lost 1.3% and 0.6%, following growing Renminbi weakness.

This week is fully of US labor market reports, the significance of which has grown in light of the fact that the Fed shifted to meeting-by-meeting approach, hinting that policy actions will more depend on incoming data. In addition, signs that US inflation is easing increase the importance of other macroeconomic parameters, including labor market parameters. This week will see the JOLTS report on new vacancies, ADP on Thursday and NFP report on Friday. The focus will also be on speeches by Fed officials such as Charles Evans, Loretta Mester and James Bullard. In my opinion, the risk of upside correction in DXY to the level of 106 increases, given that the bearish pullback from yearly high pushed prices to the edge of the medium-term channel, in addition, another technical level, the 50-day moving average, has acted as a support:

Reports on the European economy are not expected today and events in geopolitics are likely to be the main drivers of EURUSD. Any unfavorable development in relations between China and the United States will most likely have a negative impact on the European currency, firstly, due to the growth in demand for the dollar as a defensive asset, and also due to the fact that trade risks will increase, because EU exports rely heavily on Chinese demand.

Even if the situation with Nancy Pelosi’s visit to Taiwan takes a de-escalation course, EURUSD strength is highly doubtful, as EU growth prospects are vague due to the risks of an energy crisis while potential recovery in risk demand may increase the tendency to use the euro as a funding currency, which will lead to increased supply of the common currency.
The pair in the short term may resume movement to 1.02 and test support levels below.

The RBA raised rate by 50 bp today, as expected, but the signal that further policy action will increasingly depend on incoming data increased the risk of a pause in tightening in case of downside surprises in the data. Increased tensions in US-China relations have intensified the fall of AUDUSD, in case of an escalation, there is a risk that the pair will test 0.69. The meeting report is out on Friday and due to the shift in priorities for what to focus on, the report will likely contain some market-moving information that will cause volatility in AUD.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

361

Upbeat US ISM release suggests hopes of Fed dovish shift may fade quickly

Provocative from Chinese point of view, Nancy Pelosi’s visit to Taiwan and the promised tough response from the Chinese authorities met with a rather tepid market reaction yesterday, the main US indices closed in a moderate minus, the dollar index met resistance at 106.50 and turned lower on Wednesday. The Fed’s verbal interventions have brought back to reality dreamy Treasury investors, who have recently been increasing their bets that the central bank will soften the pace of tightening or be forced to cut rates in 2023. Yields on 10-year bonds jumped yesterday from 2.52% to 2.7%, which also provided support for the dollar. The OPEC+ meetings passed without surprises for the market, the participants agreed to moderately increase production.

Pelosi’s visit to Taiwan received a lot of attention, primarily because of China’s alarming warnings, but further developments showed that an escalation had been avoided. China “retaliated” by banning sand exports to the island, expanding restrictions on fruit shipments to Taiwan, and announcing military exercises Aug. 4-7. It also became known that the Chinese manufacturer of batteries for electric vehicles changed his mind about investing in the construction of a plant in the United States. That’s all.

There were also speculations that China might respond by dumping Treasuries, causing market instability, but China’s decline in Treasury holdings is due to other reasons, most notably the need to sell foreign exchange reserves to contain CNY devaluation. The mainland yuan has been under significant pressure from an outflow of investors who expected the hard lockdowns to trigger a severe slowdown in China. In addition, China could sell bonds as a precautionary measure, alarmed by the case with the freezing of Russian foreign exchange reserves.

A number of Fed officials who spoke yesterday hinted that investors may be delusional in expecting the central bank to slow down policy tightening or that the tightening cycle will quickly give way to an easing cycle in 2023. Loretta Mester said yesterday that she sees no signs of much easing in inflation, and that the risks of wage inflation due to a strong labor market (which will cause spillovers to consumer inflation, aka second-round effects) are high. Therefore, the Fed will raise rates and will do it vigorously. Comments from other Fed officials also focused on a strong labor market, a major pillar of the economy that keeps the Fed on course. As a result, 10-year yields jumped up yesterday:

The ISM report in the US non-manufacturing sector today pointed to a favorable combination of the dynamics of inflation index and other indicators, including leading ones. The overall figure beat estimates, rising from 55.3 to 56.7 points (forecast 53.5 points). The price index fell from 80.1 to 72.3 points, indicating a weakening increase in inflationary pressure, while the index of new orders rose from 55.6 to 59.9 points, business activity - from 56.1 to 59.9 points. The hiring index is getting out of the negative zone - 49.1 against 47.4 points. In general, the report proved to be much better than expected, due to which the dollar was able to bounce even higher:

The raft of upside surprises in the report suggests that the much-discussed “soft landing” by the Fed officials - reducing inflation while preventing economy from falling into recession is feasible. In my view there is a risk that market players will again price in the outstripping growth rates of the US economy compared to competitors, and therefore better real yield outlook. In turn, this will likely be one of the main bullish drivers of the dollar.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

362

Decreasing US economic uncertainty pushes equity prices back into bull territory

Incoming data on the US economy continues to surprise on the upside, triggering massive unwinding of recession bets and luring investors back into risk assets on decreasing uncertainty. One such report was the ISM report on the non-manufacturing sector released yesterday which surprisingly showed that the sector continued to expand in July at a healthy pace despite aggressive Fed rate hikes and consumer spending pressured by high inflation. The behavior of the index components proved to be even more unexpected: the price index fell from 80.1 to 72.3 points, indicating that pipeline inflation pressures decreased, the new orders index rose from 55.6 to 59.9 points, laying the groundwork for expansion of activity next month, while the business activity index, contrary to expectations of a decrease, rose from 56.1 to 59.9 points.

ISM Report Price Index

ISM Report New Orders Index

The reason why the report had major bullish implications for the market is simple – accelerating inflation combined with the Fed’s ultra-aggressive pace of rate hikes led to a sharp rise of recession plays in May and June. The point is that the tightening was supposed to suppress high inflation, but at the cost of “demand destruction”—lower consumer spending and reduced investment. However, a number of recent data, in particular the ISM report, have shown that the scenario of a “soft landing” of the economy, which the Fed hopes so much for – bringing inflation back under control while maintaining positive growth rates in consumer demand and investment - is becoming more realistic. The July reports did indeed show the first signs of an easing in price pressures, while at the same time, activity and output indicators, leading indicators such as new orders continued to rise, and in some cases even better than estimates. Given that there is still much uncertainty priced in risk assets, the current rebound should have some room to continue especially if data continues to show resilience of economic activity to the Fed tightening and inflation. The next report in focus is labor market’s NFP which will likely extend the streak of positive US data surprises, giving another boost to risk assets (i.e., equities) and greenback.

Also yesterday, two Fed officials, Barkin and Daly, made comments, refuting rumors about policy easing cycle next year. According to the policymakers, the inflation comedown will likely be slow (due to the fact that approximately 50% it is driven by supply-side factors) while fears that policy tightening will drive the economy into a recession that will require rate cuts, are exaggerated. In general, this week, the Central Bank increased verbal interventions to curb the rise of market expectations that the pace of policy tightening will slow down or that the easing cycle will start next year. As a result, the odds that the third rate hike by 75 bp will take place in September increased from 26% to 45.5%:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

363

Better than expected China inflation hints US CPI report may deliver bullish surprise today

US bonds remain under selling pressure ahead of release of the US inflation report today. This makes it more difficult for yields to rise further in the event of a positive surprise, however, the near end of the curve may be more sensitive to the release, as the Fed, as we know, can only influence short-term market rates. In addition, inflation data may finally affect expectations regarding the Fed’s decision to sell bonds from the balance sheet (quantitative tightening).

The first half of the week proved to be trendless for the dollar, the US currency erased gains fueled by the strong unemployment report published last Friday. There will be a major event today in terms of implications for Fed policy that is likely to be the most important not only this week, but even this month. The US CPI is expected to indicate a weakening in headline inflation and an acceleration of core inflation above 6% YoY.

Sustained high core inflation, which is more difficult to control via monetary tightening should be an argument in favor of the Fed’s position, which says that much remains to be done to restore price stability. In addition, core inflation, in line with the forecast, should reinforce expectations that the Fed will raise rates by another 125 bps before the end of the year. If there is no significant acceleration above the forecast, which will be very unexpected, because preliminary data indicate a reversal in the price growth trend, then the impact of the report on the foreign exchange market will be limited to keeping dollar within its current range (106-107 on DXY). There is still a little more than a month before the Fed meeting in September, and if volatility remains low, interest in carry trading will additionally provide moderate support to the dollar due to the fact that the supply of low-yield currencies such as EUR and JPY will increase.

EURUSD continues to dangle near annual lows, and apart from an increase in expectations of easing of the pace Fed’s tightening, there are no reliable fundamental grounds to hold bullish view on the pair. Geopolitical risks and uncertainty in the EU’s energy security continue to be a source of significant premium in the common currency. Since there are no reports on the EU economy today, the movement in the pair will most likely be tied to the release of CPI. The decrease in potential volatility in currency options suggests that the market has no desire to test lower levels (1.00-1.01). At the same time, technical analysis indicates a gradual increase in pressure from buyers after the main rebound wave, which increases the chances of an upward breakout:

The decline in inflation in China in June, both manufacturing and consumer, increases the chances of seeing a favorable outcome for the markets of the US CPI release today. Today’s report on China showed that consumer inflation was 2.7% against the forecast of 2.9%, manufacturing inflation - 4.2% against the forecast of 4.8% in July.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

364

EURUSD breaks bearish channel on the CPI report signaling about possible medium-term reversal

Equity markets made another leap upwards amid a buildup of expectations of a slight dovish shift in the Fed policy. This was facilitated by release of the US July CPI, which showed that inflation in July decelerated faster than expected. Core inflation remained unchanged at 5.9% (despite expectations of acceleration), headline inflation slowed down by 60 bp. to 8.5%. The main contribution to the easing in headline inflation was expectedly made by fuel and gasoline prices:

The decline in gasoline prices eased inflation pressure in transportation services as well, where prices declined 0.5% MoM. Some cooling of consumer demand occurred in the market of used cars, where monthly deflation of 0.4% was observed. Clothing prices inched lower by 0.1%.

The dollar lost about 1% yesterday against a basket of major currencies as the CPI report dented prospects of 75 bp rate hike in September. The odds, according to rate futures, have fallen below 40%, the base case is now a 50 bp rate hike. In the Treasury market, the shift in expectations did not last long, largely thanks to the comments from Fed officials (Evans and Kashkari), who, after the release of CPI, continued to develop the recent line of rhetoric of the Fed - the chances of US recession are low, the fight against inflation is not over and policy easing is not expected next year. Yield to maturity on two-year US bonds fell by 20 bp after the release, but recovered 15 bp towards the end of the day. Today the short-term bond trades at around 9 bp below the yield, which was before the release of CPI (3.28%).

A real shift in market expectations and the Fed policy should probably be expected after two key indicators of inflation trend - shelter prices and wages - show signs of slowing down. The first one is important because it is the most “sticky” among all inflation components, the second - because it is a leading indicator of cooling of consumer demand. As long as the imbalance in the US labor market persists, and it generates wage inflation, the Fed is unlikely to change its rhetoric, given how the central bank damaged its reputation with a belated start of tightening and huge underestimation of inflation persistence in the first half of 2022.

The next major event for those who follow the Fed’s policy will be the Jackson Hole Symposium August 25-27, which is famous for central bank officials sharing their strategic views on how monetary policy should be conducted.

On the technical side of EURUSD chart, as expected, market made a breakout from the bearish channel following formation of the wedge pattern, and today a test of the key resistance line took place, which until the beginning of July acted as support (1.04). The prospect of EURUSD movement further up will be determined by a potential breakout of the line and the possibility of fixation above it:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

365

Three key factors of short-term support of the Dollar

Foreign trade indices of major energy importers continue to hit new lows and markets are increasingly focused on how governments will respond to rising natural gas prices. At the same time, the weakening of the yuan and a number of potential upside surprises for the US economy today decrease the odds of a bearish dollar correction after the rally.

There are now three factors of short-term support for the dollar. The first factor is the supply shock on the gas market, which drove up gas prices, due to which large importers (EU, Asian countries) are faced with a situation where import price increases significantly outpace export price growth, which is a negative income shock. Governments are expected to take measures to mitigate the blow to the economy and what they offer will impact growth outlook, and hence real yield outlook offered by domestic assets. In turn, these expectations will form the demand for national currencies. So far, there are no tangible support measures, so currencies such as the Euro, Pound Sterling and the Yen are again under serious pressure. The US economy is relatively insulated from a gas supply shock by being less dependent on external energy supplies, which is factored into additional demand for the US dollar.

The second factor is a signal from the Chinese Central Bank that the economy needs a weak yuan to stimulate the movement of the economy towards its goals. PBOC cut the medium-term lending rate by 10 bp, which was a signal for USDCNY buying. In a few days, the price added about 1% approaching 6.80 and now the attention is on whether the Central Bank will further weaken the reference rate:

Earlier in April, when USDCNY surged 6%, the dollar rose against a basket of major currencies by about the same amount as well, suggesting that the situation with monetary stimulus in China will also act as a support factor for the dollar.

Data on the US economy, which has been surprising on the upside in August, may also be an argument in favor of a strong dollar. Today and tomorrow the reports are due on industrial production and retail sales. Given that the sharp drop in gasoline prices is a positive shock to both supply and demand (lower costs, more consumer spending power), the risks on these two reports are skewed towards a positive surprise. The Fed will put out the Minutes of the last FOMC meeting, given hawkish FOMC members’ bias, despite favorable signals in inflation, a hawkish surprise tomorrow cannot be ruled out.

The news that the German government is imposing a gas levy suggests that the government doesn’t have enough means to smooth out the shock and also that inflation may be more persistent. In turn, this may require more tightening by the ECB, however raising rates in a period of fragile growth creates the risk of an accelerated slowdown in the economy. EURUSD is likely to retest 1.00 given the failed upside breakout of the medium-term bearish channel and subsequent downside breakout of the key short-term uptrend line that guided EURUSD recovery after the parity test, indicating that the next support should be expected at the level of 1.00:

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

366

FOMC Minutes: strong dollar will help to weather tough period of high inflation

The level of 107 in dollar index (DXY) remains a hard nut to crack as a bullish retest failed yesterday, the Fed Minutes did not work as a catalyst for a sweeping move, although there were some solid grounds to expect an increase in hawkish rhetoric. Nevertheless, key takeaways from the report argue in favor of a strong dollar, which we will discuss below.

The minutes of the July FOMC meeting showed that the policymakers welcomed strengthening of the dollar, for the simple reason that it is a strong national currency that is an efficient way to contain import inflation. Given the negative US trade balance, the expensive dollar came in handy to keep inflation from accelerating even higher. The Fed does not think that a strong dollar is hurting the economy or somehow suppressing its growth. Therefore, it is now in the best interests of the Fed to shape policy so as to get through a period of high inflation with a strong exchange rate.

The report said that weakening euro was the key driver of dollar appreciation, which the Fed believes was the result of widening real yield differential. Nominal 2Y US-Bund yield spread rose to the highest level in three years with the yearly peak seen on August 1 (2.87%):

To expand room for maneuver, in case incoming US economic data warrants slowdown or pause in tightening, there was a mention in the report about the risk of overdoing rate hikes and QT. This, in fact, was behind dropping forward guidance at the last meeting - now the Fed is talking less about its medium-term tightening plans and instead urging markets to focus on incoming economic data in order to understand what to expect at the upcoming meeting. Essentially, this means a risk that the Fed can put less pressure on the brakes by slowing down the economy to dampen inflation, and given that this will happen in the world’s first economy, growth in the rest of the world may also be suppressed to a lesser extent. Consequently, currencies that rise during the boom phase of business cycles gain a support factor.

There are three events ahead of us that will help to gauge the odds of 75 bp rate hike in September. These are the Jackson Hole Symposium (August 25-27), the August NFP (September 2) and the Inflation Report (September 13).

The exchange rate of the European currency, the pound and the yen has now become almost entirely a function of gas prices, which in turn depend on the level of tension in relations between Russia and the EU. A ceasefire or a truce in Ukraine will help reduce tensions, so markets can be very sensitive to any signals in this direction. Turkish President Erdogan has once again volunteered to extinguish the flames of the conflict, with reports that he will try to convince Ukrainian President to agree for a temporary ceasefire at a meeting in Lvov on Thursday and even try to revive the Istanbul negotiation process. The markets’ attention may be focused on the news after the meeting.

The economic calendar today is not particularly interesting. The final estimate of inflation in the EU for July remained unchanged. US jobless claims data and business data from the Philadelphia Fed may draw some attention. Among them are indices of hiring, new orders, prices paid, and investments in fixed assets. The overall index of manufacturing activity is expected to rise from -12 to -5. Later in the evening, the speeches of the Fed officials, George and Kashkari, are due.

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