US Inflation Report Coming Up as Dollar Storms Higher

Central Bank

Economic

Summary:

The spike in US yields this week gave the dollar a boost, but the longevity of this recovery will be decided by the next edition of US inflation. According to the Cleveland Fed Nowcast model, there is some scope for an upside inflation surprise, which would be a blessing for the dollar. Aside from this release, there isn’t much else that can disturb the waters next week.

Dollar shines ahead of inflation test

Global markets are still reeling from the aftershocks of the US credit downgrade. Coupled with the Treasury’s announcement that it will be increasing its bond issuance in the coming months, these events propelled US yields higher this week, boosting the dollar through the interest rate channel.

The dollar attracted some safe-haven flows too, as riskier assets such as stocks suffered from the spike in yields. Moving forward, the question is whether this is the beginning of a lasting recovery in the US dollar, or simply a correction within the prevailing downtrend that started last year.

US Inflation Report Coming Up as Dollar Storms Higher_1

Fortunately, the outlook will become clearer on Thursday with the next round of US inflation data. Forecasts suggest that both the headline and core CPI rates rose by 0.2% in monthly terms in July, which would translate into an increase in the yearly CPI rate but a decline in the core rate. Specifically, the core rate is expected to drop to 4.7%, from 4.8% previously.

Yet, the risks surrounding these forecasts might be tilted to the upside. The Cleveland Fed has a model that attempts to forecast inflation, and it currently points to an increase of 0.4% for both the headline and core CPI rates, in monthly terms. Historically, this model tends to be quite accurate, so there is some scope for a hotter-than-anticipated CPI report.

In the FX arena, this could translate into a stronger US dollar as traders recalibrate the Fed’s interest rate path in a higher-for-longer direction, lifting US yields even higher.

US Inflation Report Coming Up as Dollar Storms Higher_2

Overall, it is becoming increasingly clear that the American economy remains resilient, with economic growth running around 2%, solid consumption trends, and a labor market that is in good shape. In contrast, business surveys suggest the European economy is slowly descending into a recession, as the downturn in manufacturing has started to infect the services sector.

If this relative US outperformance continues to play out, it is likely to be reflected in the FX market eventually, putting downward pressure on euro/dollar.

British GDP eyed after BoE disappoints

In the United Kingdom, GDP stats for Q2 will hit the markets on Friday. This will be an important piece of the puzzle for the Bank of England, after the central bank raised interest rates in a cautious manner this week, dealing a blow to the British pound.

Still, the pound remains the second-best performing major currency this year, behind the Swiss franc. This powerful rally reflects two elements – expectations that the BoE will push rates higher than other central banks because the UK has a bigger inflation problem, and the cheerful tone in stock markets that tends to benefit the risk-sensitive pound.

US Inflation Report Coming Up as Dollar Storms Higher_3

Now the question is whether these elements will remain in force moving forward. Business surveys suggest the British economy is set to “flatline at best in the coming months”, which is not exactly inspiring. Meanwhile, inflationary pressures continue to rage, painting the picture of an economy that is about to experience a period of stagflation.

Similarly, stock markets seem vulnerable to a correction after a stunning rally this year. This rally was not backed by rising earnings, so valuations simply became more expensive. Therefore, if yields keep rising, that could spark a correction in stocks that in turn inflicts collateral damage on risk-linked currencies like sterling.

Japanese and Chinese releases

Crossing into Asia, the ball will get rolling on Monday with the Bank of Japan’s summary of economic opinions for the July meeting, where the central bank raised its effective ceiling on Japanese yields.

Over in China, the downturn in the manufacturing sector has taken a heavy toll on the economy and the stimulus measures announced by Beijing so far seem insufficient to turn the tide. This puts extra emphasis on the trade and inflation numbers for July, which will be released on Tuesday and Wednesday, respectively.

Another disappointing dataset could amplify concerns about the health of the world’s second-largest economy, and by extension, keep China-sensitive currencies like the Australian dollar under pressure.

Source: XM

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Justin

Central Bank

Economic

Jobs disappoint, wages rise, unemployment falls

We have a very mixed US jobs report for July. US non-farm payrolls rose 187k versus the 200k consensus prediction and there were 49k of downward revisions. Manufacturing employment fell 2k with private sector employment rising 172k in total, a third of which came from healthcare. This is all from the establishment survey, which questions employers. The household survey is stronger, seeing the unemployment rate drop to 3.5% from 3.6% with employment rising 268k and unemployment falling 116k.

Employment change according to businesses and according to households (000s)

Mixed US jobs Data Signals September Pause_1

Fed to remain wary of a tight jobs market

Meanwhile, average hourly earnings rose 0.4% month-on-month/4.4% year-on-year, not 0.3%/4.2% as hoped. The participation rate held steady at 62.6%. The market is seemingly putting more emphasis on the wage and unemployment number rather than jobs, which is fair. Stickier wages and a tight jobs market will make their job of returning inflation to the 2% target more challenging. Nonetheless, this does contradict some of the evidence within the Fed's own Beige Book report that stated "contacts in multiple Districts reported that wage increases were returning to or nearing pre-pandemic levels". The Employment Cost Index, which is a broader measure of labour costs was also lower last Friday so any market moves should be fairly small, especially with CPI and PPI out next week.

One area of disappointment within the household employment survey is that the strength was driven by part-time jobs. The household survey shows part-time employment rose just under 1mn last month while full-time employment fell nearly 600k. So while wage growth apparently remained robust, swapping full-time workers for part-time workers is in aggregate going to lower household incomes.

Full-time versus part-time employment (mn)

Mixed US jobs Data Signals September Pause_2

September Fed pause set to continue

On balance this report doesn’t suggest any need for renewed impetus for the Fed hiking interest rates again in September. The Fed have signalled a desire to tighten policy more slowly and the report appears consistent with the gradual cooling of the labour market. As mentioned, all eyes will now switch to CPI and PPI and a couple more 0.2% MoM prints as we and the market expect should further dampen talk of a potential September hike, of which only 4bp or 5bp is currently priced.

Furthermore, the move higher in Treasury yields and the dollar in the wake of the Fitch downgrade and the US Treasury funding announcement only adds to our conviction that the Fed won’t need to hike interest rates further. These market moves in combination with higher volatility are tightening monetary conditions and will also put up mortgage rates and corporate borrowing costs. With the Federal Reserve Senior Loan Officer Opinion survey showing a further tightening of lending conditions with the prospect of more to come in 3Q, lending growth looks set to turn negative. This combination of higher borrowing costs and reduced credit availability is going to be a major headwind for economic activity that will help to get inflation down to 2% next year and keep it there.

Source: ING

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Damon

Economic

Providing third-party research and analysis that then ranks an entity’s debt or equity outlook, including companies and sovereign nations, requires extremely high integrity. The mostly negative news headlines responding to the Fitch Ratings downgrade of the United States Long-Term issuance to AA+ from AAA is an indication of how much pressure analysts must be under to avoid issuing a downgrade. This is true whether the rating impacts the entire free world, or the stakeholders and their families of a small public company through company-sponsored research.

Most high-caliber analysts have built a model that gives them little room for pressure from the outside, either from the ranked entity, the investors, or even the financial media. It is undoubtedly easier to do nothing and cross your fingers as an analyst, but that doesn’t actually serve anyone well, including investors or the entity.

Background

In late May, while investors and other market watchers were trying to determine on which day in June the US Treasury would run out of money, Fitch, a securities rating service, placed a ratings watch on US debt which they had held at triple-A, the highest rating, indicating the lowest default risk for the issuer.

On July 31, the US Treasury unveiled an overview of its third-quarter debt issuance needs. At $1.007 trillion, it would be the largest third quarter on record. I have experience as an issuer ranked by Fitch and Moody’s while CIO of two funds that held a rating in order to meet specific investor guidelines. Rating agencies are the first to be made aware of any changes being considered. So I suspect that Fitch, Moody’s, and S&P analysts were all aware of the details of what the Treasury planned and projected going forward. Moody’s downgraded the US back in 2011 from its lowest default risk rating. Its treatment back then was also not one of appreciation from the markets, investors, or the issuer.

Thoughts on Ratings Move

Cathie Wood had a conversation on (Twitter) Spaces this morning with Pension & Investments’ Jennifer Ablan in an exclusive mid-year interview. Ms. Ablan asked Ms. Wood’s thoughts on the US downgrade. The Ark Invest founder didn’t hesitate to say that there is “a side that is happy to see it.” She went on to explain that it helps those managing the organization, in this case Washington, to do a better job. She explained that it says, “legislature, let’s get your act together.” Wood, added “government spending is taxation.”

While Cathie Wood was discussing the most powerful nation in the world, the same concept should be applied to a company she holds, or you own that experiences a downgrade. It serves to help management discover weak areas they could pay more attention to and gives the investor the understanding and confidence that a third party is looking on and even consulting with management before they make any moves that may alter the rating.

Michael Kupinski, the Director of Research at Noble Capital Markets, is a veteran analyst that has undoubtedly had to ignore pressure from the outside and follow models he’s created to the path they help provide. Mr. Kupinski says, “Ratings and earnings revisions are a function of the dynamics of new, and, likely extreme, inputs on the investing continuum.” He then explained how all could benefit, “Such revisions then present management a roadmap for the new baseline in expectations or for a course correction. As such, ratings provide a valuable currency to determine investment merits, set investment expectations, and for investors to determine risk,” said Michael Kupinski.

Take Away

Don’t shoot the messenger – instead, thank them.

A negative change in ratings, whether it be on debt issuance, equity issuance, or frankly ones own credit rating could serve to preserve something before it goes further down a bad path, and can be used as a guide to adjust and do better. While there was a lot of criticism for Fitch placing the USA on credit watch for a downgrade back in May, if they had not issued a downgrade as US Treasury issuance climbed even higher, it would cause investors to think that no one is paying attention. The outcome of not having another trusted set of eyes, on any security issuance, is weaker pricing.

Sources: Channelchek

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Cohen

Commodity

Saudi, Russia Pledge Extended Oil Cuts

Saudi Arabia has voluntarily pledged to extend its oil production cut of 1 million barrels per day (bpd) until the end of September, while Russia has also promised to reduce its oil exports by 300,000 bpd in the same period. This move by these two oil giants, announced ahead of a critical OPEC+ meeting, has ignited concerns about supply shortage, thereby pushing oil prices higher.

Economic Factors Threaten to Curb Oil Demand

Despite this, there are economic factors that might curb the demand for oil, thereby applying downward pressure on prices. Fresh U.S. data points to a tightening labor market and a slowing service sector, implying a potential economic slowdown. Similarly, the strengthening dollar could suppress oil prices as market participants speculate whether a heated labor market will impel the Federal Reserve to tighten its monetary policy.

Europe’s Economic Slump May Lower Oil Demand

In Europe, economic activity seems to be slowing, with the downturn in Eurozone business activity in July being more severe than initially projected. Moreover, the Bank of England’s decision to increase its interest rate to a 15-year peak could dampen economic growth by increasing borrowing costs, which might consequently decrease oil demand.

Short-term Forecast

However, despite these potential headwinds, an improved demand outlook and a constrained supply could continue to support the oil markets. A key piece of data to watch out for will be Friday’s U.S. non-farm payroll figures, which will likely guide market sentiment. In the short-term, we could expect a bullish outlook for oil prices, given the ongoing production cuts from major oil-producing countries. Yet, it’s crucial to note that any changes in economic conditions or monetary policy could shift this forecast.

Technical Analysis

Oil Price Forecast: Saudi Arabia, Russia Production Cuts Fuel Price Rise_1

4-Hour Crude Oil

Current sentiment for Crude Oil points towards robust, bullish momentum. The slight rise in the 4-hour price confirms this momentum. The current price sits above both the 200-4H and 50-4H moving averages, indicating strong bullish market sentiment in both the short and long term. The 14-4H RSI reads at 59.95, reinforcing the stronger momentum.

The current 4-hour price is within the main resistance area, a critical factor to consider for potential pullbacks. All in all, the market is decidedly bullish, warranting careful watch for any signs of resistance level breakouts or a potentially bearish closing price reversal top.

Sources: FXEMPIRE

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Alex

Commodity

Central bank buying slowed in Q2 but remained resolutely positive. This, combined with healthy investment and resilient jewellery demand, created a supportive environment for gold prices.

Q2 gold demand (excluding OTC) dropped slightly by 2% y/y to 921t, driven by a marked deceleration in net central bank buying compared to above average purchases in Q2’22. Inclusive of OTC and stock flows, total demand strengthened 7% y/y to 1,255t.

Despite sales from Turkey in response to specific local market conditions, the 103t of net official sector purchasing in Q2 is in line with the underlying positive trend towards gold among central banks.

Jewellery consumption managed a modest improvement despite the high gold price environment, up 3% y/y at 476t. With jewellery fabrication of 491t, inventories increased by around 15t in Q2, in part as Chinese jewellery consumption failed to meet the trade’s optimistic expectations.

Bar and coin investment increased by 6% y/y to 277t in Q2, with Turkey a major driver of growth. And while ETFs saw net outflows of 21t (concentrated in June) these were notably smaller than the 47t outflow in Q2’22.

OTC investment jumped in Q2, reaching 335t. Although opaque, demand from this sector of the market was apparent as the gold price found firm support even in the face of ETF outflows and a reduction in COMEX net longs.

Demand for gold used in technology remained very soft thanks to continued weakness in consumer electronics; it held at just 70t for a second consecutive quarter.

Total gold supply was 7% higher y/y at 1,255t, lifted by growth in all segments. Mine production is estimated to have reached a record for H1 of 1,781t.

Firmer jewellery and investment demand helped offset slower central bank buying in Q2*

Sources: Metals Focus, Refinitiv GFMS, World Gold Council;

Data as of 30 June 2023.

Highlights

The LBMA (PM) gold price averaged US$1,976/oz during Q2, a record high. This price was 6% higher y/y and 4% above the previous record high from Q3’20. Currency moves meant that several countries saw further strength in local gold prices, notably China and Turkey.

H1 gold demand (excluding OTC) was 6% lower at 2,062t. The y/y decline was largely explained by this year’s modest outflows from gold ETFs being compared with the strong surge of inflows in early 2022. Total demand in H1 (inclusive of OTC and stock flows) increased by 5% to 2,460t.

Central bank gold buying in H1 reached a first-half record of 387t. Despite the Q2 slowdown, the strong Q1 start set the seal on a record-breaking H1. Buying activity remains widespread and distributed among both emerging and developed countries.

Local market conditions have driven exceptional gold demand in Turkey in recent quarters. Combined H1 jewellery, bar and coin demand reached 118t, the highest first half year since 2007 when Turkish lira gold prices were a fraction of their current record levels. Presidential elections, dizzying inflation and currency weakness all contributed to drive demand up.

Gold recycling for the first half was 9% higher y/y, with much of that growth coming from China and India. Base effects played a role in both markets, as recycling had been relatively weak in Q2’22. Recycling activity has yet to pick up, notably in Western markets, despite high gold prices and cost of living pressures.

Sources: World Gold Council

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Owen Li

Cryptocurrency

Market picture

The crypto market capitalisation has seen little change over the past 24 hours, stabilising around $1.165 trillion. The Fear and Greed Index is also little changed at 54 since the middle of last week. The market has been waiting for new signals, equally ready to return to growth or continue to fall.

The most fluctuation in Bitcoin over the last week and a half has been around $29.2K. And this is interesting because during this time, the dollar has gone into a growth mode, and there has been significant profit-taking in the equity market. It's unlikely that investors' caution in Bitcoin is due to expectations of the US jobs report.

Crypto Is Awaiting a Signal to Choose its Direction_1

A drop below $28.8K could quickly take the market to $28K or even $27K. A rise above $29.5K would open a quick path to $30K and on to $31K.

News background

Most investors prefer to buy Bitcoin while trading below $30K, Glassnode noted. The number of addresses with a balance of at least 0.01 BTC has reached an all-time high of more than 12.22 million, while the number of wallets in deficit is 14.04 million, the highest since late June.

MicroStrategy bought 12,333 bitcoins worth $347 million in the second quarter of this year, the largest quarterly purchase since 2021.

Former CFTC lawyer Mike Selig suggested that if spot bitcoin ETFs are allowed to launch in the US, ETFs linked to Ethereum and XRP are next in line.

Hong Kong issues its first cryptocurrency retail trading licence. HashKey crypto exchange has been authorised to provide services to local retail investors.

The Australian Securities and Investments Commission (ASIC) sued the eToro platform over its line of CFDs that allow speculation on cryptocurrencies.

Sources: FXS

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Kevin Du

According to the latest data, inflation in both the euro area and the US is mainly driven by its core component and thus, at first glance, by demand. Supply factors are also at work through the spillover effects of the shock on energy and commodity prices and food inflation. These first-round effects show first signs of fading, which should pull inflation down more sharply in the coming months. Wage dynamics are closely monitored given their inflationary nature, which is modest but persistent, justifying the monetary response.

How much is current inflation (still) supply-side driven? How much is it due to excess demand? There is no easy answer, with the underlying question about the need for monetary tightening, its continuation, and the risk that central bankers will overtighten if inflation is more supply-led than demand-led.

What does the simple analysis of the breakdown of inflation according to its main items tell us? In the euro area, inflation could be regarded, at first glance, as essentially supply-side driven given the prevailing role played by the energy component at the beginning (chart 1). Indeed, from April to July 2021, this component explained up to 60% of headline inflation. Its relative contribution then declined as the first-round effects of this shock spread to the other components of the consumer price index (CPI), food inflation surged (which can also be related to a supply shock), and core inflation rose, an apparent sign of demand-led inflation.

Eurozone and the United States: Where Does Inflation Come From?_1

A simple relative distortion of prices at the outset, inflation then really came back, in the sense of broad-based, sustainable, and self-sustaining price increases, which is its definition. Today, with energy prices lower than a year ago, the direct contribution to inflation of this component of the CPI has vanished, pushing the headline down. In view of the sharp decline in our indicator of inflationary pressures (which combines the input prices, output prices and delivery times components of the manufacturing PMI), a larger decline in inflation over the coming months seems likely (chart 3). Inflation is nonetheless still very high (6.1% y/y in May, according to Eurostat’s flash estimate). Food inflation (12.5% y/y) explains 40% of that figure and core inflation (5.3% y/y) 60%, making inflation more persistent. From these figures alone, euro area inflation appears now driven mainly by demand.

Eurozone and the United States: Where Does Inflation Come From?_2

In the United States, the dynamics are different, with inflation apparently less supply-driven than demand-driven (chart 2). The energy component explained a maximum of 35% of US inflation (in April 2021, according to the CPI). The contribution of core inflation has been dominant from the beginning. At its lowest in June 2022, it still accounted for just over half of inflation (33% for energy, 15% for food). Today, thanks to the fall in the contribution of the energy component, the crossing curves of headline and core inflation is noteworthy. In March, headline inflation had been below core inflation for the first time since the end of 2020. As in the euro area, it is to be hoped that the inflationary process is coming to a halt in the United States, thanks to the gradual fading of first-round inflationary effects due to rising commodity prices. Another encouraging news from the US is that inflation persistence declined significantly in April, according to the latest analysis by the New York Federal Reserve.

Eurozone and the United States: Where Does Inflation Come From?_3

The Institute of International Finance (IIF), on the other hand, evaluates that inflation in the euro area is still essentially driven by supply because its surge has been uniform across euro area countries despite significant differences in output gap]. A diagnosis reinforced, again according to the IIF, by weaker wages dynamics in the so-called peripheral countries of the euro area, and which makes it possible to put into perspective fears of a price-wage loop. The strong increase in the ECB’s negotiated wages indicator (+4.3% y/y in Q1 2023, Figure 4) is to be closely monitored given the role of wages in the formation and dynamics of services prices and thus in the inertia of inflation.

Eurozone and the United States: Where Does Inflation Come From?_4

A chart presented by Philip Lane sheds interesting light on this role of wages compared to the one played by energy prices. It distinguishes between three types of core inflation: “energy-sensitive”, “wage-sensitive”, and “not energy-sensitive”. “Energy-sensitive” core inflation remains significantly higher than “wage-sensitive” core inflation (respectively around 7% and 5% y/y in April 2023). Encouragingly, both types of inflation are showing signs of stabilisation. “Not energy sensitive” core inflation is just over 4% y/y, and in April it fell slightly, another encouraging news. This inflationary role of supply-side effects related to energy prices can be found in Bernanke and Blanchard’s (2023) recent analysis of the origin of post-pandemic US inflation. According to the authors, US inflation is not primarily driven by an overheating labour market: it has its roots in a series of shocks to commodity prices and product market (leading to various sectoral shortages).

While US labour market tightness has not been the main driver of US inflation so far – a research from the Federal Reserve Bank of San Francisco also shows that labour cost dynamics play a modest role in current inflation – Bernanke and Blanchard argue that the inflationary effects of such a tight labour market are more persistent than those of product-market shocks. Tightening monetary policy has therefore a role to play in counteracting these effects, in order to control inflation and push it back to the 2% target by contributing to a better balance between demand and labour supply.