Global risk assets rose strongly as U.S. CPI fell below expectations in July. Investors interpreted the data as a reason for the slowdown in the pace of Fed policy tightening. But ING pointed out that this looks like a dangerous assumption. With the Fed expected to battle higher core inflation, the dollar will find support on declines – especially against the euro and yen. Here’s a compilation of views from the bank’s analyst Chris Turner.
USD: Room for a correction seems limited
Yesterday’s weaker-than-expected July CPI data, which investors saw as a reason for the Fed to raise rates by 50 basis points instead of 75 basis points at its next meeting on Sept. 21. However, the adjustment in the U.S. interest rate market did not last long. The U.S. two-year Treasury yield fell 20 basis points immediately after the CPI data was released, and has since risen another 15 basis points, a sign that the market is reassessing the impact of the release.
Indeed, as James Knightley, chief international economist at ING Financial Markets, highlighted yesterday, it is too early to expect a sharp drop in core inflation (rent and wages will remain high), which means core inflation is likely to return to the cycle high of 6.5% as we head into the fourth quarter.
Additionally, Fed spokespeople were quick to reiterate their commitment to raising the policy rate to 3.25/3.50% by the end of the year, and possibly even 4% next year. Of course, a 4% move isn’t priced in by the market, and the August 25-27 Jackson Hole annual meeting seems more likely to fan the flames of market bets that interest rates will eventually hit 4% than to prop up any next year’s Relax expectations.
All that said, it seems too early to expect a sustained decline in U.S. Treasury yields (hence the rapid rebound in 2-year yields yesterday). Historically, it has been difficult for the U.S. 2-10-year yield curve to invert more than 50 basis points since the 1980s. This suggests limited downside for U.S. Treasury yields, including the 10-year U.S. Treasury , which should favor renewed long USD/JPY .
The US dollar index should have good demand below 105 and we favour a rebound towards the 106.00-106.30 area.
EUR: Don’t chase a rebound
As mentioned above, we do not expect a moderately weaker U.S. interest rate environment to persist for long. 1.0350-1.040 may prove to be the top of the August trading range in Europe and the US. In addition to the threat of Russian energy outages, European manufacturing now has to contend with drought and low water levels on the Rhine. This will challenge the transport of goods such as coal and keep European gas prices near high levels. This factor remains negative for the euro.
A slight improvement in risk sentiment and some strengthening in core inflation in July (providing the case for a 50bps rate hike by Norges Bank next week) are all helping NOK. We expect now is the window for EUR/NOK to advance towards the 9.65 area.
GBP: Continue to wait for tomorrow’s GDP data release
A weaker greenback allowed GBP/USD to gain decent gains yesterday, but stalled in front of resistance at 1.2300. We think GBP will struggle to break this level and favour a move back towards the 1.20 area. We recommend tightening stops on short positions above 1.2300.
Interestingly, EUR/GBP traded lower yesterday. It’s a reminder that the pound’s moves today are more dependent on the outlook for economic growth than in Europe. Given the calmer FX trading in August, this could send EUR/GBP back below 0.8400 if economic conditions in the UK are good – and GBP bears could be confused. The next catalyst for GBP will be tomorrow’s UK GDP data for Q2 2022, which is widely expected to contract by 0.1/0.2% q-o-q.