FOMC Helps Dollar, but It's not Running Away

The US dollar is broadly firmer in the wake of the FOMC statement, but there are some notable exceptions. The market appears reluctant to sell sterling ahead of next week's MPC meeting, where hawkish dissents are likely.  There will also be the immediate release of the minutes, and new macro-forecasts.  The Australian dollar is resilient in the face of a drop in building approvals nearly twice what the consensus expected (-8.2% vs -4.4%), and the continued fall in gold, copper, and Chinese stocks (Shanghai -2.2%).

The Scandis are firmer too, helped by some month-end flows and the stronger than expected Swedish Q2 GDP. The 1.0% quarter-over-quarter expansion bests the consensus forecast for 0.7% and Q1 GDP of 0.4%. The year-over-year pace was lifted to 3.0%, the fastest pace in nearly four years, from 2.5%. 

The Riksbank's negative interest rates and QE are not responses to growth concerns but deflation.  This flies in the face of worry that deflation saps growth.   The same anomaly is evident in Spain as well.  Today Spain also estimated Q1 growth at 1.0% (3.1% year-over-year).  This was as the central bank had forecast.  

Sweden and Spain enjoy the strongest growth among the high income countries, and both are experiencing deflation.  Preliminary July data was released for Spain today as well.  The harmonized measure fell back to -0.1% from zero in June, snapping five months of improving (less negative) prices. 

Separately, German states reported July inflation numbers and there on the soft side, suggesting risk that the harmonized national rate eased  back to zero from 0.1% in June.  German employment data was disappointing.  Although the unemployment rate was unchanged at 6.4%, the number of unemployed increased by 9k (the consensus was for a 5k decline) and the June unemployed rose 1k rather than fall by 1k.  The June-July gains come after an eight-month streak of declines. 

Nevertheless, yesterday's FOMC statement remains the key talking point.  Although we read the statement with a clear hawkish bias, we note that the September and December Fed funds futures contracts were unchanged (implied yields of 17.5 bp and 31 bp respectively).  Not every one was convinced. 

There were two word clues that the bar to a September rate hike is low.  First, the Fed referred to the recent job gains as "solid".  This is an upgrade from June where the Fed had noted that job growth had picked up.  That followed the April statement after the softer March jobs report that acknowledged that the pace of job gains had moderated.   

The second word clue was in the minimal forward guidance provided.  Previously the FOMC statement had read that officials wanted to see additional improvement in the labor market.  They are seeing it and modified the desire by wanting to see "some additional improvement."  This qualification seems to soft the requirement.    We take this mean that essentially if there are no significant negative surprises in the next two employment report that will be released before the Fed meets again, a hike will be delivered in September.   

This has been our view since the poor Q1 data shifted our June call to September.   Comments by the IMF's Lagarde yesterday also pointed toward a September hike.  Not that she knows but was probably politely informed that despite the IMF's recommendation to wait until next year, it was likely to go this year.    

At the June meeting, a slight majority of officials had indicated that two rate hikes this year may be appropriate.  Developments since probably have not changed many assessments.  In order to maximize the Fed's options, it has to hike in September.  Without a hike then, two hikes this year seems unlikely. Whereas a hike in September gives it the flexibility to only hike once, but also twice if desired.

Today's first look at Q2 US GDP is the main focus.  We suspect there is upside risks to the consensus 2.5% forecast.  However, the wildcard is the annual revisions that will, among other things, include new seasonal adjustments.  Some growth that we anticipate for Q2 could be pushed back into Q1. In addition to the headline, we expected consumption improved from the 2.1% pace in Q1 toward almost 3%.  Also, the core PCE deflator may double from the 0.8% Q1 pace.  

The weekly initial jobless claims may also draw some attention.  Last week's 255k is the lowest in more than 40 years.  It covers the week that the July nonfarm payrolls survey was conducted.  Although there may not have been any irregularities in the jobless claims report, economists expect a rebound.  This time series is volatile, which is why it is often smoothed with a four-week average.  That now stands at 278.5k.  Ideally the rebound will keep the new claims below 270k. 

Also today, the US will introduce a new advance report on merchandise trade.  It is intended to be released 4-7 business days before the international trade report (that covers trade in services as well).  Today's report will provide preliminary data for June.  

The euro broke below $1.10 yesterday and has been unable to resurface it today.   Although it recovered from the $1.0940 area, this down move does not appear to been exhausted.   The $1.0930 area is a retracement target of the rally from the July 20 low near $1.0810 to Monday's high near $1.1130.  

The prospect of Fed tightening, the rise in US bond yields and US and Japanese shares have helped lift the dollar back through the JPY124.00 to reach almost JPY124.35.  Additional dollar gains are likely here too.    The yen drew no comfort from the stronger than expected June industrial production report (0.8% vs consensus of 0.3%).  The hourly trend line comes in above JPY124.00 now. 

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