Weekly Investment View – Bullish Dollar

This Week

Bilal discusses BoJ comments on the yen and our bullish USD/EUR view; Dominique focuses on US price data and inflation expectations; Mustafa targets 4.5% for 10Y Treasuries by yearend; John likes to underweight the Russel 2000 as hikes hit small caps; Caroline argues improving C/As will offer little near-term FX support for CEE; Mirza considers USD/CNY in view of the PBoC’s next moves; Henry previews the ECB meeting on Thursday, anticipating a 25bp hike; Viresh see Brent hitting $95 by the end of September.

Bilal Hafeez – Global Macro

BoJ Governor Ueda made comments over the weekend about possibly ending the BoJ’s negative rates policy. But given recent wage data was not a blowout, nor is domestic demand particularly strong, we think it was an attempt to strengthen the yen. This makes even more sense after earlier comments by the MoF about currency intervention. It appears Japan does not want USD/JPY trading much above 148.

We still believe that for currency intervention, whether verbal or actual, to work, we need to see US yields turn down as well as anything on the Japan side. That said, we cannot ignore this shift in policy stance. We are therefore less confident about being bullish USD/JPY.

But we remain bullish the dollar overall, especially against European currencies. We outlined our view in my last Macroscope piece. I only add that while the USD has strengthened a lot against the JPY this year, it has not against the EUR or GBP (Chart 1). So there is more upside for the USD against European FX.

Dominique Dwor-Frecaut – US Macro

This week, I focus on the price data and the University of Michigan’s short-term consumer inflation expectations. I expect a roughly unchanged CPI, but the PPI could be interesting because both the manufacturing and services PMI show a stabilization of the prices paid subindices. Historically, those have tended to be correlated with the PPI (Chart 2). Stabilization of the PPI would be consistent with my fundamental view that goods price inflation is likely to turn positive due to the rise of protectionism and the shortening of global supply chains, as well as due to extreme weather.

I also look for an increase in the short-term inflation expectations in the University of Michigan survey (consensus expects no change). This is because gas pump prices in August were about 10% higher than in July, and historically short-term inflation expectations have tended to track energy prices. University of Michigan short-term inflation expectation have turned up for the past couple of months, and another increase could signal faster wage growth ahead.

Mustafa Chowdhury – US Rates

10-year Treasuries have more room to sell off. Our next target is 4.5% by yearend. Also, the 2s/10s slope will disinvert further if oil prices keep rising. The flow of economic data as a factor driving the yield curve will take a back seat. Instead, oil prices and supply-demand dynamics will be the key factors.

There is a heavy flow of data this week, with both CPI and retail sales. The last few major data releases failed to move the needle on hiking probability for the September or November meetings, as embedded in the OIS curve.

The hurdle for the market to fully price in another hike is now higher than before. Additionally, there is heavy supply this week with 44b in 3-year notes, 35b in 10-year notes, and 20b in 30-year notes. Demand remains muted, with foreign holdings of US Treasuries remaining almost flat at 7.5 trillion since the beginning of this year. Looking at the OIS forward curve below, where the forward rates are flatter now than early May, there is no evidence of rising term premium yet. There is room for term premium to increase.

John Tierney – US Equities

The large cap S&P 500 and NASDAQ 100 continued their sideways slide last week, dropping about 1.4% (Chart 4). But the small cap Russell 2000 took a harder hit, dropping 2.3%. If the 10Y Treasury keeps rising to 4.5% as we expect, we will see more pressure on this index.

Larger caps are weighing the plusses of a modestly steeper yield curve (less recession risk) and the minuses of modestly rising breakeven inflation rates (Fed on hold for longer). We expect large cap indices to continue trading in a range for now.

Only six companies report this week, but they include tech heavyweights Oracle Corp and Adobe, who may add fuel to the AI bonfire. Homebuilder Lennar may provide insight into how rising rates are affecting homebuyer appetite.

We like to underweight the Russell 2000 via the IWM ETF. We continue to like a tactical underweight in the homebuilder XHB ETF due the pressure of rising mortgage rates.

Caroline Grady – Emerging Markets

Ongoing improvement in trade dynamics should ensure continued C/A improvement (Poland and Czechia are both due on Wednesday). Exports remain weak across the region, but imports are declining faster, reflecting both exceptionally subdued domestic demand and a lower energy import bill. Poland’s current account is already back in surplus on a 12m basis (+0.1% GDP), partly reflecting the earlier improvement in services. Czechia’s deficit remains wide at around 4.5%. But the trade component is already in surplus with the nine-year high in the income deficit (-6.5% GDP) the main drag.

Improving C/A dynamics are unlikely to offer near-term FX support. PLN will remain under pressure following the NBP’s decision to frontload rate cuts and reluctance to rule out further cuts ahead of the election. For CZK, CNB preference for a weaker currency as an offset to lower policy rates should mean EURCZK continues to drift higher.

Mirza Baig – Emerging Markets

USDCNY continues to test the weak side of its trading band, which may tie PBoC’s hands at this week’s MLF rate decision. The Trilemma is starting to bite. Since the onshore FX market cannot clear above the top of daily trading band, offshore forwards are spiking and onshore funding seems to be tightening. Soft capital controls are being implemented in a sign that the new leadership at PBoC is determined to avoid volatility in the near term.

We acknowledge that the central bank will have to re-align the band at some point. Most people expect this will occur gradually, which is why USDCNH ERKOs and call spreads are so popular. But what is popular is seldom profitable. We suggest being square here. There is too much policy risk and too much positioning risk.

Henry Occleston – Eurozone & UK Macro

Despite the slowing in Eurozone growth, our lean is that the ECB needs to tighten further on the back of core inflation trajectory, hawkish inflation forecasts and the transmission of policy seen so far (Chart 7). We err towards them hiking 25bps this Thursday. And we stand by our longstanding expectation for terminal rate at 4.0%, with upside risk.

There is a tail risk that they choose not to hike on the back of the slight slowdown in August core inflation momentum and the recent negative survey data. Regardless of the decision, we expect they will stress the data dependence of future decisions and push back on pricing for 2024 cuts.

While our lean is for a hike in September, our stronger view is that there is value positioning for a higher terminal rate more generally, and to fade the cuts priced in 2024. We like paying 6m fwd 1Y EUR OIS.

Viresh Kanabar – Commodities

Oil: Brent rose by 2% last week to $90.65. Despite higher front-month futures, X3Z3 calendar spreads narrowed by $0.13, signalling the rally last week has been driven by speculative flows as opposed to further tightening on the supply side.

Speculative positioning reflects this. The latest CoT data shows that managed money longs as a percentage of total managed money contracts are back at the 90th percentile, while managed money longs as a percentage of open interest is around the 60th percentile.

Meanwhile, average gas prices in the US are at or around $3.82 per gallon, higher than this time last year. We should expect a demand response given the prices we are now seeing at the pump, not just in the US but also in Europe.

We still see further upside to around $95 by the end of September.

(The commentary contained in the above article does not constitute an offer, a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)