Overview: 

The US dollar is trading with a firmer bias against all the G10 currencies ahead today's August US CPI report.

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Even increased speculation that the ECB will hike rates tomorrow has failed to lift the euro, while a larger than expected contraction in the UK's July GDP pushed sterling briefly through last week's lows. The dollar rose to a marginal new high for the week against the Japanese yen, as the market seemed uninspired by the cabinet reshuffle, but is wary of intervention. Most emerging market currencies are a bit heavier, but not the Chinese yuan, which has stabilized amid a continued liquidity squeeze in Hong Kong.

Equities and bonds are heavier. All the large markets in the Asia Pacific region fell today, with Taiwan and India the notable exceptions. Europe's Stoxx 600 is off nearly 0.60%, which, if sustained would be the largest decline since mid-August. US index futures are slightly softer. European benchmark 10-year yields are 3-5 bp higher, though Gilts are outperforming after the GDP figures. The 10-year US Treasury yield is up two basis points to 4.30%. A stronger dollar and firmer rates have weighed on gold. Monday's high was near $1931, and yesterday's low was closer to a little above $1907. It is consolidating in a narrow range above that low, which is nearly a three-week low. October WTI remains bid. It gains have been extended to about $89.65 today. It settled last month near $83.65.

Asia Pacific

China's economic calendar is busy ahead of the weekend. First, the PBOC will set the benchmark one-year Medium-Term Lending Facility. After shaving the rate by 15 bp to 2.50% last month (following a 10 bp reduction in June), look for the PBOC to leave the price steady but it could increase the quantity. In August, the amount was boosted to CNY401 bln from CNY103 bln, the most since March. Still, this year's average, through August is almost CNY350 bln compared with nearly CNY269 bln average in the first eight months last year. Separately, China is expected to report a sequential increase in the year-over-year pace of industrial output and retail sales. The contraction in property investment may be accelerating. Meanwhile, after rising in the first part of the year, newly built commercial residential building prices (70 cities) fell in May and June.

Japan's PPI (0.3% for a 3.2% year-over-year increase, the least since March 2021) is not a market-mover. The focus is on the Bank of Japan. Governor Ueda's comments helped buoy the yen for less that 24-hours and the greenback has resurfaced above JPY147 and approached Monday's high (~JPY147.30). Today's gains were extended to JPY147.45. The 10-year JGB yield remains above 0.70%, where some observers had expected the BOJ to offer to buy bonds in an unscheduled operation. The first thing tomorrow, Japan is expected to report a pullback in core machinery orders in July after a 2.7% jump in June. The preliminary July industrial production report showed a 2% decline, and this is subject to revision. Meanwhile, as anticipated, Prime Minister Kishida announced the first re-shuffling of his government's ministers. It does seem as much about policy per se, balancing factions in the LDP while setting the stage for next year's leadership challenge and boosting the number of women represented. The current cabinet configuration had seen support in the opinion polls fall. Senior LDP officials, Motegi, the secretary general, and Aso, vice president, lead the second- and third-largest factions. "My Number" national identification system, is an important drag on support for the Cabinet. The planned increase in defense spending also seems controversial. Finance Minister Suzuki kept his post, but former Justice Minister Kamikawa was named foreign minister, and Kihara, was appointed as defense minister.

Early Thursday, Australia's August employment report is due. The loss of 24.2k full-time positions in July (-14.6k jobs overall) overstates the weakness of the Australian economy. A recovery is expected. The median forecast in Bloomberg's survey is for a gain of 25k jobs. With the participation rate steady at 66.7%, the unemployment is seen unchanged at 3.7%. The cyclical low was set last July at 3.4%. It has chopped between 3.5% and 3.7% this year. 

The dollar reached JPY147.45 in Tokyo earlier today, a marginal new high for the week. The pre-weekend high was almost JPY147.90. The market seems to be probing for the pain threshold of Japanese officials. After the US CPI is out of the way, the next string of real sector data, retail sales and industrial production, are expected to downshift and this could help ease the upward pressure on US rates and, perhaps, the dollar. The Australian dollar is consolidating in about a half-of-a-cent range above $0.6400, where options for A$620 mln expire today. Positioning for a stronger jobs report could see the Aussie test resistance in the $0.6450-60 area. A break of the $0.6390 area could signal a retest on last week's lows slightly below $0.6360. The market seems content to job the Chinese yuan in a narrow range, awaiting perhaps, stronger directional cues by the other major currencies, which are mostly trading sideways. Today's range has been roughly CNY7.2785 to CNY7.2905. A break of CNY7.27 could spark a deeper dollar setback toward CNY7.24, this month's low. The PBOC set the dollar's reference rate at CNY7.1894 (CNY7.1986 yesterday). The average estimate in Bloomberg's survey was CNY7.2808. Meanwhile, note that the liquidity squeeze in Hong Kong, has boosted the costs of borrowing yuan to sell. The three-month cost is the most in five years.

Europe

Given the national readings, the 1.1% decline in the eurozone's aggregate July industrial production is not much of a surprise. That it is the second decline this year does not say very much. The July contraction more than offsets the May-June performance. With today's report, the average monthly change this year is around  minus 0.2%, roughly the same as last year. The focus is on tomorrow's ECB meeting. Talk that the revised forecast to be issued tomorrow will show next year's CPI above the June forecast of 3% has lifted the perceived odds a hike tomorrow. The probability drifted higher this month and are now slightly above 65% from a little more than 50% yesterday. The odds were closer to 25% at the end of August. The swaps market is pricing in about a 95% chance of a hike before the end of the year. We suspect the ECB may shave this year's 0.9% GDP forecast. The base effect warns of a sharp fall in eurozone CPI this month and next month before recovering in the last couple of months of the year. In June, the ECB's staff forecast 5.4% CPI this year and 3.0% next. The 2025 forecast had CPI still slightly above the 2% target (at 2.2%).

The UK's economy contracted by 0.5% in July. The median forecast was for a 0.2% decline after a 0.5% expansion in June. Weakness was widespread. Led by a 0.8% decline in manufacturing output, industrial production fell by 0.7% after surging 1.8% in June. The big negative surprise was in the index of services fell by 0.5% instead of the 0.1% economists expected. It was the biggest decline of the year. Construction output fell by 0.5% (+1.6% in June). The trade shortfall narrowed slightly. The odds of a quarter-point hike next week have stabilized a little below 80%. It was slightly above 90% a week ago. With the recent comments by Governor Bailey, the swaps market is nearly evenly split over whether next week's likely move finishes the tightening cycle or whether there is one more hike to be delivered. 

The euro closed well yesterday after approaching $1.0770. However, there was no follow-through buying today even after the talk about the ECB inflation forecasts and the increase in the perceived likelihood of a hike tomorrow. The euro has made higher highs for three consecutive sessions, but it sounds more impressive than it is, and the streak may be snapped today. The euro has simply not gone very far. Last Wednesday's range was about $1.0705-$1.0750. Today's range so far is roughly $1.0730-$1.0765. The poor July GDP report saw the sterling slip fractionally through last week's low, slightly above $1.2445. After the low was recorded, sterling bounced to about $1.2485 before sellers re-emerged. The 200-day moving average is a little below today's low, closer to $1.2430. Sterling has not traded below this long-term moving average since March.

America

It is all about the August US CPI now. Owing primarily to higher energy prices, the monthly CPI print is seen accelerating to 0.6%. That will lift the year-over-year rate for the second consecutive month. It had bottomed at 3.0% in June and rose to 3.2% in July, and given the base effect, may have risen to 3.6% last month. A 0.6% increase in August would be a 4% annualized pace over the past three months. That is up from about 2.4% in the previous three-month period. There may be some consolation in the core rate, where a 0.2% month-over-month gain would allow the year-over-year measure to ease to 4.3% from 4.7%. A 0.2% increase in the core rate would put the three-month annualized rate near 2.4%, half of what it was in the previous three-month period.

The US dollar peaked near CAD1.3700 last Thursday, and at yesterday's low (~CAD1.3545), had pulled back by about 1.1%. From a technical perspective, it is looking increasingly like some move was completed last week. The momentum indicators did not confirm the high and have formed a bearish divergence. The five-day moving average may cross the below the 20-day in the next couple of sessions for the first time in over a month. A break of the CAD1.3490-CAD1.3500 area would lend credence to this more constructive view of the Canadian dollar. That said, on Friday, there are two sets of chunky options expiring ($775 mln at CAD1.35 and $915 mln at CAD1.3525). The greenback peaked against the Mexican peso last Thursday as well near MXN17.7080. It fell 1.8% on Monday and another 0.30% yesterday. It has given back nearly half of its rally from the end of August (found ~MXN17.2085. The dollar slipped slightly below yesterday's low (~MXN17.2185), but has steadied in a narrow range, below MXN17.2750. The next retracement (61.8%) is closer to MXN17.09. 

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