Overview: The US dollar is trading with a heavier bias ahead of the July CPI report. The intraday momentum indicators are overextended, and this could set the stage for the dollar to recover in North America. Outside of a handful of emerging market currencies, which include the Mexican peso and Hong Kong dollar, most are trading lower. Losses in US equities yesterday and poor news from another chip maker (Micron) weighed on Asia Pacific equities. Europe’s Stoxx 600 is steady and US futures are a little higher. The US 10-year yield is going into the CPI report softly at around 2.76%. The US Treasury sells 10-year notes today as the second leg of the quarterly refunding. European benchmark yields are 2-3 bp lower. Gold continues to press against the $1800 cap. It has not closed above it for over a month. September WTI is hovering around $90. It appears stuck for the time being in an $87-$93 range. US natgas is about 1.1% higher after rising 3.2% yesterday. Europe’s benchmark is up 3%. It rose 1.5% yesterday. Iron ore is flat, while September copper is about 0.5% stronger after a small loss yesterday snapped a three-day advance. September wheat is up 1%, as it extends this week’s rise. If sustained, it would be the third consecutive gain, which matches the longest rally since March.
 

Asia Pacific

China's July inflation readings underscore the scope for easier monetary policy, but officials have shown a reluctance to use this policy lever. The key one-year medium-term lending rate will be set in the coming days, but it is unlikely to be reduced from the 2.85% rate since January. July CPI rose to 2.7% from 2.5%, its highest level in two years, but shy of the 2.9% median forecast in Bloomberg's survey. Food prices were up 6.3% from a year ago, driven by a 20.2% jump in pork prices, the first rise since September 2020. Fresh food prices rose 16.9% and vegetable prices rose almost 13%. However, this seems to be a function of supply, while demand still seems soft. Service price pressures slowed to 0.7% from June's 1.0% increase. The core rate eased to 0.8%. Meanwhile, producer price increases slowed to 4.2% from 6.1%. The median forecast (Bloomberg's survey) was for a 4.9% increase. Chinese producer prices have slowed for nine consecutive months. It peaked at 13.5% last October.

Japan's well-telegraphed cabinet reshuffle was not about policy. Key ministers kept their posts, including the finance minister and chief cabinet secretary. Former Prime Minister Abe's brother, Defense Minister Kishi was replaced by Hamada, but he will stay on as a national security adviser. Trade Minister Hagiuda, an Abe acolyte was replaced by Nishimura, also for the Abe faction, but will become party policy chief. Prime Minister Kishida named his one-time rival Takaichi as minister of economic security. The reshuffle seemed to be about re-balancing power among the key factions and solidifying the government whose support has waned. The next economic policy focus may be on the drafting of a supplemental budget. In terms of monetary policy, BOJ Kuroda's term ends next April, while the term of his two deputies ends in March.

The dollar is in a narrow range of less than half a yen today, hovering around JPY135.00. It did edge above yesterday's JPY135.20 high but held below Monday's high slightly below JPY135.60. The exchange rate will likely take its cues from the reaction of the US Treasury market to today's CPI report. The US 10-year yield remains within the range set at the end of last week with the stronger-than-expected employment report (~2.67%-2.87%). The Australian dollar held support near $0.6945 but has stalled near $0.6975 in the European morning, where this week's hourly trendline is found. Intraday momentum indicators are stretched, suggesting that even if there is some penetration, follow-through buying may be capped. There are options for A$400 mln at $0.6985 that expire today. The greenback edged a little higher against the Chinese yuan, but it remains subdued. It is well within recent ranges. The dollar's reference rate was set at CNY6.7612, slightly above expectations (median in Bloomberg's survey) for CNY6.7606.
 

Europe

The more potent risk is not that the center-right wins next month's Italian election. That is increasing looking like a foregone conclusion. It is hard difficult to tell how much this reflects the judgment of voters and how much reflects the ineptitude of the center-left parties. The risk is that the center-right secures a two-thirds majority in both chambers, which would make constitutional changes possible. A poll published yesterday by Istituto Cattaneo shows the center-right drawing 46% of the vote and securing 61% of the deputies and 64% of the Senators. Analysis by Istituto Cattaneo suggested that even if the center-right saw its share of the votes go up, it might not be able to increase the number of deputies or senators. Italy's 10-year premium over German has fallen in eight of the past ten sessions, including today. It is around 2.10% today, slightly more than 25 bp off its recent peak, and a little below its 20-day moving average. Italy's 2-year premium fell to 0.73% yesterday, the lowest since mid-July. It peaked above 1.30% in late July. 

Ironically as it may sound, it is not Italy's center-right that is attacking the Bank of Italy or the European Central Bank. It is Truss who is leading Sunak to become the next leader of the Conservatives and Prime Minister. BOE Governor Bailey warned that the UK was about to go into a five-quarter contraction (that does not even count the 0.2% contraction that economists expect the UK will announce for Q2 ahead of the weekend). Truss quickly responded that her GBP39 bln tax cuts (~$$7 bln) could avert that scenario. Sunak hiked the payroll tax this past April. She would unwind it. Truss would suspend the green levy on household energy bills and nix Sunak's corporate tax increase that was to be implemented next year. The swaps market is 85% confident of a 50 bp hike at the mid-September MPC meeting, less than a fortnight after the new Tory leaders are chosen. In the last two meetings of the year, the swaps market is pricing another 75 bp in hikes. 

The euro is the first firm holding above $1.02 so far today, the first time since August 1. However, it remains within last Friday's range (~$1.0140-$1.0250). The 1.2 bln euro options at $1.0210 that expire today likely have been neutralized ahead of today's US CPI report. The session high, slightly above $1.0225 was set in the European morning. This stretched the intraday momentum indicator, and we suspect it will probe lower now. Initial support below $1.02 is seen in the $1.0170-80 area. Sterling is in the same boat. It too is consolidating within the range seen before the weekend (~$1.2000-$1.2170). The push to session highs, a little above $1.21, in Europe has stretched the intraday momentum indicators. The risk is for a return to the $1.2050-60 area.
 

America

Today's CPI report is interesting but at the risk of exaggerating, it does not mean much. First, the strength of the employment data, even if flattered by seasonal adjustments or incongruous with other labor market readings, suggests the labor market slowdown that the Fed wants to see is still in the very early stages. Second, as we have noted, financial conditions have eased recently, and the Fed has pushed back against this. Third, before the FOMC meets again, it will have the August CPI in hand. Fourth, no matter what the data shows today, it will not and cannot meet the Fed's definition of a sustained move toward the 2% target. The median in Bloomberg's survey has converged with the Cleveland Fed's Inflation Nowcast. The median in the survey is for an 8.7% headline rate (down from 9.1%) and a 6.1% core rate (up from 5.9%). Cleveland's Fed Nowcast has it at 8.8% and 6.1%, respectively. The Fed funds futures market has about an 80% chance of a 75 bp hike next month discounted. It may not change very much after the CPI report. 

The US Treasury sold $34 bln in 1-year bills yesterday at 3.20%. That represents a 24 bp increase in yield. The bid-cover dipped but was still three-times oversubscribed and the indirect bidders took down almost 63%, a sharp rise from a little less than 51% last time. The US also sold $42 bln in 3-year notes, also at 3.20%. This was an 11-bp increase in yield. The bid-cover edged up to 2.5% and the indirect participants took 63.1% of the issue, up from 60.4% previously. Today, Treasury goes back to the well with a $30 bln 119-day cash management bill and $35 bln 10-year notes. At the last auction, the 10-year was sold at 2.96%. In the when-issued market, the 10-year yield is about 2.79%.

The US dollar traded between around CAD1.2845 and CAD1.2900 yesterday and remains in that range today. There are options for almost 1.15 bln at CAD1.29 that expire today. The greenback slipped to session lows in Europe but as in the other pairs, we took it to recover. A move above the CAD1.2910 area could spur a move toward CAD1.2950. Mexico reported slightly higher than expected inflation yesterday. It underscored expectations for a 75 bp hike by Banxico tomorrow. The US dollar is offered against the peso today and it is pressed near yesterday's low around MXN20.20. The top side is blocked around MXN20.27-MXN20.30. Options for around $765 mln at MXN20.30 expire today. A convincing break of the MXN20.20 area could target the MXN20.05 area. 

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