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A dollar-centric narrative would note that the greenback rose against most of the G10 currencies last week. Yet, the dollar, the most actively traded currency, was arguably not the prime mover in recent days. Rather, the unwinding of carry trades seems to be the driver of much of the price action.

The low yielding yen and Swiss franc were the only G10 currencies to rise against the US dollar. The Australian and New Zealand dollars were the worst performers, losing almost 2% against the US dollar last week. Among emerging market currencies, the Mexican peso was easily the largest loser, and was thought to have been a beneficiary of the carry trades. The peso tumbled more than 2% against the greenback. Brazil's real was the second worst emerging market performer, off slightly less than 1%. It may have weighed on US equities, which also bounced into the weekend as the yen stabilized. 

In most of our lives, cause takes place, but the markets are anticipatory in a nature. And the cause of last week's dramatic price action may be less the past BOJ intervention (its authoritative report in the coming days will provide some figures for the covert intervention), and more the upcoming events, especially the BOJ meeting on July 31 and the FOMC meeting several hours later.

The derivatives market warns that the failure of the BOJ to raise rates could be more destabilizing that a rate hike itself. The market expects the Federal Reserve to stand pat, but the market is not pushing back against expectations for a 25 bp cut in September, barring a new shock.

The latest forecasts in Bloomberg's survey have been for a weaker nonfarm payroll report, and the median now sits at 175,000 (206,000 initially in June). The unemployment rate is expected to be unchanged at 4.1%, while wage pressure continues to moderate.

United States

Two events which the market seems particularly sensitive to take place in the week ahead: the FOMC meeting, and the monthly employment report. The Fed meeting is one of those times where what it says will more important than what it does. It will not do anything.

Despite what appears to be a cacophony of Fed voices, there seems to be a consensus that while confidence that inflation is on a sustainable path back to its target has improved, it is not quite sufficient yet. A strong consensus is for a September cut. Neither Fed comments nor stronger-than-expected retail sales and industrial production have forced the market to reconsider.

Following the Beige Book, the FOMC statement is likely to acknowledge that growth is moderating, even though economic activity accelerated in Q2. It is also likely to recognize a modest slowing in job growth. In June, it noted that "there has been modest further progress toward the Committee's 2 percent inflation objective." It could upgrade this assessment by omitting the word "modest."

The statement could also modify the last sentence of the second paragraph that discusses risk: "The economic outlook is uncertain, and the Committee remains high attentive to inflation risks."

Given the various comments about the risks moving move into balance, including the statement itself, it could stop the word "inflation." The key takeaway is that the statement and Fed Chair Powell's press conference are unlikely to push against the market consensus of a rate cut without pre-committing to it. 

Anecdotal reports and hard numbers demonstrate that the labor market is slowing. What seems to be the issue is the speed. Weekly jobless claims, for example, are at the highs for the year, and the four-week moving average is holding above 230,000 compared with below 210,000 in January. The number of long-term unemployment (27+ weeks) has risen sharply. Nonfarm payrolls rose by an average of 177,000 in Q2. It is the slowest three-month average since early 2021.

In Q2 23, the monthly average was almost 100,000 greater. The median forecast in Bloomberg's survey anticipates that nonfarm payrolls rose by 175,000 in July, of which 140,000 are thought to be from the private sector. Nonfarm payrolls rose by 206,000 in June, and 136,000 were in the private sector.

The unemployment rate, derived from the household survey (rather than the establishment survey) may draw particularly close attention, as a small gain would likely trigger Sahm's rule (a recession is signaled without fail and without false positives when the three-month moving average of the national unemployment rate rises by 0.50 percentage points or more relative to the minimum of the three-month average from the previous 12-month reading).

The Dollar Index frayed resistance at 104.50 but failed to close above it, leaving it mired in a consolidative range. It finished the week little changed, and is hovering around its 200-day moving average (~104.35). A break of the 104.00-104.50 range may point to the direction of the next phase. The positioning of the momentum indicators may suggest an upside bias. 

Japan

Several hours before the FOMC meeting concludes on July 31, the Bank of Japan will announce the results of its meeting. There are two key elements of its decision. First is its bond purchase plans. Currently, it is buying about JPY6 trillion a month (~$38 billion), which is also roughly the amount that is maturing from its vast holdings.

The BOJ has signaled it will announce its intentions. Some slowing seems inevitable, and this will cross the threshold into what has been dubbed as "quantitative tightening.” While this is an important step toward normalization, the exchange rate may be more sensitive to what the BOJ does with interest rates. The failure to hike rates will likely spark yen sales.

The BOJ/MOF will release the day that will shed light on its intervention this month. Preliminary data suggests at least two bouts of intervention, though given the stealth nature of the recent operations, the risk is of more rather than fewer operations. 

The greenback's slightly more than 6% drop from the July 10 high to the July 25 low may have exhausted the dramatic position adjustment. It briefly dipped below JPY152 to approach the 200-day moving average (~JPY151.55) and the (50%) retracement of this year's rally (~JPY151.40). The last leg of the dollar's drop began with the high on July 19 near JPY157.85. The pre-weekend recovery approached the halfway mark of that leg found near JPY154.90. Above there, resistance is seen in the JPY155.60-75 area. 

United Kingdom

The Bank of England meets on Aug. 1. Bloomberg's survey of economists found almost 80% expect a cut, but the swaps market is less sanguine. There is about a 45% chance a cut discounted, and it is not fully priced in until November. Still, the pricing is consistent with a little more than a 90% chance of two cuts this year. Looking further out, the market is pricing in high confidence of another 50 bp cut in H1 25.

The UK 2–10-year curve was around 90 bp inverted in early July 2023, and it has trended steeper since then. In fact, it has steepened for the past seven consecutive weeks, and it turned positively sloped at the start of this month. It has remained so with only a few exceptions. Now, at around 18 bp, it is the most positively sloped since Q4 22. It has been bullish steepening in the sense that debt prices have risen (two-year yields have fallen faster than long-term rates). 

Sterling was sold through the support we had anticipated to see near $1.2880, though follow-through selling was limited to the $1.2850 area. It held above the halfway mark of this month's 4 1/3-cent rally found near $1.2830. The former support at $1.2880 now offers initial resistance, followed by the $1.2940 area. The momentum indicators are still moving lower, and the five-day moving average (~$1.2895) looks poised to fall through the 20-day moving average (~$1.2865) next week. 

Eurozone

ECB President Lagarde said at the recent press conference that the "door was wide open" for the September meeting to emphasize the absence of an agreement, and that its decision is dependent on the incoming data (which includes the updated economic forecasts due then, as well). That itself is a type of forward guidance.

This week, the first estimate of Q2 GDP will be reported. Quarterly growth is likely 0.2%-0.3% after 0.3% in Q1 24 (it was flat in H2 23). It will not be the decisive data point for the ECB. It is a good thing that the preliminary CPI will not be, either. The ECB will have another CPI report in hand before it meets in September.

In July 2023, headline CPI slipped by 0.1%. This makes for an easy comparison this year. The year-over-year rate will likely edge up to 2.6%-2.7%. It would be the third increase in three months, and will give a sense that progress toward the inflation target has stalled. At an annualized pace, Eurozone CPI rose 4% in Q1 and again in Q2 after rising at less than a 1% pace in H2 23. The Eurozone's August 2023 CPI rose by 0.5%. Barring a new shock, the risk is that the year-over-year rate will fall back in August.

The euro found support near $1.0825, but it was unable to recover much above the $1. 0865 level.The 200-day moving average (~$1.0820) has not been violated on an intraday basis since July 4. The (50%) retracement of the euro's nearly three-cent rally off the last June low is found slightly above $1.0805. The momentum indicators are still headed lower, and a break of the $1.08 level could see it reach the $1.0750-75 area. We suspect a move above $1.0885-$1.0900 would signal the end of this consolidative/corrective phase. 

Canada

The Bank of Canada cut its target rate last week for the second time this year. It now stands at 4.50%. The market's attention quickly turns to September, and the swaps market has a little better than a 75% chance of a cut discounted. The swaps market has two cuts fully discounted by the end of the year.

Canada is to report May GDP. The economy is likely to have expanded by about 0.2% after 0.3% in April (flat March). The key to the September decision will not be in the GDP data, barring a shock. In fact, after contracting in H2 23, growth has resumed this year, and Q2 growth is likely to be around 1.5% (1.7% annualized in Q1).

More important will be the employment data on Aug. 9 (full-time positions were lost in May and June, and the unemployment rate has risen to 6.4% in June from 5.4% in June 2023), and the July CPI on Aug. 20 (another soft report is likely). The US 2-year premium over Canada is near 80 bp. It reached 90 bp last month, the most since 2006. 

The US dollar made a marginal new high for the year near CAD1.3850 following the Bank of Canada's dovish cut. The next upside target is the high from late last year near CAD1.39. It traded quietly ahead of the weekend in a narrow range (~CAD1.3810-CAD1.3830). In fact, the US dollar's slight pullback before the weekend was sufficient enough to snap a seven-day advance. Still, the greenback finished higher for the second consecutive week. It was the first back-to-back weekly gain since early April. Initial support is seen a little below CAD1.3800 and then in the CAD1.3750-75 area. 

Australia

While the Bank of Canada is seen as among the most dovish of G10 central banks (along with the Sweden's Riksbank), the Reserve Bank of Australia is seen as among the most hawkish. The derivative markets see RBA's first cut around the middle of next year. The US 2-year premium over Australia reached of more than 140 bp in late 2022, and it has been trending lower. It reached a two-year low earlier this month near 30 bp on July 12, a day after the Australian dollar peaked near $0.6800, a six-month high.

Australia reports Q2 CPI, and the risk is on the upside after Q1 24 3.6% pace. The RBA forecast 3.8% in May, when it delivered a hawkish hold. The monthly readings were stronger than expected in April (3.6% year-over-year) and May (4.0% year-over-year). It was at 3.4% in January and February.

Australia is also set to report retail sales. They have risen by an average of 0.3% this year through May compared with a 0.2% average in January-May 2023 period. June trade figures are also due. Australia's goods trade surplus has trended lower this year. Through May, the goods surplus stands at about A$33.3 billion compared with nearly A$59 billion in the first five months of 2023. Exports have fallen and imports have risen. 

The Australian dollar was bludgeoned by the unwinding of yen carry trades and fell for nine consecutive sessions against the US dollar before bouncing before the weekend. In that nine-day slide, the Aussie shed 4% (almost three cents). It overshot the (61.8%) retracement of the rally from the year's low in mid-April (~$0.6365) found near $0.6530 intraday but not on a settlement basis. Initial resistance may be in the $0.6580 area, and then at around $0.6520. 

Mexico

The median forecast in Bloomberg's survey is that the Mexican economy grew by 0.8% in Q2 (quarter-over-quarter) after expanding by 0.3% in Q1 24 and a flat Q4 23. This seems somewhat optimistic, especially given the nearly flat monthly IGAE economic indicator in April-May. Consumption looks weak, though retail sales may be stabilizing after falling for three consecutive quarters through Q1 24.

Worker remittances remain strong. In April and May, worker remittances (part of Mexico's current account) were $11.04 billion (after nearly $14.1 billion in Q1 24), 3% higher than the year ago period. June remittances are due, but a couple days after GDP.

The tight monetary policy in face of what appears to be faint economic impulses is unlikely to change when Banxico meets on Aug. 8. Yet, pressure is mounting, and the risk of a move in late September may be increasing, even though inflation headline inflation is stubborn (while the core measure has fallen to nearly 4% (from almost 7% last June). 

The unwinding of yen carry trades appeared to weigh on the Mexican peso. It fell against the dollar in eight of the past ten sessions, including in the last four. Around the middle of the month, the greenback forged a shelf around MXN17.60-MXN17.65 and reached almost MXN18.59 on July 25, before it consolidated ahead of the weekend. The momentum indicators suggest the US dollar has not peaked. Nearby resistance may be in the MXN18.60-MXN18.66 area. The post-election high was near MXN19.00. 

China

Many observers seem to have an asymmetrical view of Chinese data. If it is stronger than expected, it cannot be true, and if it is weak, it is more evidence that wholesale reform is necessary. This applies to the July PMI due next week. Still, many Chinese officials seem to recognize the need for concrete measures to strengthen domestic demand (which is a broader category than consumption).

The 10 bp rate cut at the start last week, followed by similar cuts in the prime loan rates, is more symbolic than substantive. More measures will likely be forthcoming, and as always, implementation is where the rubber hits the road. 

We have understood that part of the yuan's weakness was the use of the offshore yuan as the short leg of carry trades. The unwinding of carry trades helped spur a short squeeze on the yuan. The rolling 60-day correlation of changes of the yuan and yen reached its highest level in more than a decade (~0.82) on July 19, and it remained elevated slightly above the 0.70 mark at the end of last week.

The dollar recouped some of its losses ahead of the weekend, but its 0.40% loss was still the biggest weekly decline since early May. It was the third weekly decline in four weeks. Still, the dollar could move back into the CNH7.26-CNH7.30 range.

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