by Marc Chandler
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Tuesday marks the 52nd anniversary of the end of Bretton Woods currency arrangement, which pegged the dollar to gold and other currencies to the dollar. Some economists have tried framing their views in terms of Bretton Woods II and there have even been proponents of Bretton Woods III, but these are informal arrangements at best, no reciprocity, or mutual obligations. The point of the matter is that the end of Bretton Woods ushered in the modern era of floating currencies, which in practice has meant volatile exchange rates.
One of the big picture ideas from international relations is hegemonic stability theory. It sees capitalism working best when there is one country that can set and enforce international rules of engagement. The attempts to resurrect Bretton Woods miss the insight captured by Ian Bremmer's "G-Zero" concept. Bretton Woods was made possible by the unsustainable asymmetry of power that existed in 1944. That asymmetry of power has not existed for decades, and even with the collapse of the Soviet Union, the US moved away ideologically from fixed exchange rates and embraced market fundamentalism. Letting markets determine exchange rates has resulted in the current low double digit actual (historic) three-month volatility of the Antipodean currencies and Scandis. The volatility of the other G10 currencies vary between about 6% (Canadian dollar) and 9% (Japanese yen).
The volatility requires businesses and investors to take currency swings into account and manage the risk. Explanations for short-term movements tend to emphasis the flow of economic news, surprises, and technical factors. In the week ahead, there are a few concentrations of data points. The US, for example, reports July retail sales, and so does China, the UK, and Mexico. The US, China, and the eurozone report their latest industrial production figures. Japan, the UK, and Canada report July CPI, and the UK and Australia provide new labor market readings. Technically, the dollar has proven more resilient than we expected. We had anticipated that the recovery since mid-July would end around the time of the US CPI report. Momentum indicators are stretched, and some have begun turning lower for the dollar, but the price action itself has yet to confirm our suspicions.
United States: After contracting in Q1 and Q2 22, the US economy has been expanding faster that what the Fed has identified as the non-inflationary pace of 1.8% for the past four quarters. The Atlanta Fed's GDP tracker sees the economy accelerating in Q3 to more than twice the speed limit. The three reports that highlight the week ahead of expected to improve sequentially from June. The median forecast in Bloomberg's survey is for retail sales to have risen by 0.4% after a 0.2% increase in June. However, the core group that some GDP models use, which excludes autos, gasoline, building materials, and food services, may slow from 0.6% in June to 0.4%. Housing starts in June tumbled 8% and likely stabilized in July. Permits are also likely to have steadied after falling 3.7% in June. Lastly, industrial output slumped by 0.5% in June and likely recouped most of that in July. The market's idea that the economy will slow from 2.4% in Q2 to 0.6% in Q3 is partly predicated on a halving of the growth of consumption (1.6% in Q2 and projected at 0.8% here in Q3) and a sharp drop in private investment (from 5.7% in Q2 to -1.1% in Q3). This week's reports directly impact the assessment of both. At the same time, the soft-landing scenario does not look to be challenged in the coming days, keeping the odds of a September rate hike low.
The Dollar Index is in the upper end its recent range. It closed above 102.75, which is an important area from a technical point of view. It is both the (38.2%) retracement objective of the losses since the year's high was recorded in early March (~105.90) and the (61.8%) retracement of the losses since the May 31 high (~104.70). The broadly sideways movement so far here in August has allowed the Dollar Index to take out the trendline connecting the May, July, and early August highs (starts the new week near 102.45 and finishes the week around 102.25). The MACD is still trending higher, but the Slow Stochastic has stalled, but has yet to turn down. The next technical area is103.00 and then 103.40-60, which houses the 200-day moving average and last month's high. A break of 101.60-75 would help confirm a top.
China: Beijing has taken more measures this year to make its economic data less accessible. The market has long been skeptical of the veracity of Chinese economic data and reports, when it is not being purposely opaque. Adding to the sense of Kabuki theatre were reports in the Financial Times that: "Multiple local brokerage analysts and researchers at leading universities as well as state-run think-tanks said they had been instructed by regulators, their employers and even domestic media outlets to avoid speaking negatively about topics ranging from fears of capital flight to softening prices." China reports July industrial output, retail sales, property investment, property sales and surveyed jobless rate. To a large extent, even if the data enjoyed more credibility, it has been rendered moot by the Politburo's recognition of the need for more economic support. There may be two takeaways. First, measures up until are not sufficient and the property market is still broken. Second, in an exercise of affirmation-through-negation, by increasing repression, officials recognize the discontent. The PBOC is likely to increase the volume of funds at the one-year medium-term lending facility while keep the rate steady at 2.65%. The poor July lending figures added to the pessimism and saw the CSI 300 tumbled by 2.3% ahead of the weekend, the largest loss since last October. A cut in reserve requirements still seems to be an option, though the timing is uncertain.
The dollar's resilience and the poor Chinese data (soft prices, falling exports, and weak lending) keeps the pressure on the yuan. The dollar rose to almost CNY7.24 last week, and the 0.9% gain was the largest so far in Q3. The PBOC's fixings still is helping moderate the dollar's rise. Last month's high was near CNY7.2550 and the year's high set at the end of June was by CNY7.2690. In November 2022, the greenback spiked to almost CNY7.3275. Chinese officials could step up their game, but the move looks to be more about the dollar than the yuan and with deflationary forces evident, there is little urgency to turn the yuan around.
Japan: Weakness in Japanese consumption and slower wage growth took pressure off Japanese government bonds. The generic 10-year JGB yield jumped from around 0.45% before last month's BOJ decision to almost 0.66%. The BOJ stepped in to buy government bonds twice in the first week of August but did not intervene last week. Most of Japan's economic data in the days ahead will not shed much fresh light on economic activity in the world's third-largest economy. The preliminary estimate for Q2 GDP looks to be in line with the Q1 performance of 0.7%, but it will be mostly accounted for by net exports. Consumption and business investment appear to be weaker. The GDP deflator is seen rising to 3.8% year-over-year (from 2.0%). The national CPI may draw attention but the release, ago of Tokyo's July report steals much of the thunder. Tokyo's headline CPI was steady at 3.2%. The core, which excludes fresh food, eased to 3.0% from 3.2%. The measure that excludes fresh food and energy rose to a new cyclical high of 4%. The new news may lie primarily with the July trade figures. Seasonal patterns favor a deterioration from the JPY43 bln surplus reported in June. The July trade balance has deteriorated in 14 of the past 20 years. And even it may not say much about the Japanese economy. The decline in imports (12.9% year-over-year in June) reflects falling prices of commodities and the softness of exports (1.5% year-over-year in June) reflects weaker demand (and sanctions on China).
The dollar finished the week on a firm note near a nanometer below JPY145, which may have traded before the weekend. The year's high was set slightly above JPY145 at the end of June. Above there, the JPY146.00-15 area may see some resistance, but formidable resistance is not seen until closer to JPY150 (last year's high was almost JPY152). A close now below JPY143.80 may be needed to signal that the dollar's run from around JPY137.25 in mid-July is over. That would seem to imply that US 10-year yields peak soon too. The high for the year was set on August 4 near 4.20%.
United Kingdom: Market expectations for the September BOE meeting were scaled back after the softer than expected June CPI. In the coming days, the UK will report the July CPI, job and wage data, and retail sales. In the four months last year from June through October, UK CPI rose at an annualized rate of nearly 10%. Ae the high monthly prints are replaced with smaller increases, the year-over-year rate, which peaked at 11.1% last October and was still at 10.1% as recently as March, will likely continue to moderate. The Bank of England forecast a 5% rate at the end of the year. It was at 7.9% in June. The tightness of the labor market and the rise in average weekly earnings (6.9% in May 3-months year-over-year), a new cyclical high, will be closely watched. That said, in the US real wages have been rising, but in the UK weekly earnings are rising less than inflation. This may help explain why household consumption rose by a meager 0.2% in Q1 and was flat in Q2. Still average weekly earnings appear to have accelerated for the fourth consecutive month in June. Separately, the payroll count may have fallen for the second consecutive month. Retail sales (UK reports in volume terms) is a narrower measure than household consumption. July retail sales will also be released next week. The average monthly increase in Q2 was 0.4%, which is the most in a quarter for two years. Given the comments from BOE officials, we suspect that the employment data and CPI will overshadow retail sales.
Sterling set the high last week near $1.2820 after the US CPI but reversed and settled below the previous day's low in an outside down day on August 10. Even the stronger than expected Q2 GDP was insufficient to lend sterling much support. The $1.2825-50 area is critical resistance and a close above it is necessary to improve sterling's technical tone. On the downside, a break of $1.2600 would be a potentially ominous technical development. That said, the MACD is trending lower and is oversold. The Slow Stochastic has turned up but looks fragile. Sterling's four-week down draft is the longest losing streak since May 2022.
Eurozone: The next batch of eurozone data will be of little consequence to the market, and what shapes the outlook for the next month's ECB meeting will not be found in June data: trade, industrial and construction output, and a second look at Q2 GDP and quarterly employment figures. Germany sees the August ZEW investor survey, but while more current is unlikely to move the needle. The assessment of the current situation is simply poor. It has been negative since late 2021. The average this year is -47.6, almost twice as negative as the year ago period. The expectations component was negative beginning March 2022, but managed to recover in January-April this year but has fallen back below zero in the past three months. The stir caused by Italy's plan to levy a tax on banks quickly appears to have eased without causing much of an impact in it premium over Germany. The 10-year spread showed little reaction and remained well below last month's high of around 175 bp. It is hovering near the 20-day moving average a little below165 bp. Italy's two-year premium showed more of a reaction, but it peaked near 70 bp, slightly below the June and July highs. It finished last week around 65 bp.
The euro spiked to $1.1065 after the US CPI and rose above the 20-day moving average for the first time in two weeks, but it quickly reversed. It traded below $1.0945 before the weekend. The price action was disappointing, and the euro fell for the fourth consecutive week, which matches the longest losing streak since March 2022. The Slow Stochastic has turned up and the MACD has leveled off. The choppy consolidative price action is frustrating but still inclined to see this as a base forming after pulling back from the year's high in mid-July near $1.1275. That said, a break of this month's low (~$1.0910) could signal losses toward $1.08.
Canada: There are two headwinds. First, is the external environment. The risk-off phase works against the Canadian dollar. Moreover, the correlation between the S&P 500 (proxy for risk) has increased recently. Also, the Canadian dollar is sensitive to the broader trend of the US dollar (proxy the Dollar Index). The second headwind is a series of disappointing Canadian dollar. This includes the July employment report and IVEY PMI, and the wider than expected June trade deficit. The Canadian dollar has drawn little support from the seven-week roughly 21% rally in oil prices. Indeed, it has fallen by almost 2% during oil's run. The highlight in the week ahead is July CPI. The base effect means that a 0.2% increase in the month-over-month pace, will cause the year-over-year rate to tick to 2.9% from 2.8%. It peaked last June at 8.1% and has not fallen in only two months subsequently. The decline in Canada's inflation likely bottomed. The base effect warns that the headline rate is likely to increase in August and September before again in October, but then rising again into the end of the year. The underlying rates of inflation have been steadily even if gradually falling. The bar to a Bank of Canada rate hike at its September 6 meeting seems rather high, especially in the context of the Fed pausing again.
The US dollar rallied from around CAD1.31 in mid-July to CAD1.35 last week. On an intraday basis, the trendline connecting the year's high in mid-March (~CAD1.3860) and the late May high (~CAD1.3650) was taken out but the greenback was not able to close above it. The US dollar held below it ahead of the weekend (~CAD1.3470). This is also true of the 200-day moving average (~CAD1.3450) --the greenback violated it on an intraday basis but respected in on a settlement basis. The MACD is overbought but the Slow Stochastic has curled down. A close below CAD1.3365 would lend credence to our suspicion that a high in place.
Australia: The possible labor dispute at several natural gas projects could put 10% of the world LNG production capacity at risk, according to some estimates. Japan and South Korea are the largest importer of LNG from the fields that are at risk. The recent strike votes sent ripples through the nat gas market and appears to have intensified negotiations to avoid a disruption. Separately, Australia reports July jobs data on August 17. Australia created about 255k jobs in H1, of which almost 220k were full-time posts. This compares to around 345k and slightly more than 365k, respectively, in H1 22. The unemployment rate stood at 3.5% in June, down a smidgeon from 3.6% in June 2022. The participation rate is unchanged over the past year at 66.8%. The anticipated takeaway from the July report is slower job creation and a tick-up in the unemployment rate. And no reason to reassess the likelihood of a September RBA rate hike. The futures market has downgraded the probability of a hike this year, after Bullock takes the reins from Lowe after next month's meeting.
The Australian dollar's price action has been exceptionally poor. After rebounding to about $0.6615 after the US CPI report, the Aussie reversed lower and posted a bearish outside down day. Follow-through selling ahead of the weekend pushed it below $0.6500. The year's low was set at the end of May slightly below $0.6450, and it is the next obvious target. A break suggests potential to at least $0.6400. As we have seen with some other currency pairs, the momentum indicators are mixed. The MACD is falling and is over-extended. The Slow Stochastic is closer to turning. It has flatlined in over-sold territory. A close above $0.6600 would stabilize the technical tone.
Mexico: Although inflation continues to ease in Mexico, the central bank kept the overnight target rate at 11.25%. The rate has been left unchanged since the quarter-point hike in March. In March, CPI stood at 6.85%. Last month it was slightly below 4.80%. That implies a rise in real rates. Adjusted for current inflation, Mexico’s real overnight rate is about 6.45%. Brazil's is around 10%, and it has begun an easing cycle. Chile delivered a 100 bp rate cut last month has a real overnight rate around 3.75%. Still, what will get Banxico to cut rates is unlikely to rest June retail sales, the main economic report in the week ahead. The Mexican economy expanded 1% in Q1 and 0.9% in Q2. Yet, retail sales fell by 0.4% in Q1 are doing considerably better in Q2. April and May together saw about a 0.8% increase.
The Mexican peso was one of the few currencies in the world that managed to hold their own against the US dollar last week. The peso rose by about 0.5% against the dollar. On August 3-4, the dollar peaked near MXN17.43 and in the last two sessions traded below MXN17.00. The week's low was almost MXN16.91. The next downside target is around MXN16.8450, with a break bringing the multiyear low into view set in late July (~MXN16.6660). The MACD looks poised to turn lower in the coming days, while the Slow Stochastic has rolled over. The MXN17.12-15 area should offer resistance.
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