Dollar consolidation is morphing into correction

Overview: The failure of computer systems has disrupted airlines, banks, media companies, and the London Stock Exchange, ostensibly stemming from an update from a third-party software update, according to Microsoft. The dollar is trading with a firmer bias. The consolidation, we anticipated, appears to be morphing into a correction. Weaker than expected retail sales has driven sterling to new lows for the week. On the week, among the G10 currencies, only the Swiss franc and Japanese yen gained on the greenback amid what appears to be some unwinding of carry trades. Emerging market currencies are also mostly softer. Only the Czech koruna and Philippine peso, among emerging market currencies, have managed to post gains, albeit minor, against the dollar. 

Equities are under pressure. Hong Kong and Taiwan fell by more than 2%, while South Korea was off 1%. Among the large bourses, only mainland Chinese equities rose (Hong Kong-listed mainland shares fell 2.25%). Europe's Stoxx 600 is off about 0.5%. If sustained, this would be the fifth consecutive losing session, the longest decline this year. US index futures are trading lower. The S&P 500 is off 1.25% this week, coming into today. If sustained, it would be the largest loss in three months. The NASDAQ is down nearly 2.9% this week ahead of today's session. It would also be the biggest weekly loss since mid-April. Benchmark 10-year yields are little changed. The 10-year US Treasury yield is slightly below 4.20%, off about three basis points this week. The two-year yield is almost flat at 4.47%, a couple basis points higher than a week ago. Gold set a record high on Wednesday near $2483 before reversing. It is off nearly $30 today and is approaching the week's low near $2400. September WTI is consolidating quietly between $80.50-$81.35. 

US Dollar:  The week ends with a light news stream. The Fed's Williams and Bostic speak today but their views are known. NY Fed President and FOMC Vice Chair Williams expressed what seems to be the broad consensus. The moderation in inflation is encouraging, but more data are needed. Atlanta Fed President Bostic was one of the Fed officials that saw scope for one cut this year. The market sees practically no chance of a cut later this month and has a cut fully discounted for the following meeting (September 18). It is virtually unchanged this week. Similarly, the Fed funds futures strip has two cuts and almost a 60% chance of third cut this year. This is slightly higher than a week ago. It is as if the stronger than expected retail sales and industrial production figures were blunted by the rise in weekly jobless claims. The Dollar Index being sold through 104.00 for the first time in three months, in the middle of the week. It recovered yesterday and further today. A move above 104.50 signals a return toward 105.00. 

Euro: Surprising no one, the ECB left rates on hold yesterday. And the euro traded with a heavier bias, but it did not lose more sterling or the yen, suggesting a dollar move rather than a euro move per se. The swaps market has about an 80% chance of a cut discounted for the next meeting (September 12), which is about the average this month. ECB President Lagarde said the September decision was "wide open," which operationally is what data dependence sounds like. There are about 46 bp of easing discounted for the remainder of the year. That is one quarter-point cut is fully priced in and about 85% chance of another. The eurozone's CPI was at 5.5% in June 2023 and last month it stood at 2.5%. The ECB's June forecasts warned to expect little improvement in the second half, and Lagarde echoed that. The base effect poses a challenge to the H2 outlook. Consider than an annualized pace, eurozone inflation rose a 4% clip in Q1 24 and Q2 24. In Q3 23, CPI rose at an annualized rate of 2.8% and in Q4 23, it actually fell at a 1.2% annualized rate. Its deposit rate peaked at 4.0% last September and remained there until the 25 bp cut in June. Policy is still restrictive. Lagarde warned that the growth risks were on the downside, and that growth in Q2 was looks slightly softer than Q1 (0.3% quarter-over-quarter). The euro trended gently lower after the ECB meeting but finished poorly on its lows slightly below1.0900. We suspect the near-term move was completed near $1.0950 earlier this week and a consolidative phase could bring it back toward $1.0840-50, initially, and maybe back to $1.08.

Yen: Japan reported June CPI. It does not contain significantly new information to what we learned from the Tokyo CPI a few weeks ago. The national headline rare was unchanged at 2.8% (it was expected to have risen to 2.9%), while the core ticked up to 2.6% (from 2.5%). The measure that excludes fresh food and energy, rose to 2.2%, as expected, from 21%. The focus is on two things. The first is the covert intervention, and official tactics have changed as volatility and direction seem less the trigger. The other focus is the BOJ meeting at the end of the month. The swaps market has about half of a 10 bp rate hike discounted, reflected the split views among market participants. Yet, if the BOJ does not hike, we suspect the disappoint would weigh on the yen and undue some of the costly results of the intervention. Some observers are focusing more on the slowing of JGB purchases, which would mean it was buying fewer bonds than were maturing (QT). The dollar extended yesterday's recovery and reached JPY157.85 in the Asia Pacific session. It tumbled quickly to below JPY157.00 and some suspect the BOJ's hand. 

Sterling: The UK reported that June retail sales fell twice as much as expected. The 1.2% drop follows the 2.9% surge in May. Despite key CPI and labor market reports earlier this week, the data have left the market nonplused. Now the swaps market discounts about a 50% chance of a cut at the August 1 BOE meeting, down from slightly from the end of last week. Sterling reached a one-year high in the middle of the week near $1.3045. It has fallen to a new low for the week today near $1.2900. A break of $1.2880 targets $1.2830. 

Canadian Dollar: Canada is expected to report a 0.6% decline in May retail sales after a 0.7% rise in April (1.8% excluding autos). The market remains highly convinced that the Bank of Canada will deliver its second cut in the cycle next week (July 24). The swaps market has around a 92% chance of a hike being delivered, which is up from about 75% a week ago. Neither bull nor bear will find much satisfaction as the greenback trades a little above the midpoint of the CAD1.36-CAD1.38 three-month trading range.

Australian Dollar: If the Bank of Canada (and Sweden's Riksbank) are seen as the most dovish of G10 central bank, the Reserve Bank of Australia is perceived to be among the most hawkish, with a rate cut not expected until well into next year. The Australia dollar was unable to make much headway yesterday despite healthy jobs growth, but slipped fractionally yesterday when the US dollar was stronger against the other major currencies, reflecting its underlying resilience. The Aussie was ground lower yesterday and is pushing through $0.6700. The break of this previous resistance could force late longs to the sidelines and signaling an outright correction--rather than consolidation. It may signal a return toward the lower end of the previous range near $0.6600. 

Mexican Peso: The dollar bounced along its trough for the last few days but surged yesterday to trade above MXN18.07 at the extreme. It pushed above the 20-day moving average (~MXN18.03) for the first time in two weeks, though settled below it. The next target is the MXN18.10-20 area. While the peso was off about 1% yesterday, the Brazilian real also got tagged for a little more (~1.7%). The greenback rose to an 11-day high, slightly below BRL5.59 and looks poised to test the two-year high near BRL5.70 seen earlier this month. The five weakest emerging market currencies yesterday were from Latam, led by the Chilean peso's 1.9% drop.

Chinese Yuan: On July 11, when BOJ likely intervened after a soft US CPI reading, and the dollar fell from around JPY161.50 to about JPY157.45, the dollar forged a range against the offshore yuan that persists: CNH7.2580-CNH7.2925. Against the onshore yuan, the range from July 11 (CNY7.25-CNY.2.2750) continues to define the price action. A more detailed report from the Third Plenum is expected in the coming days. The PBOC set the dollar's reference rate at CNY7.1315 (CNY7.1285 yesterday). The fixes ranged from CNY7.1270-CNY7.1328 this week. Yesterday's May US Treasury International Capital report (TIC) appeared to show a record liquidation of US assets by Chinese investors (~$42.6 bln). We note that in May, the 10-year US yield fell 18 bp and the S&P 500 rose by 4.8% as indications that the US asset markets managed to absorb the record Chinese sales seemingly without disruption.