US economic slowdown helps the Fed cool demand leading to questions on further interest rate increases

Last week’s Fed’s rate increase of +75bps was highly anticipated, however they dropped forward guidance for Sept and shifted towards data dependency.  US Q2 advanced GDP came in a -0.9% vs -1.6% prior.  But how can party be over when jobs are plentiful at the same time households and businesses have plenty of cash? Corporate earnings have come in mixed but stronger than expected helping to lift equities.  A stronger than expected payroll number this Friday (F +250K) would likely confirm the Feds intention to continue to raise rates and push the dollar higher.

BOE is expected to raise benchmark rate by +50bp to 1.75% on Thursday although inflation calls for more aggressive action. Political uncertainty cools some as Liz Truss emerges as the front runner to become the next PM.  Her platform for looser fiscal policies and tax cuts could present major challenges for the BOE who may be forced to tighten rates even more aggressively in the low growth environment.

Eurozone GDP for Q2 came in at +4% YoY solidly beating the US.  However Russia cut Europe’s gas exports to 20% of capacity and Eurozone CPI came in at +8.9%.  The Common Currency got a lift when the ECB lifted rates more than expected earlier in July but projections of further increases still lag the Fed.  S&P cut Italy’s debt rating after Draghi resigned and budget doubts return. Friday’s German Industrial Production figures could be worse than the -1.3% YoY expected pressuring the euro.

Last Friday, Canadian GDP (May) printed 0.0% m/m vs +0.3% prior (+5.6% y/y) which was better than expected.  Economist are projecting 2.0% growth for H2 leaving higher oil and continued rate hikes from Bank of Canada as the tailwinds for the loonie. Labor market data this Friday is expected to show a gain of 15K jobs helping offset some of June’s surprise -43K loss of jobs. Stronger jobs numbers on Friday could lead to a 0.75% rate increase by Bank of Canada at the September meeting.

Reserve Bank of Australia meets tomorrow and looks to raise its benchmark rate 0.50% from the current 1.35%.  Inflation forecasts will likely be raised as will inflation.  RBA is playing catch-up as cash rate is substantially below neutral – believed to be about 2.5%.  Aussie has rebounded 5% since lows on July 14 (see table below) but with the safe-haven status residing with USD additional gains may be difficult.

After the US GDP print last Thursday USDJPY was a big mover finally breaking below 136. The US 10yr Treasury rate fell back to 2.6% from recent 3.5% taking the wind from many short yen trade pushing the yen to a 6-week high. The much watched 50-day moving average (134) was given on Friday as speculators switch to long yen positions.