Economic data, news & events
EU: At the end of Friday's emergency meeting, EU energy ministers gave their endorsement to several draft measures unveiled earlier in the week by European Commission President Ursula von der Leyen. These include capping the reven ues of power plants that use fuel that is cheaper than gas, measures for a coordinated reduction in electricity demand across the EU and amendments to state aid rules to allow governments to provide liquidity support to ailing utility companies. A majority of member states rebuffed the proposal of imposing a price cap solely on Russian pipeline gas and called instead for a wider cap on all gas imports entering the bloc, irrespective of their geographical origin. It is still unclear whether the tool would apply only to pipelines or also to liquefied natural gas. The meeting’s final statement acknowledges that “further work is needed on the possible introduction of such a measure”. Building on Friday's conclusions, the Commissionis expected to present concrete legal texts tomorrow, before Ms. Von der Leyen’s annual State of the Union address on Wednesday. All the measures could be rapidly implemented under an emergency procedure.
UK: Monthly GDP rose 0.2% mom in July, only a partial rebound after falling by 0.6% mom in June. The outcome was inline with our forecast but weaker than consensus had expected. Services output rose 0.4% mom, industrial production fel l 0.3% mom and construction output fell 0.8% mom. The rebound in services output is largely explained by the extra bank holiday in June and the shifting of the late May bank holiday into June, which resulted in one additional working day in May and two fewer working days in June, and this temporarily raised output in May and depressed it in June. Monthly volatility aside, underlying economic activity is slowing, with construction and manufacturing hardest hit.
Italy: We expect industrial production contracted by 0.5% mom in July, following two monthly consecutive declines (10:00 CET). Manufacturing confidence indicators have recently suggested a visible slowdown in output and new orders. Firms are probably facing both a slowdown in global trade and a weakening in domestic demand – dragged d own by a red fuctionin household purchasing power.
Germany: Today, the collective bargaining round in the metal and electrical industry starts. The industry employs nearly four million people in key sectors such as autos and machinery. Before the summer break, labor union IG Metall already demanded a wage hike of 8% on a 12-month basis, the highest demand since 2008. In a recent interview, Jörg Hofmann, leader of IG Metall, stressed the need for permanently higher wages instead of one-off payments in light of surging i nflation rates. In contrast, the employers’ association Gesamtmetall pointed at the level of production in the metal and electrical industry, which is currently 12% lower than in 2018. Hence, any swift agreement between union and management is unlikely. Warning strikes would be allowed after the expiration of the industrial peace obligation at the end of October.
USD outlook turns a little more balanced
FX View: From a low-point in August (11th) the DXY index has been on a steady grind higher and to the high this week had advanced 5% but since Wednesday the dollar has retraced over 1.0% of that move. There is some logic to the correction – the ECB and the BoC both hiked by 75bps this week and it is clear that G10 central banks are now more in sync with the scale of tightening being undertaken by the Fed. Spreads have been generally moving against the dollar of late. Add to that the growing expectation that Europe will tackle President Putin’s curtailment of energy supplies to Europe head-on with huge fiscal support and you have a combination that is more favourable for risk and more bearish for the US dollar. That may well result in better two-way flow for a period that leaves us below the USD highs. However, we doubt this means the start of a sustained turn lower for the dollar. Risk appetite is unlikely to prove sustained and we see greater risks of a further tightening in financial conditions that will provide renewed support for the dollar.
Is the tide beginning to turn against the USD?
It has been a volatile week in the foreign exchange market. In the first half of the week the dollar extended its recent advance hitting fresh year to date highs against other major currencies. EUR/USD hit a fresh year to date low of 0.9864 on Tuesday followed by cable hitting fresh year to date low at 1.1406, and USD/CNY and USD/JPY hitting fresh year to date highs at 6.9799 and 144.99 respectively on Wednesday. After putting in place fresh year to date highs the USD has since corrected sharply lower in recent days. It has been the largest sell-off for the dollar index since July.
It has been an abrupt turnaround for the USD. The upward trend for the USD at the start of the week was reinforced by the announcement from Gazprom that it has suspended the flow of natural gas through the Nord Stream 1 pipeline for the foreseeable future. Kremlin officials have since indicated that the flow of gas is unlikely to resume unless Europe eases sanctions on Russia. The further tightening of gas supplies to Europe triggered an initial 18% rally in the price of the TTF natural gas futures contract and heightened fears that it could jump to fresh year to date highs. However, the price of gas has since given back a lot of those initial gains and remains around 40% lower than the highs from in late August. The favourable price action supports many commodity analysts view that the “worst case has been priced in”. He is forecasting lower natural gas prices in the coming quarters. A development which could help to further ease downward pressure on the EUR. Price action in the EUR has also suggested that a lot of bad news is already priced in as it has struggled to break further below parity in recent weeks.
The EUR is deriving more support as well from the hawkish repricing of ECB rate hike expectations. Yields in the euro-zone have been rising more in the euro-zone than in other major economies such as the US and Japan over the past month resulting in yield spreads moving in favour of the EUR. The favourable yield spread developments have not fully fed through to a stronger EUR especially against the USD, although the EUR has outperformed more notably against other G10 currencies. The EUR hit its lowest point against an equally-weighted basket of other G10 currencies on 25th August, and since then it has been the best performing G10 currency. The ECB’s hawkish policy update should keep upward pressure on euro-zone yields.
Source: Bloomberg, Macrobond & MUFG GMR
in the near-term, and provide more support for the EUR. While we are not convinced that higher euro-zone rates will be sufficient to lift EUR/USD much further above parity in light of the negative energy shock that is hitting the euro-zone economy, they do appear to be helping to prevent the pair from breaking further below parity. It supports our recent decision to cut our short EUR/USD trade idea.
At the same time, the broader pullback for the USD has been driven by the heightened risk of policy action in Japan to counter the rapid jump higher in USD/JPY towards the highs from in 1998 at 147.66. The level of concern displayed by Japanese policymakers has escalated significantly in recent days. It has culminated in the strongest comments yet from Chief Cabinet Secretary Matsuno today who stated that recent JPY moves can “clearly” be described as “excessive”. He added that Japan is ready to take necessary steps if current FX moves continue, without ruling out any options, and will closely co-ordinate with the BoJ and currency authorities in other countries on FX markets.
It follows the joint meeting between the BoJ, FSA and MoF, and meeting between PM Kishida and BoJ Governor Kuroda in recent days which have all understandably heightened uncertainty over whether Japan is moving closer to policy action to provide more support for the JPY either through intervention to buy the JPY for the first time since 1998 and/or the BoJ coming under more pressure to adjust YCC policy settings. Verbal intervention alone has already helped to lower USD/JPY back towards the 142.00-level, although it will need to be backed up by policy action to be sustained especially at the time when other major central banks are increasingly adopting hawkish policy stances relative to the BoJ.
The other main development over the past week has been the surprise policy announcement from the UK government under the leadership of new PM Liz Truss. It has added more uncertainty over the outlook for BoE policy going forward and the GBP. The energy price cap freeze set at GBP2,500 per year on average for households will significantly lower the outlook for inflation in the year ahead. Inflation is now expected to peak out below 13% which was the BoE’s forecast set in August, and could average closer to 5.0% next year. It should ease some of the pressure on the BoE to raise rates as forcefully in the near-term as it is less likely that higher inflation becomes embedded through the expectations channel. However, the BoE will also be concerned that the significant easing of fiscal stimulus will create more inflationary pressure in the medium-term as the economy will not slow as much as forecast. As a result, we still believe that the BoE will hike rates by 50bps at their next policy meeting which has been delayed until 22nd September following the death of Queen Elizabeth II. We then expect the BoE to keep raising rates heading into next year although not as much as expected by the UK rate market. Market participants are currently pricing in a terminal rate of around 4.25% during the 1H of 2023. Normally, the reduction of stagflation risks in the UK should help to ease downward pressure on the GBP. But we remain cautious over recommending adding long GBP positions right now while global financial conditions are continuing to tighten. The UK’s heavy reliance on external financing remains an achilles heel for the GBP which could be made worse by the big fiscal stimulus package.
In these circumstances, the pullback for the USD has made us more cautious over chasing further USD upside in the near-term. We are not convinced that it is the start of a more sustained reversal lower for the USD, but there is a risk it could drop further in the near-term. One potential downside risk in the week ahead for the USD is the release of the latest US CPI for August. The Fed has already downplayed the weaker US CPI report for July, but another weaker CPI report for August could challenge market expectations for a third consecutive 75bps hike later this month.
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