Macro/FX Watch: US resilience and ECB dovishness spell disaster for EUR

US data resilience keeps Fed’s hawkish pause in play

US August CPI came in firmer-than-expected both on the headline and core. While gains in headline could be shrugged off to be driven by higher gasoline prices, the uptick in transportation costs driving the core higher may be a cause of concern for the Fed. Likewise, the uptick in supercore (ex-food, energy and housing) inflation to 0.4% MoM could also gather some attention. While market reaction was muted as there was little change to Fed expectations, the print reaffirmed that the final stretch of disinflation will be bumpy.

A day after CPI, now US retail sales and PPI for August have also surprised to the upside. Headline retail sales was up 0.6% MoM (exp 0.2%, prev 0.5%) as gasoline station sales surged to 5.2% from 0.1% in July. The control metric – the hone that feeds into the GDP – also posted a surprise gain of 0.1% despite expectations of a 0.1% decline, although the prior was revised down to 0.7% from 1.0%. US PPI meanwhile rose 0.7% MoM in August, above the expected and prior 0.4%, marking the largest increase since June 2022 and heavily driven by a 10.5% increase in the energy component. Market reactions to these data releases have confirmed once again that labor and growth data is more important than the inflation prints as we navigate this end-of-cycle turbulence.

This resilient data has again sparked expectations of another rate hike by the Fed, a pause for next week remains fully priced in. This suggests that the Fed will keep a hike in its dot plot next week for the year, and in fact raises the risk of a hawkish shift in 2024 projections. That means the dollar will remain supported into the Fed meeting, unless we see some significantly weak numbers. In essence, the Fed’s hawkish pause can likely still push US yields higher, compared to the drop in yields seen with the ECB’s dovish hike yesterday. Focus is now shifting to next week’s key macro highlights which include key central bank meetings from Fed, BOE and BOJ, as well as the release of global PMIs.

EUR: Downside in focus after ECB’s dovish hike

The European Central Bank announced another 25bps rate hike, taking the deposit rate to 4.0%, however the hike was dovish as it came with hints of the end of tightening cycle. The statement included a comment which said, “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target”. President Lagarde tried to push back on the idea of peak rates, but dovish interpretations could not be ruled out. This dovish hike proved to be more dovish than July’s hawkish pause, with 10-year Bund and Italian yields down 6bps and 10bps respectively, compared to a fall of 1bps and 3bps respectively after the July decision.

Meanwhile, staff projections have added more fuel to stagflation concerns as they pointed to high inflation and low growth. 2023 inflation was upgraded to 5.6% from 5.4%, 2024 raised to 3.2% from 3.0% as hinted by the Reuters leak, and 2025 lowered to 2.1% from 2.2%, but still ultimately seen just above target. Growth projections for 2023-25 were lowered across the board to 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025, which still look optimistic in our opinion and will have to rely on a big way on China’s recovery.

EURUSD broke below 1.07 handle to test support at May lows of 1.0635, which if broken could expose the 1.05 handle. EURCAD, as highlighted in FX Watch this week, saw a sharp move lower and broke to near 3-month lows of 1.4359 as CAD continues to benefit from rising crude oil prices and EUR could be hit further by oil gains. Sterling also dropped with Eurozone stagflation risks likely to put further pressure on the UK economy. GBPUSD tested the 1.24 handle after breaking below 1.2430 support but EURGBP remains pressured in Asian session today, testing 0.8570 after closing below 50DMA.

Market Takeaway: EURUSD could remain a sell on rallies into the US FOMC meeting next week. EURCAD also sees downside bias with oil gains continuing to support CAD but weigh on EUR.

CNH: Liquidity boost and more green shoots

China reported better-than-expected activity data for August, showing improvement in retail sales and factory output as well as a further decline in unemployment rate. Retail sales rose by 4.6% YoY from July’s 2.5% gain, while industrial production was up 4.5% YoY vs. 3.7% in July. The positive surprise in industrial production confirmed the pickup in manufacturing PMIs seen earlier, and services data also improved on the back of increasing travel demand over the summer which could well continue into the National Day holiday period at the end of the month. Data on investment was less encouraging, highlighting more measures are needed to address the headwinds from the real estate sector.

This better-than-expected economic data came after sentiment was boosted by RRR cut announcement late on Thursday that followed an interest rate cut on medium-term loans earlier, and more liquidity injections were seen today. Overall, these measures hinted that the easing stance of Chinese authorities may be getting more aggressive, even as a massive stimulus remains unlikely. Policy support is also seen to be going beyond interest rate cuts, given that the MLF rate was kept unchanged today, to include direct support via liquidity injections and fiscal spending. Risks remain, including fresh fragmentation risks coming from Europe and China’s EV battle. However, a tactical turnaround in sentiment cannot be ruled out as these measures further boost the Chinese economy.

The yuan was boosted by the slight upturn in sentiment, with USDCNH testing the 7.26 handle from 7.29+ levels after the open and early September lows of 7.2392 may be in focus. Still, a stronger US dollar, US-China policy divergence as well as structural issues in the Chinese economy could mean the downside for USDCNH could remain limited until broad US economic data starts to turn weaker.

Market Takeaway: Yuan recovery could take hold if China momentum continues to build, but US economic strength still overpowers for now. It may, therefore, be easier to consider playing CNH strength across the crosses such as EURCNH and GBPCNH.

AUD: Boosted by China and domestic employment data

AUD has been the best performer against the US dollar on the G10 board so far this week, on the back of a supported risk sentiment. The performance has been further boosted by a strong August labor market report yesterday and signs of improvement in China’s activity data as well as the surge in iron ore prices.

Australia’s employment rose 64.9k after July’s negative reading, although the spike was primarily driven by part-time jobs. However, these can still bring wage pressures if converted to full-time jobs later, which continues to make it difficult to call an end to RBA’s tightening cycle just yet. Markets still remain reluctant to price in another rate hike by RBA, but new Governor, Michele Bullock, takes the helm today replacing Lowe, and may want to start by showing her commitment to inflation-fighting. Her comments will be closely watch to assess if RBA’s market pricing could be exposed to a hawkish shift.

Meanwhile, iron ore prices have continued to climb higher breaking above $120 in Singapore, the highest in five months, on the back of strong production from China steel mills with a seasonal pickup in construction, and this is also boosting AUD. However, this tailwind could reverse if China’s steel production slips into the end of the year.

AUDUSD is making its way towards 0.65 and early September highs of 0.6522 may be the first barrier, especially if US data remains strong in the run up to next week’s Fed meeting. EURAUD is testing support at 100DMA at 1.6469, break below which could bring June lows of 1.5849 in focus.

Market Takeaway: Upside bias in AUDUSD could remain but risk of a pullback remains if Fed comes out more hawkish than expected. EURAUD could see downside risks after ECB’s dovish shift.