On what planet does a prognosis of no rate hike favor a rise in the currency?

Euro

The euro whipsawed yesterday, along with just about every other currency. From 1.1535 at the open at 7 am, it jumped to 1.1563 by 9 am and then crashed back to 1.1539 by noon. It looks less dramatic on the 240-minute chart insert, and so far we have the euro on the rise again starting in London. All the same, the chart shows a downside breakout of the primary uptrend channel. The parabolic SAR is a sell (although not in the daily) and the price remains inside the cloud. This is iffy but not decisive.

On what planet does a prognosis of no rate hike favor a rise in the currency? It’s backwards. It depends on the robust economy, those high Treasury yields, and at least some safe haven buying.  The Fed is not the only game in town. But we suspect it won’t last, depending on what the other central banks have to say. A strong offset is European and UK environmental conditions that compare badly with the US, mostly arising from the heat wave that has lowered the rivers catastrophically and the shortfall in energy supplies for the upcoming winter. As ING predicted recently, the BoE and ECB may not be in the mood to raise rates, either. 

About the yen: It’s clear that the 160 level is perceived as the true line in the sand. See the red horizontal line on the 240-minute chart. Actually, it may be the cloud top a little lower at 159.54, which is also the 50% retracement of the intervention move.

From left field yesterday came a Reuters story from Dolan that Japanese investors are switching from dollar bond investments to the Europeans—in droves. “Official data for June released this week showed that Japanese investors reduced their holdings of U.S. Treasuries by $5.6 billion while adding $2.2 billion to French government debt, $1.5 billion to UK bonds and $1.2 billion to ​Italian sovereign paper.”

In addition to the amounts, which could be a temporary fluke, “the timing of the gilt purchase was notable, coming in the month that Keir Starmer stepped down as Britain's prime minister and Andy Burnham began the process of succeeding him. The French purchases are also noteworthy given looming political and budgetary issues in Paris. Most striking was the switch away from Treasuries even as the dollar surged to 40-year highs against the yen.” We say you might think the famously cautious Japanese would avoid these situations, so have a motivation that outweighs political risk, like a push from the government.

Outlook

The inflation data was ho-hum—pretty much as expected. But the CME betting market shifted dramatically. From 51.6% expecting no change at the Fed on Sept 16, it went to 62.1% by 1:30 yesterday. From a 48.4% probability of a hike at the Sept FOMC, it fell to 37.9%. This is in keeping with what many big bank economists, including ING and Goldman, are saying. The bond vigilantes are MIA—yields fell, if only a little. This means, perhaps, no temper tantrums when the Fed does precisely that—stay on hold.

Or maybe not. We wish the standard financial press would report the Treasury auctions as they used to do. Now you have to scratch and scramble for the information. Top line: the 10-year auction yesterday of $42 billion had either a “lukewarm” reception or was well-received, depending on which site you check—and when you check it.

Bloomberg reports the auction delivered “the highest yield for the securities since 2007.” This is not accurate. The highest was 4.845% in Oct 2023.

Yields were soft before the government released the July deficit at $432.3 billion, which Bloomberg says was over the expectations of the dozen economists surveyed by Bloomberg. “It was also nearly as big as the previous two months combined and the largest in about 5.5 years, when the post-pandemic stimulus hit.”

The WSJ reports the inflation release “offered few surprises—being neither firm enough to make a September interest-rate hike more likely, nor cool enough to seriously quiet debate about a rate increase in the coming months. A $42 billion Treasury auction of 10-year notes also had little effect on the market, meeting solid, but not spectacular, demand from investors.”

Today we get a 30-year auction ($25 billion).

We also get PPI today, always a bit of a puzzle. While PPI leads CPI in most of the world, in the US it has a checkered performance record. A lot depends on whether retailers pass on wholesaler price increases, which can cause a delay. A problem with PPI is that is excludes the cost of imports, which is ridiculous given Trump’s new tariffs arriving next week. Excluding the extra new costs is not realistic. 

At the same time, the US Treasury has had to refund some $100 billion from the Supreme Court-ordered tariff refunds. Just guessing, but that cash flow will not appear in the price data but in the P&L of the importers. Why would they pass it on? The WSJ reports the big names getting refunds include Apple, Nike and FedEx. 

This emphasizes the point that inflation is a lagging factor. We all know, or think we know, that the Iran war is not ending any time soon and given the energy supply problems already accrued, energy prices will not be falling significantly or lastingly.

But nobody is terribly excited about much of anything. It’s August. Everyone is on holiday, especially in Europe. Variability (not volatility) tends ro be low. The whipsaw we had yesterday is a rare thing for August. So, what’s ahead? Well, there’s Jackson Hole, which sometimes delivers a surprise or two. It comes at month-end (Aug 27-29).

Then there is Labor Day, one of the big three-day weekends in the US. It comes on Sept 7. Note that we will be in London that week and not publishing. We will also miss the jobs report on Sept 4 and be recovering from jet lag when the next CPI is released on Sept 11. 

September is considered a big month for FX, although data doesn’t bear it out. In 1931, the UK left the gold standard. In 1985, it was the Plaza Accord. In 1992, it was the UK forced out of the ERM and Soros being credited with “breaking the bank.” In 2001, it was the World Trade Center.  These few events are not enough to say Sept is a big deal, and if and when we ever get AI, we can check it out. A few years ago we tested whether Feb and March really were a cycle event for the yen (supposed repatriation ahead of the end of the fiscal year) and it didn’t pass the statistical test. Still, September feels like a fresh start for many and views are going to shift. 

Forecast

If sliding rates of inflation are interpreted as a trend, the Fed can justify not raising rates in September. We will have the PCE, August CPI and nonfarm payrolls before that meeting. Obviously headline inflation “should” go back up again on energy prices.

While a dip in the price of oil plus the widening perception that the Fed is not going to hike are tailwinds for the economy (and stock market), the stalemate in Iran poses a huge risk. At what point does Trump lose patience and start bombing? Does he dare do it before the midterms? Risk aversion arising from renewal of the war favors the dollar. Bottom line, it ain’t over yet.

Fun Tidbit: The most important election is in the UK, where Farage faces a slew of competing candidates today, including Count Binface, a far better educated guy. Farage will likely win against Binface and the other loonies, but by how much?