Week ahead – US CPI and Warsh testimony to take centre stage, BoC eyed too

Warsh back in the spotlight

It’s been more than a month since Kevin Warsh took over as head of the Federal Reserve but after one FOMC meeting and two public appearances later, investors are still trying to gauge where the new chair sits on the dove-hawk scale. The coming week will present another opportunity for investors to assess Warsh’s views, as he is due to testify in his semi-annual hearing before House and Senate lawmakers on Tuesday and Wednesday, respectively.

Not that there’s high hopes that Warsh will succumb to pressure and reveal anything he hasn’t already on interest rates, but perhaps the grilling by Congress will at least extract more out of him about his plans on reforming the Fed.

Will CPI report boost Fed bets?

What could make Tuesday’s testimony particularly interesting is that the latest CPI data is released 90 minutes prior to the start of the hearing, making it difficult for Warsh to bypass questions about the inflation picture in the United States.

With both headline CPI and PCE readings above 4.0%, it is fair to say that inflation is at serious risk of spiraling out of control. Underlying measures have been a little more tamed, but policymakers should be concerned, as the core PCE price index has been trending upwards over the past few months, reaching 3.4% in May.

What’s more significant about the current upswing is that the Fed hasn’t met its 2% target with any of the inflation metrics since early 2021, hence Warsh’s resetting of policy priorities. There may be some relief in the June data, as headline CPI is forecast to have eased to 3.9%, while core CPI is expected to have stayed unchanged at 2.9%.

Policymakers might feel they can afford to wait a little before pressing the hike button if inflation appears to be peaking, especially as the energy crisis has started to ease. But with the minutes of the June meeting acknowledging that price pressures are becoming more broad based and not just confined to energy, any upside surprises in the CPI data could revive bets for a July rate hike.

Plenty of drivers for the Dollar

For the US dollar, the biggest risk is a scenario where the CPI report is hot but Warsh repeats in Congress his recent comment that inflation risks “have come down”. Alternatively, if Warsh does not rule out a rate hike in July if asked, the dollar is well positioned to resume its post-FOMC climb.

In the absence of clear direction from either the CPI numbers or Warsh’s appearance on Capitol Hill, investors will divert their attention to the other releases out of the United States, of which there are plenty.

The producer price index for June comes out on Wednesday together with the Empire State manufacturing index. The Philly Fed’s manufacturing gauge follows on Thursday, along with retail sales and pending home sales. More housing indicators are due on Friday and wrapping up the week are industrial production figures for June and the University of Michigan’s preliminary consumer sentiment index for July.

Geopolitics and earnings to test market nerves

With Fed speculation potentially going into overdrive next week, the situation in the Middle East could add to the volatility. Following the flareup that prompted President Trump to declare that the ceasefire deal with Iran is over, a further escalation is highly possible as neither side seem to be in a very comprising mood.

The important thing for the markets, though, is whether the Strait of Hormuz will remain open, at least partially, or if another blockade is on the cards. The latter would boost both the safe-haven dollar and oil prices, pushing up policy tightening expectations for the Fed and other major central banks.

A return to full-blown fighting in the region could sour sentiment in equity markets – where sentiment is already fragile – and distract traders from the Q2 earnings season, which goes into full swing next week. The major banks will be in focus, so too will Netflix, but most investors will probably be primarily concerned about what the earnings outlook holds for the AI sector, as ASML Holding and Taiwan Semiconductor report their results.

China’s economy may have hit a bump in Q2

Despite China being at the centre of the trade war storm with Trump, its economy suffered surprisingly few bruises from all the tariff blows. However, it may not have been so immune to the Middle East conflict, as economic growth likely cooled in the three months to June.

After notching up solid growth of 5.0% y/y in Q1, GDP is expected to have risen by 4.4% y/y in Q2, which would mark the slowest annual expansion since the end of 2022. On a quarterly basis, growth is expected at 0.9% q/q – a pace last seen in Q4 2023.

However, although the energy price shock was probably the biggest drag, China’s economy has been in some trouble for a while. The government’s efforts over the past decade to deleverage the economy have put the brakes on growth. But although these policies have had only modest success in reducing debt, one side effect is that it triggered a property crash.

Consumer demand has consequently tanked and has been unable to recover even with endless support measures by the government to lift spending. A jump in exports this year doesn’t appear to have been enough to push overall growth into higher gear. The latest trade figures due on Tuesday will show whether export growth maintained momentum in June. A day later, the GDP data will follow, which will include the June readings for industrial production and retail sales.

Stronger-than-expected GDP numbers could boost risk appetite, although probably not much, while any sharp slowdown could hurt global equities as well as the risk-sensitive aussie and kiwi.

Dovish BoC does the loonie no favours

Talking of the kiwi, the RBNZ’s decision this week to raise interest rates and flag more to come gave the currency a substantial lift. However, the Canadian dollar is unlikely to enjoy a similar boost when the Bank of Canada meets on Wednesday.

No change in rates is anticipated at the BoC’s July meeting, as Governor Tiff Macklem remains worried about the “weak” economy. Although there’s been some improvement in the jobs market and headline inflation is on the up, growth is still sluggish and underlying CPI measures remain stable.

Moreover, with oil prices having almost erased the post-war rally, even after the past week’s spike, the inflation threat appears to be receding, removing the urgency for policymakers to respond with tighter policy.  Crucially, after Macklem’s repeated playing down of the inflation risks, investors see just over a 50% probability of a 25-bps rate hike by December.

The Fed, on the other hand, looks sure to hike rates at least once over the coming months, and this divergence between the Fed and BoC has been damaging to the loonie, which has slumped to 15-month lows versus the greenback.

Pound shrugs off political risks, euro and yen struggle

The pound, whose performance this month is on par with the kiwi’s rather than the loonie’s, will also attract some attention next week, with investors watching the monthly GDP estimate for May on Thursday. UK GDP contracted by 0.1% m/m in April when Gulf oil and gas supplies remained constrained. A further decline in May would raise concerns about the British economy’s resilience just as Labour’s Andy Burnham is all set to replace Keir Starmer as prime minister later this month.

Labour MPs have until July 16 to submit nominations for the leadership race, otherwise Burnham would automatically become party leader and PM by July 20. Burnham may wait for the official declaration before presenting more policy details, leaving the pound vulnerable to speculation until then.

The euro, meanwhile, has been underperforming against both the pound and dollar lately. But there could be some support for the single currency on Friday if there’s an upward revision to the Eurozone’s final estimate of June CPI.

The yen is another laggard, and traders will be on high alert for possible intervention by Japanese authorities as the dollar keeps marching higher in relentless fashion, now approaching the 163-yen level.