US Dollar: Relief rallies seen shallow – BBH

Brown Brothers Harriman’s Elias Haddad notes that the US Dollar (USD) has recovered part of its recent losses as concerns over the Federal Reserve’s (Fed) credibility ease, but sees limited scope for a sustained rebound. Balanced US labor market conditions, wage growth consistent with the Fed’s 2% inflation target, and strong productivity growth support the disinflation outlook, while upcoming Q2 non-farm productivity data could help shape near-term rate expectations.

Fed credibility gap and data focus

"USD recouped some of yesterday’s losses against most major currencies. SEK bucked the broad USD move as Sweden’s mixed July CPI kept a Riksbank hike by year-end firmly in play. Brent crude is holding just below $80 per barrel after a provisional Iran-Oman agreement raised the prospect of more energy flows resuming through the Strait of Hormuz."

"The drag to USD from the Fed’s credibility gap has eased. US 5y5y inflation swaps have retraced much of the rise triggered by Fed Chair Kevin Warsh’s failure to turn tough inflation rhetoric into credible policy. Comments from some Fed officials may have helped steady the ship."

"Nonetheless, USD relief rallies are likely to remain shallow. USD is trading in line with interest rate differentials, and we see limited scope for a more hawkish repricing in Fed funds rate expectations. The US labor market is in balance, wage growth is consistent with the Fed’s 2% inflation target, and Fed policy is restrictive, assuming a neutral rate of 3.00%."

"Given that services accounts more a much larger share of the US economy (around 80%), weaker services hiring argues for Fed patience, but the renewed pick-up in services price pressure suggests upside inflation risks have yet to fully recede. That raises the cost of waiting to raise rates, with the Fed increasingly at risk of falling behind the curve. Fed funds futures continue to imply about 60% probability of a September rate hike."

"More encouraging for the Fed is the disinflationary force from strong US productivity growth. The Employment Cost Index (ECI) wages & salaries - the Fed’s favorite wage data – was 3.2% y/y in Q2, consistent with the Fed’s 2% target given average annual labor productivity growth of 2.1%. Q2 non-farm productivity report is due today (1:30pm London, 8:30am New York)."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)