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EUR/CHF's down trend resumed last week and fell to as low as 0.9520, just ahead of 100% projection of 0.9995 to 0.9670 from 0.9840 at 0.9515. A temporary low should be in place with subsequent recovery. Initial bias is turned neutral this week for consolidations. Outlook will remain bearish as long as 0.9670 support turned resistance holds. Break of 0.9520 will resume the fall from 1.0095 to 0.9407 low.

In the bigger picture, medium term outlook is staying bearish as the pair is capped well below falling 55 W EMA (now at 0.9876). Down trend from 1.2004 (2018 high) is in favor to continue. Sustained break of 0.9407 will target 61.8% projection of 1.1149 to 0.9407 from 1.0095 at 0.9018. For now, this will remain the favored case as long as 0.9840 resistance holds, in case of strong rebound.

In the long term picture, outlook remains bearish as it's staying well below 55 M EMA (now at 1.0459). Break of 1.00095 resistance is needed to be the first sign of bottoming, or the multi-decade down trend is expected to continue.

Summary

United States: Ground Control to Major Powell: Odds of Soft Landing Rising

• Economic data continued to beat expectations this week. Real GDP came in at a stronger-than-expected 2.4% annualized rate in Q2. Inflation and compensation costs have decelerated; yet, we suspect the FOMC would like to see continued moderation before it concludes that inflation is sufficiently low and stable.
• Next week: Construction Spending (Tue.), ISM Indices (Tue. & Thu.), Employment (Fri.)

International: European Central Bank Raises Interest Rates; Bank of Japan Tweaks Monetary Policy

• The European Central Bank (ECB) raised its Deposit Rate 25 bps to 3.75% at this week's policy announcement, but was cautious in offering any guidance about policy beyond this July meeting. We expect the ECB to hold rates steady for an extended period in September and beyond, and do not see the ECB easing monetary policy until Q2-2024. The Bank of Japan tweaked its monetary policy stance in a hawkish direction, saying it would allow 10-year Japanese Government Bond Yields to rise flexibly to somewhere between 0.50% and 1.00%.
• Next week: China PMIs (Mon.), Reserve Bank of Australia Policy Rate (Tue.), Bank of England Policy Rate (Thu.)

Interest Rate Watch: Fed Hikes and Keeps Its Options Open

• The Federal Open Market Committee hiked the federal funds rate by 25 bps at its July monetary policy meeting. The post-meeting communication was little changed from June as the committee keeps its options open regarding additional tightening.

Topic of the Week: Summer Strife

• A string of labor disputes have put union activity and workers' bargaining power front and center. The willingness to strike reflects the tight state of the labor market as well as decades-high inflation. With union compensation growth lagging behind inflation and non-union pay over the past few years, the push appears to be more catch-up than a canary of future wage trends.

Full report here.

U.S. Highlights

• Fed Chair Powell signaled a meeting-by-meeting approach on changes to the fed funds rate, opting to evaluate incoming data and fine-tune interest rates to help temper inflation.
• The second quarter’s GDP release showed an economy that continues to chug along at a solid pace – exceeding expectations for a steeper slowdown.
• The Fed will keep rates in restrictive territory into next year so, even if a recession is avoided, tepid economic growth is to be expected.

Canadian Highlights

• Canadian GDP growth has pointed to a new cruising speed, as the country worked through several shocks, including the public sector strike and wildfire shutdowns.
• The BoC’s summary of deliberations signaled the central bank is trying to strike the right balance between bringing inflation back to target without putting too much pressure on the economy.
• With underlying data pointing to inflation being stuck around 3%, the BoC appears to be leaning hawkishly, which has kept yields elevated and supported the loonie.

U.S. – Preparing for Landing

Readers would be right to ask, what’s “moderate” about another upside surprise to economic growth in the second quarter? Fed Chair Powell signaled a meeting-by-meeting approach on changes to the fed funds rate, opting to evaluate incoming data and fine-tune interest rates to help temper inflation. Incoming data have shown that the economy remains resilient – buoyed by healthy consumer spending growth and business investment – as fears of a recession gradually fade. What remains to be seen is whether inflation will continue to moderate in the coming months or whether the Fed will have to push interest rates higher still – thereby raising the odds the economy contracts.

The second quarter’s GDP release showed an economy that continues to chug along at a solid pace – exceeding expectations for a steeper slowdown. However, the composition of growth was interesting. In line with our forecasts, consumer spending growth advanced 1.6% quarter-on-quarter (q/q) annualized – slowing from 4.2% in Q1. The Fed will be reassured that its rate hiking cycle is filtering through to consumer behavior as spending growth slows despite a drum-tight labor market. Moreover, with rates at multidecade highs, the housing market is feeling the force of tight financing conditions, with residential investment continuing to pull back in the second quarter – now contracting for the ninth quarter in a row. With demand growth slowing, imports pulled back again – now having contracted for the third time in the past year. The gradual slowdown is also not unique to the U.S., as plummeting export growth indicates the global economy is slowing under the weight of inflation and higher interest rates.

A pleasant surprise in the data was the healthy activity in the business sector that provided a meaningful lift to the economy (Chart 1). Nonresidential investment advanced 7.7% q/q – good for the strongest showing since the first quarter of 2022. The flow of federal funds to support climate friendly investments is helping fuel the ongoing strength in structures and equipment investment – the latter registering its best quarterly growth rate since 2011, outside of the post-2020 lockdown bounce.

With full second quarter data showing a healthy consumer, all eyes were on June’s personal income and outlay report for signals of spending and price momentum heading into the summer months. Healthy spending held up in June and outstripped income growth, denting the personal savings rate. Between higher interest rates, strong inflation and depleting savings the pandemic era spending binge is slowing down. This is music to the Fed’s ears as it means softening inflationary pressures. Needless to say, the downside surprise on core PCE inflation (4.1% year-on-year vs. 4.2% expected) was a particularly welcome development. Even more encouraging, the near-term trend (Chart 2) has eased to its slowest pace since March 2021.

With inflation slowing and consumer spending remaining resilient the odds of a soft landing are ticking higher. However, the Fed will keep rates in restrictive territory into next year so, even if a recession is avoided, tepid economic growth is to be expected.

Canada – Canadian Economy Searching for Balance

Economic momentum in Canada looks to be finding its cruising speed in spite of a number of shocks that hit the country over the last few months. With GDP accelerating in May, and payroll data bouncing back strongly, expectations for another Bank of Canada (BoC) hike have nudged higher this week (Chart 1). This has the Canada two-year yield reaching a 22 year high of 4.8%, pushing the Canadian dollar to the upper end of the 72 to 76 U.S. cent range that has prevailed over the last ten months.

After leading the G7 in GDP growth in the first quarter of 2023, tracking for the Q2 has come in right around our estimate of 1% quarter-on-quarter annualized. Not bad considering the negative impulse coming from the public sector strike and wildfires that caused many firms in the oil & gas sector to shut production. Indeed, growth remained quite broad, with 12 of 20 industry sectors in expansion. Within this, the service sector continued to drive growth, a sign that cyclical strength may persist through the remainder of the summer.

As has been the case over 2023, strong consumer demand has been the impetus for Canadian economic resilience. And it hasn't just been people spending on 'need to have' items. Canadians have been spending on luxury items, such as new cars and dining out at restaurants. Such behaviour is not what occurs when people are preparing for recession. The robustness of the labour market has raised confidence. People have been seeing plenty of jobs on offer and wages rising faster than inflation. This improves purchasing power, notwithstanding the high interest rate environment. Just look at this week's payroll data, which showed a 130k gain in May and more than offset the impact of April's public sector strike decline.

The BoC has highlighted the resurgence in economic momentum for why it decided to execute on back-to-back rate hikes in June and July. While the BoC still thinks that consumer spending will cool on the back of past rate hikes, in its summary of deliberations, it stated that the "moderation will take longer than previously anticipated given the stronger-than-expected momentum in consumption in the second quarter and the combination of a still-tight labour market with accumulated savings by households”. In the BoC's mind, longer lags and less sensitivity to interest rates were convincing enough to keep increasing interest rates.

This speaks to the internal debate going on at the BoC. On one hand, the 475 basis point increase in the policy rate since early last year should eventually slow economic growth. But with the economy having surprised to the upside for most of this year, the Bank has had to question whether it has done enough. As we have written about a lot, the strength in consumer demand has caused expectations for core inflation to be stuck above 3% (Chart 2). So, although total CPI has moved to 2.8% year-on-year in June, forward-looking inflation indicators are signaling that the BoC will be hard-pressed to get inflation to settle at its 2% target.

Fresh labour market data for Canada and the U.S. lands next week. And both Bank of Canada Governor Tiff Macklem and U.S. Fed Chair Jerome Powell will be on the lookout for signs that higher interest rates are cooling things down.

In Canada, we expect a 25,000 uptick in new jobs in July following a stronger increase of 60,000 jobs last month. Still, surging population growth means that won’t be enough to absorb all new labour market entrants. The unemployment rate edged up 0.2 percentage points in each of May and June and we look for another tick higher in July. Total job postings have also been trending lower. And slower wage growth in recent months has been consistent with signs that the surge of excess demand for workers in the economy has weakened.

The jobs report is among a slew of indicators to come in advance of the BoC’s next interest rate decision on September 6th (including one more monthly inflation reading.) The key question is whether interest rates (overnight rate now at 5% after another hike this month) are sufficiently restrictive to tame inflation. GDP has remained firmer than expected but has also been boosted by strong population growth. Per-capita GDP growth rates have been substantially softer. And higher unemployment rates would help to reassure the BoC that the balance of labour demand and supply is returning. We see softening job markets keeping the BoC on the sidelines with no additional interest rate increases this year. Still, central banks in Canada and abroad won’t hesitate to hike interest rates further if needed to put inflation back in target range.

Week ahead data watch

The next U.S. jobs report will come out on Friday. We expect the unemployment rate to hold steady at 3.6%, and non-farm payroll employment to rise (+185,000) in July, slightly lower than the +228,000 in the prior month. Labour markets remain firm, but we look for unemployment to drift higher during the second half of the year.

US

With inflation steadily cooling, the Fed’s historic tightening campaign appears to be ending.  The focus on Wall Street won’t just be inflation but now also economic activity.

The upcoming week will be filled with several economic readings.  On Monday, we will see two Fed regional surveys.  The MNI Chicago PMI is expected to slightly improve while the Dallas Fed manufacturing activity report remains deeply in negative territory.  Tuesday will be busy with the final manufacturing PMI reading, the ISM manufacturing report, and JOLTS job openings.  Wednesday contains the ADP employment change which is expected to show hiring cooled from the 497,000 pace to 185,000. Thursday has initial jobless claims and the ISM services report.  Friday is all about the July nonfarm payroll report, which should show hiring eased from 209,000 to 185,000.  The unemployment rate is expected to remain steady at 3.6%, while average hourly earnings on a monthly basis tick lower to a 0.3% pace.

Earnings will be massive this week as we get updates from Caterpillar, Pfizer, Uber, JetBlue, Humana, Yum Brands, Apple, and Amazon.

Eurozone

Next week gets off to a fast start, with eurozone flash HICP data released shortly after the European open. Further progress is expected in the report, albeit the more substantial moves aren’t expected until September. Still, favourable base effects and lower energy prices should ensure inflation continues to fall in the months ahead, alleviating pressure on the ECB to hike again in September.

UK 

Many of the major central banks are now pondering whether further rate hikes are necessary, meaning meetings without them are going to become increasingly common. Unfortunately for the Bank of England, it can’t include itself in that list with at least a couple more hikes likely needed before it can even consider pausing. The inflation data last month was a big step in the right direction and if repeated over the next couple of months could leave the MPC in a much better position in November. For now, 25 basis points is the least we can expect and new forecasts will tell us how close they now feel they are to achieving their mandate.

Russia

The CBR is expected to release its monetary policy report on Monday which will be keenly eyed as the central bank has started raising interest rates again. There’s also a wide array of data being released next week including GDP, retail sales, unemployment, and PMIs.

South Africa

Next week mainly offers tier two and three economic data with the whole economy PMI on Thursday probably the pick of the bunch.

Turkey

Inflation is expected to spike again in July, rising 9.1% on the month and 47.3% on an annualized basis. The central bank has started raising rates again after the predictable failure of its pre-election easing program. But it has faced criticism for raising too slowly, something this report may highlight. Whether it will change anything is another thing as the central bank knows the views of President Erdogan and what has happened to previous policymakers that have raised rates faster.

Switzerland

CPI data on Thursday is expected to provide some comfort for the SNB, with prices seen falling slightly month on month in July. That is expected to take the annualized figure to 1.6% and well within the central bank’s target range, removing the pressure to raise rates again in September.

China

On Monday, we will have July’s NBS manufacturing & non-manufacturing PMIs. The consensus is for another month of contraction for the manufacturing sector at 49.2, slightly above June’s reading of 49. In the service sector, growth is forecast to decline further to 52.9 from 53.2 in June. If these data turn out as expected, it will be a fourth consecutive month of contraction for the manufacturing PMI and a fourth consecutive month of growth slowdown for the non-manufacturing PMI.

On Tuesday, the Caixin manufacturing PMI that includes small and medium-sized enterprises for July will be out. A slight dip in growth to 50.3 is expected, from 50.5. In addition, the Caixin services PMI will be released on Thursday; the consensus is eyeing a dip to 52 from 53.9 in June. If it comes in as expected, it will be the slowest growth in services since January 2023.

If these key PMIs continue to show softness in both external and internal demand, China policymakers are likely to see an increased need to introduce more targeted stimulus to shore up consumer demand and confidence after the recently concluded Politburo meeting that has vowed to introduce “counter-cyclical” measures to negate the current weakness seen.

India

Two key data will be released; the manufacturing PMI on Tuesday and the Services PMI on Thursday. A slight dip in growth in July’s manufacturing to 57 from 57.8 is expected in July. If it turns out as expected, it will be a second consecutive month of growth slowdown in the manufacturing PMI.

The services PMI for July is expected to dip slightly as well to 58 from 58.5 in June. If it turns out as expected, it will be a third consecutive month of growth slowdown in the services sector.

Australia

The key highlight for this week will be the RBA interest rate decision on Tuesday; a 25 basis points hike on the policy cash rate is expected to 4.35% after the RBA left it unchanged during the previous meeting.

Interestingly, data from the ASX 30-day interbank cash rate futures as of 28 July has only priced in an 8% chance of a rate hike of 25 bps on Tuesday which is down significantly from 48% last Friday, 21 July. This reduction in odds is likely due to the recent slowdown in Q2 inflationary growth.

Next up, we will have the balance of trade for June on Thursday.

New Zealand

Two key data points to watch in the coming week. Firstly, ANZ business confidence for July with the forecast calling for another dip to -22 from -18 in June.

Employment data will be out on Wednesday. The consensus for Q2 employment change is for a dip to 0.6% from 0.8% in Q1 while the Q2 unemployment rate is expected to tick up slightly to 3.5% from 3.4%, and the participation rate to hold steady at 72%.

Japan

Several key data releases in the coming week. On Monday, we will have industrial production, retail sales, and housing starts for June as well as consumer confidence data.

Industrial production is forecast to improve to 5.3% y/y in June from 4.2% y/y in May, the consensus for retail sales is expecting a slight increase to 5.9% y/y in June from 5.7% y/y in May while consumer confidence for July is forecasted to improve further to 36.8 in July from 36.2 in June.

The unemployment rate for June will be released on Tuesday with the consensus eyeing a slight dip to 2.5% from the 2.6% recorded in May.

Lastly, market participants will scan for more clues on further monetary policy normalization in the Bank of Japan’s monetary policy meeting minutes on Wednesday as it just implemented a creative flexible tweak on the upper and lower limits of the Yield Curve Control program for the 10-year JGB yield.

Singapore

The manufacturing PMI for July will be out on Wednesday, a slight improvement to 49.9 from 49.7 in June is being forecasted. Retail sales for June will be released on Friday where a dip is being forecast to 1% y/y from 1.8% y/y in May.

Lastly, the two major Singapore banks; DBS Group, and Oversea-Chinese Banking Corp will release their Q2 earnings on Thursday and Friday, respectively, before the market opens.

Monday, Jul 31, 2023

Tuesday, Aug 1, 2023

Wednesday, Aug 2, 2023

Thursday, Aug 3, 2023

Friday, Aug 4, 2023

The Bank of England and Reserve Bank of Australia will wrap up the summer central bank decisions in the coming week, although the US jobs report may attract the most attention. The ISM PMIs will be the other highlights in the United States, while employment numbers are due in Canada and New Zealand too. Over in Europe, the agenda will be dominated by flash inflation and GDP data. Oil will also be in the spotlight as the OPEC+ alliance holds its monthly meeting.

Another close call for the RBA?

The Reserve Bank of Australia meets on Tuesday for its August policy decision and markets and economists are split as to what the outcome will be. Analysts are predicting a 25-basis-point increase in the cash rate to 4.35% following a pause in July. However, the minutes of the July meeting revealed the decision was a close call and that the Board would “reassess the situation” in August.

The Bank will publish updated economic projections on Friday but it’s doubtful how much clarity they will provide. Economic data has been somewhat mixed lately – the jobless rate dipped to 3.5% in June, but inflation also fell more than expected, with CPI cooling to 6.0% year-on-year in Q2.

However, other indicators have been gloomier as the manufacturing and services PMIs both contracted in July. That’s why the markets aren’t convinced that policymakers will press the hike button, although they do foresee one final 25-bps increase over the next nine months. But there is reason to be optimistic as Australian exporters stand to benefit from China’s renewed efforts to stimulate its economy.

Therefore, if policymakers choose to stay on the sidelines for another meeting, the decision might not be very negative for the Australian dollar as a hawkish hold is the most dovish scenario. But neither are they likely to close the door to additional hikes if they decide not to wait and raise rates next week, boosting the local dollar.

The aussie could also gain if the PMIs out of China show some improvement in July. The official manufacturing and non-manufacturing PMIs are out on Monday, while the Caixin manufacturing and services PMIs are due on Tuesday and Thursday, respectively.

BoE to downshift again 

The Bank of England is certain to raise the Bank Rate again when it meets on Thursday but there is less confidence about the size of the hike. A 25-bps increase is fully baked in, but markets have assigned around a 30% probability of a larger 50-bps move. Following the June inflation figures when UK CPI finally tumbled below 8% and core CPI eased too, the arguments for a second consecutive double hike have weakened considerably, and even more so after the recent dismal PMIs for July.

Very poor flash PMI estimates tend to get revised up and that could happen when the final readings are released on Tuesday (manufacturing) and Thursday (services). However, the UK economy is clearly struggling amid a slowdown in its biggest trading partners and households being squeezed from soaring mortgage costs. Hence, the Bank of England is unlikely to go big even as it stresses the need for further tightening.

In the event that the BoE doesn’t surprise, what might be more relevant for the pound is the BoE’s latest set of inflation forecasts, in particular, how fast it sees CPI falling to the 2% target.

Is the US labour market coming off the boil?

The Fed decision may be out of the way but the upcoming jobs report could prove more vital for the markets as Powell kept his options open for the September meeting. The jobs market in America has been steadily losing steam this year but not nearly fast enough to ease concerns about a wage-price spiral. However, the Fed may finally be getting what it wants as employment grew at the slowest pace in two-and-a-half years in June and that trend likely continued in July.

Nonfarm payrolls are expected to have risen by 184k in July, down from 209k previously. The unemployment rate is forecast to have held steady at 3.6%, while average earnings probably kept growing by slightly more than 4% y/y.

The weekly jobless claims have been edging lower for most of July so a positive NFP surprise is possible, though the markets might not necessarily welcome a strong print as it would bolster the case for a September rate hike.

Investors will be able to further scrutinize the US labour market with Tuesday’s JOLTS job openings and Wednesday’s ADP employment report. Other data will include the Chicago PMI on Monday and factory orders on Thursday.

But aside from the payrolls numbers, what could move the US dollar the most are the ISM PMIs on Tuesday (manufacturing) and Thursday (non-manufacturing). Like in Europe, the US manufacturing sector has been in recession this year but in stark contrast, the services economy has continued to expand, and the non-manufacturing PMI unexpectedly bounced higher in June.

With the Fed undecided about whether to raise rates again, the incoming data could swing the odds in the dollar’s favour if they are stronger-than-expected.

Euro eyes flash CPI as ECB ponders pausing

The European Central Bank made a dovish turn this week by not committing to further rate hikes. The change in stance came on the back of softer inflation readings as well as growing signs that the Eurozone economy could be headed for a recession.

Monday’s flash CPI numbers for July will therefore be crucial in shaping expectations about additional rate hikes in the euro area this year. The headline rate of inflation slipped to 5.5% y/y in June and is projected to fall again to 5.3% in July to a one-and-a-half year low.

However, underlying inflation is proving to be a lot stickier as core CPI that excludes all volatile items such as food and energy edged up in June to 5.5%. It is forecast to inch lower to 5.4% in July, but any upside surprises could lead to some scaling back of bets that the ECB is done raising rates.

Preliminary GDP estimates for the second quarter are also released on Monday. Economic growth was flat in the first quarter, but GDP likely managed a modest expansion of 0.1% in the three months to June.

With future rate hikes hanging in the balance, the euro will be very sensitive to price and growth indicators in the run up to the September meeting.

More data and an OPEC meeting

Elsewhere, CPI numbers will be watched in Switzerland on Thursday and New Zealand’s quarterly jobs data will be important for the kiwi early on Wednesday. Meanwhile, Canada will get employment figures too for July on Friday.

Another solid labour market report could boost the odds of one more rate increase by the Bank of Canada this year, lifting the loonie. On the other hand, the Canadian currency will likely shrug off a meeting of OPEC and non-OPEC countries on Thursday as the major oil producers are not expected to announce any significant changes to their output quotas. Oil futures have been rallying lately following the previously announced cuts by Saudi Arabia and Russia, but also on the hopes that more pro-growth policies in China will buoy demand.

The Reserve Bank of Australia (RBA) will conclude its latest meeting at 04:30 GMT Tuesday. Economic developments have been mixed lately, so markets are only pricing in a 20% probability for a rate increase. As for the Australian dollar, the most crucial variable might be the power and scope of China’s stimulus measures, instead of any domestic developments. 

Mixed news

The Australian economy has displayed some mixed signs lately. On the bright side, the labor market is exceptionally tight, with the unemployment rate hovering near its lowest levels in five decades.

In addition, the prices of commodities that Australia exports have started to recover, encouraged by the promise of new stimulus measures in China, who is the world’s largest consumer of commodities and also Australia’s biggest trading partner.

Meanwhile, inflation seems to be cooling down. The CPI rate for the second quarter clocked in at 6%, which is still very elevated but a clear improvement from the 7% in the previous quarter. While services inflation and rents remain extremely hot, those pressures have been partially negated by a sharp cooldown in the prices of goods.

The problem is that business surveys point to a slowdown in economic growth moving forward. In July, the composite PMI fell into contractionary territory - a warning sign that economic activity is losing steam as higher borrowing costs begin to bite consumers.

RBA decision

Turning to the upcoming meeting, market participants think the most likely outcome is that the RBA does not raise interest rates, with the implied probability for no action standing at around 80% and the chance of a rate hike near 20%.

This pricing seems fair. Inflation is cooling off and business sentiment is worsening, so there doesn’t seem to be any real urgency for the RBA to push the rate-hike button again.

Yet, the central bank might strike a relatively hawkish tone, keeping the prospect of future action alive. With the labor market so tight, there’s a concern that wage pressures could intensify, keeping the inflationary fire burning for some time. Similarly, there’s a risk inflation could receive a second wind if China rolls out a strong stimulus package.

Bearing everything in mind, the most sensible strategy might be for the RBA to keep rates unchanged but signal that the tightening cycle is not over yet. Such a combination could inject volatility into the markets.

The initial reaction in the aussie might be negative in case rates are kept unchanged, although any weakness could be short-lived and even reverse if the RBA strikes a hawkish tone.

Looking at the charts, the levels in aussie/dollar that could come into play in this scenario are 0.6710 on the upside and 0.6595 on the downside. Overall, the pair has been in a downtrend since early 2021 and it would take a clean break above 0.7160 to change that.

China matters most

In the big picture, the main driver for the aussie might be how the Chinese economy evolves, not what the RBA does. Markets know that the central bank is close to the end of its tightening campaign, even if it raises rates one final time.

On the other hand, there’s a lot of uncertainty surrounding China. Beijing has promised stimulus measures to boost domestic consumption, as the economy struggles with a slowdown in the manufacturing and real estate sectors, but hasn’t announced anything specific yet.

The details and scope of these measures will be extremely important for commodity prices, and by extension, for the commodity-sensitive Australian dollar. A round of powerful stimulus would likely propel the currency higher, but if Chinese authorities underwhelm, the aussie could suffer collateral damage.

Until there is some clarity on this subject, it’s difficult to get too excited about the aussie.

Summary

• The Bank of Japan (BoJ) sprung a surprise at today's monetary policy announcement, delivering another hawkish tweak to its Yield Curve Control policy. While the BoJ did not change its main policy parameters, it said it would conduct yield curve control with greater flexibility, regarding the upper and lower bounds of the range as references, not as rigid limits, in its market operations.
• The BoJ also said it would offer to buy 10-year JGB's at 1.00% every day through fixed-rate purchase operations if needed. In effect, the change means the Bank of Japan will cap 10-year JGB yields at 1.00% or, perhaps more accurately and in reality, somewhere between 0.50% and 1.00%.
• Overall, we view today's policy adjustment as primarily driven by operational and tactical considerations. From a purely economic perspective, we think the case for a further shift to less accommodative monetary policy is growing but not yet overwhelming. From an operational perspective we also see limited likelihood of a further policy adjustment for now if, as we expect, global tightening is near an end, meaning global bond yields could stabilize and eventually move lower. Against this backdrop, we see Bank of Japan monetary policy as on hold for the foreseeable future, and certainly at least for the rest of 2023.

Bank of Japan Loosens Grip on Long Term Bond Yield

The Bank of Japan (BoJ) sprung a surprise at today's monetary policy announcement, delivering another hawkish tweak to its Yield Curve Control policy, a move that occurred a little sooner than the October adjustment we had forecast. With respect to its main policy parameters, the BoJ held its Policy Balance Rate at -0.10%, and said it would continue to target a 10-year Japanese Government Bond (JGB) yield of 0% with a fluctuation range of +/- 50 bps. Importantly however, the BoJ said it will “conduct yield curve control with greater flexibility, regarding the upper and lower bounds of the range as references, not as rigid limits, in its market operations.” The Bank of Japan also said it would offer to buy 10-year JGB's at 1.00% every day through fixed-rate purchase operations if needed. In effect, this change means the Bank of Japan will cap 10-year JGB yields at 1.00% or, perhaps more accurately and in reality, somewhere between 0.50% and 1.00%.

In our view, a cap of “somewhere between 0.50% and 1.00%” reflects comments from BoJ Governor Ueda, who said that depending on the situation yields could go beyond 0.50%, but that he didn't expect long-term yields to get to 1.00%, nor did he think it was appropriate for yields to get to 1.00%. Ueda added that he did not view the move as a step towards normalization. The BoJ's modestly upgraded economic projections also suggest only a moderate increase in the 10-year JGB cap to “somewhere between 0.50% and 1.00%”, with inflation not yet seen rising sustainably above 2%. The BoJ raised its core CPI forecast for FY2023 to 2.5%, but lowered in core CPI forecast for FY2024 slightly to 1.9%, while keeping at 1.6% for 2025. The central bank did however acknowledge that the risk to its inflation forecasts were to the upside. Separately, the BOJ lowered its GDP growth forecast for FY2023 slightly to 1.3%.

Overall, we view today's policy adjustment as primarily driven by operational and tactical considerations, and against that backdrop, do not expect the BoJ to follow up with another policy adjustment in the near-term. From a purely economic perspective, the case for less accommodative monetary policy is growing but not yet overwhelming, in our view. With respect to economic growth prospects, it is true that Japan started 2023 on a firm footing, with Q1 GDP growing at 2.8% quarter-over-quarter annualized and the Q2 Tankan survey hinting at ongoing growth through the first half of the year. However, while wage growth has quickened it has not kept pace with the increase in prices, meaning that in real or inflation-adjusted terms, trends in employee compensation and household income have turned negative. The negative income trends could eventually restrain the consumer, and see Japan's economy lose momentum over time. We also expect inflation to recede, and indeed the Bank of Japan's own forecasts see inflation slowing back below 2% over the medium-term. Thus, from an economic perspective we do not see a strong rationale to tighten policy in the period ahead. From an operational perspective, we also see limited likelihood of a further policy adjustment for now. If, as we expect, global monetary policy tightening comes to an end in the immediate months ahead, upward pressure on global bond yields should ebb and, global bond yields could start moving lower. In this environment we would not expect 10-year Japanese government yields to rise close to the “hard” yield cap of 1.00% for the time being, and therefore do not envisage any significant new operational challenges for the Bank of Japan in terms of implementing monetary policy. Against this backdrop, we see Bank of Japan monetary policy as on hold for the foreseeable future, and certainly at least for the rest of 2023.

Personal income grew 0.3% month-on-month (m/m) in June, which was below market expectations for 0.5% growth. This marked a deceleration from the prior month's gain of 0.5%. Gains were led by compensation to employees, which also rose by 0.5% for the third consecutive month.

Accounting for inflation and taxes, real personal disposable income rose 0.2% m/m, slightly slower than the 0.4% growth posted the previous month.

Personal consumption expenditures rose 0.5% m/m, a marked acceleration from the 0.2% gain in May (revised higher from 0.1%). June's reading came in just above market expectations for 0.4% growth.

• Expenditures on services grew 0.4% m/m for the second consecutive month. Spending on financial services and insurance, housing and utilities, and recreation were the primary contributors to movements in the services category.
• There was also an increase in goods spending. Goods spending rose by 0.8% m/m, a rebound from the 0.3% decline posted in May. There was an improvement in spending on both durables (1.4%) and non-durables (0.5%)..

Adjusting for inflation, real spending grew 0.4% for the month, coming in just above the consensus estimate for a 0.3% gain. In real terms, goods spending was up 0.9% m/m, while services were up a more muted 0.1%.

The personal consumption expenditure (PCE) price deflator rose 0.2% m/m, and 3.0% on a year-on-year (y/y) basis – right in line with market consensus forecast and below May's reading (3.8% y/y).

The core PCE price deflator (which excludes food and energy and is the Fed's preferred measure of inflation) rose 0.2% m/m, again in line with the consensus forecast and below May's reading (0.3%). On an annual basis, core PCE inflation decelerated to 4.1% y/y from 4.6% y/y the month prior (consensus forecast was 4.2% y/y). This is the first time in the last seven months that the measure has gone below 4.6%.

The personal saving rate was 4.3% in June, which was 0.3%-pts below the 4.6% reading in May.

Key Implications

U.S. households were feeling optimistic in June, and it showed in their spending. Despite high prices and tightening credit conditions, consumers did their part to keep economic growth in positive territory. As such, growth in real consumption expenditure for 2023 Q2 was 1.6% annualized (down from 4.2% in 2023 Q1), and was the primary contributor to the above-expectations 2.4% (q/q annualized) growth in real GDP. Services spending did most of the heavy lifting, but goods spending also lent a helping hand.

On the prices side, inflation has been trending in the right direction, but the Fed is yet to be convinced of its staying power. With its preferred measure still hovering above 4%, the Central Bank delivered on its promise, raising its policy rate this week to a 22-year high. The Fed's task is complicated by the fact that real incomes are rising, which keeps the spending power of consumers intact. While good for consumers, it continues to complicate the Fed's task of bringing inflation in line with target. Still, a resilient consumer and strong labor market increase the odds that the Fed will eventually get to target without tipping the economy into a recession. The Central Bank may just have to exercise a bit of patience in the interim.