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Summary

United States: What Shall We Do Now?

• Piecing together the implications of this week's softer-than-expected inflation data with last week's blowout nonfarm payroll report for the Fed's policy path is top of mind for many. The FOMC has made it clear that it needs to see inflation slowing on a sustained basis before pivoting from its current stance.
• Next week: Housing Starts (Mon.), Retail Sales (Tues.), Industrial Production (Tues.)

International: Lower U.S. CPI Fuels International Financial Markets

• The U.S. dollar broadly sold off against foreign currencies, particularly emerging market currencies this week. Currencies across Latin America and EMEA rallied in the immediate aftermath of the July U.S. CPI print and sustained those gains over the second half of the week.
• Next week: Canada CPI (Tues.), German ZEW Survey (Tues.), U.K. CPI (Wed.)

Interest Rate Watch: The Great Flattener

• On Tuesday of this week, the spread between the two-year Treasury yield and the 10-year Treasury yield reached -50 bps, the largest inversion between the two securities since 2000. What is driving this move, and what does it tell us about future economic conditions?

Credit Market Insights: Running a Tight Ship

• The Fed released its Senior Loan Office Opinion Survey for Q2-2022 last week. Surveyed banks pointed to the beginnings of tightening in lending standards and plans to continue to tighten throughout the rest of the year. Demand for credit card loans rose as consumers continue to spend amid blazing inflation.

Topic of the Week: Mind the Gap: New Evidence Suggests Early Emergence of Gender Wage Gap

• Recent data released by the Department of Education suggests the gender wage gaps form almost immediately upon workforce entry. These findings provide color and insight into our continuously evolving understanding of wage disparities among gender.

Full report here.

U.S. Highlights

• The U.S. Senate passed a climate, healthcare, and tax bill known as the Inflation Reduction Act of 2022 earlier this week. The legislation is now off to the House of Representatives for a final vote later today where it is expected to pass.
• July CPI came in weaker than expected, with the headline measure flat on the month and core “only” increasing by 0.3% month-over-month.
• While the deceleration in inflation comes as welcome news to policymakers, Fed officials have reiterated that more tightening will be required to achieve price growth stability of 2%.

Canadian Highlights

• A thin Canadian economic data calendar resulted in a lot of eyes looking south of the border in hopes of getting a preview of what is to come next week.
• The main focus next week will be on Canadian CPI, which is expected to show further deceleration on the back of falling energy prices.
• We will also be watching housing sales and price data, which is set to show another drop in overall real estate activity and a further leg down in prices.

U.S. - Inflation Was the Word of the Week

It was a week full of surprises, with inflation being the key theme. Chief among them was the U.S. Senate quickly moving to pass the Inflation Reduction Act of 2022 (IRA). It now heads to the House of Representatives later today for a final vote, where it’s expected to pass. The reconciliation bill is a significantly scaled back version of the far more ambitious Build Back Better Act, though it still incorporates many of the key climate related initiatives that were included in the previous bill.

In terms of broad strokes, the IRA aims to spend roughly $430B on climate and healthcare initiatives over the next decade and is estimated to more than offset those expenditures with $740B of proposed revenue. Over 85% of the appropriated expenditures will be directed towards climate related initiatives and will be dispersed mainly through grants and loans. Of those investments, perhaps most noteworthy is the $80B in new rebates allocated to eligible households for electric vehicles (EVs) and to help decarbonize residential buildings. The additional funding for EVs not only maintains the existing $7,500 rebate but also introduces a new tax credit of up $4,000 for both used and new EVs, with the latter applying only to those vehicles made in North America.

On the healthcare side, the IRA will put a cap of $2,000 on out-of-pocket prescription drug costs for individuals on Medicare. It also aims to bring down the cost of the most expensive drugs by allowing the government to negotiate the price of a subset of those drugs covered by Medicare, though this won’t start until 2026.

All of this will be paid for through a new 15% minimum corporate tax imposed on corporations earning more than $1B, enhancements to the IRS audit and review process, and taxing share buybacks. The fact that the deficit will be reduced over the next decade is what is being used to justify the “inflation reduction” element of the bill. However, the total deficit reduction is only estimated to be $400B (or 1.6% of GDP), and will be spread over the next decade – suggesting the impact to growth and inflation will likely be negligible.

Turing to the other surprise this week, July CPI data (finally!) came in weaker than expected. The headline index was flat on the month, while core prices “only” rose by 0.3% m/m (Chart 1). Indeed, the recent pullback in energy prices subtracted from the headline measure, though accelerating food prices provided a partial offset. Looking to the core measure, there were a few encouraging tidbits. Core services grew by 0.4% m/m – down from the 0.7% m/m reported in June. A lot of the pullback was the result of a softening in travel-related categories, such as airfares, car rentals, and lodging away from home (Chart 2). Other green shoots emerged on the goods side, as prices across most categories decelerated, while used vehicle prices, apparel, and education goods all declined.

This will be welcome news to FOMC officials, but as San Francisco Fed president Mary Daly said on Wednesday “it’s still too early to declare victory”. Daly reiterated her support to dial back on the pace of rate hikes in September but didn’t rule out another 75bps move should the turn in inflation prove to be fleeting.

Canada -Looking South for Signs of Hope

With an empty Canadian economic data calendar, all eyes were on what was moving south of the border. Clearly U.S. CPI was the focus with the upcoming Canada CPI release next week. Given that headline month-on-month (m/m) CPI in the U.S. showed zero price growth in July (Chart 1), sentiment jumped on hopes that central banks may not have to hike rates as much as previously thought. This caused short-term bond yields to drop and equity markets to rally over the week.

Following the U.S.'s lead, we are looking for Canadian CPI to show a second straight print of decelerating monthly price growth. This monthly trend should translate into a peak in year-on-year (y/y) inflation, with the headline number coming back below 8%. The pullback in gasoline prices will be a primary driver here, with prices having fallen approximately 20% from their peak in early June.

Though a near-term peak in inflation will come as welcomed news, the broadening of inflation to all areas of the economy is likely to keep the annual figures uncomfortably high through the remainder of 2022. We'll be closely watching the evolution of services inflation, which is most reflective of Canadian domestic demand, and has just started to accelerate on the back of rising wages. It is currently growing at 5.2% y/y and is unlikely to show much deceleration given the still ongoing re-opening boom.

Speaking of interest rates, we will also be getting data on Canadian home sales and prices next week. We are looking for another leg down in sales activity. And with listings holding up reasonably well, this will force the sales-to-listings ratio (currently at 51.7%) even lower. This is putting even more downward pressure on home prices. Based on early readings of transaction data over July, we are expecting the peak-to-trough decline in prices since the first quarter to continue to push towards our forecast of 19%. With the BoC unlikely to pause on rate hikes until later this year, the real estate sector's fall from grace isn't done yet (Chart 2).

The rapid rise in Canadian inflation likely slowed in July as global commodity prices fell—mirroring a drop in the U.S. inflation earlier this week. By our estimate, headline inflation slowed to 7.7% on a year-over-year basis, down from 8.1% in June. The price of gasoline has declined almost 10% since July, though it remains up more than 30% from a year ago. By contrast, consumer natural gas prices spiked higher last month—particularly in Ontario and British Columbia.

There continue to be signs that global inflation pressures are easing off. Oil prices are down 25% from early June. Global freight shipping costs and times, by air and ocean, have fallen significantly over the past few months. And on the domestic front, though higher interest rates are pushing up mortgage payments, home buying costs (which have contributed substantially to price growth over the last year) have shifted from record monthly increases over the winter to declines in the spring and summer. Our own cardholder data shows consumer spending is still very strong, but has plateaued through July and into August.

Despite the expected dip in next week’s consumer price report, inflation remains much too high and isn’t likely to return sustainably to the Bank of Canada’s target levels without the economy cooling. In June, over 60% of products and services in the CPI were growing at above the Bank of Canada’s 1% to 3% target range. Against that backdrop, the BoC will continue to forcefully raise the overnight rate. We expect a 75 basis point increase in September to build on the 100 basis point hike—the largest since 1998—in July.

Week ahead data watch:

Statistics Canada’s flash estimate predicted a 1% decline in June manufacturing sales. Despite overall price growth, petroleum and coal led the decline followed by weakness in aerospace.

The early estimate of July retail sales was relatively flat at +0.3% month-over-month from June. Our own RBC consumer tracker showed spending plateauing after surging out of pandemic lockdowns.

Canadian home resales will show another decline in July based on early local market reports.
Canadian housing starts likely remained firm in July given the increase in permit issuance to over 300,000 in June.

U.S. economic data will look a little better in July despite a slowing economic growth backdrop. Retail sales likely edged higher even as gasoline station sales dropped due to falling prices. Higher motor vehicle production and a 2% increase in manufacturing hours worked should leave the industrial production report looking firm.

Barring the obvious exception

We may have entered into a typically slower time of year for financial markets but as last week showed, there really is no such thing in 2022 and I expect next week to be no different.

In fact, there are a number of headline events that will grab everyone’s attention, not least the FOMC minutes on Wednesday. While we know the Fed has shifted to data-dependency, the minutes could hold further clues as to the balance on the committee. Of course, a lot of data falls between the July and September meetings – including two inflation and jobs reports – which could make those views less relevant but there’s always scope for a surprise.

There are a number of interest rate decisions next week and unsurprisingly, the bulk will likely involve a large rate hike. The outlier is obviously the CBRT which continues to be driven by unorthodox views on the link between inflation and interest rates, much to the misfortune of all those experiencing nearly 80% inflation as a result.

US

Two reports showed US inflation is slowing and that has tilted the scales for traders in pricing in a slightly less aggressive Fed in September. Wall Street will now look for some guidance hints from the release of the FOMC minutes. The Fed has signalled that guidance wouldn’t be transparent going forward, so we will probably just have mostly reiterations of their data dependence.  It might take another cooler-than-expected inflation report before the Fed can admit that they are ready to consider slowing down hikes.

The other important data set for the week is the July retail sales report which should show the consumer is weakening. Traders will also look to see if jobless claims continue to trend higher and if the labour market is showing any signs of becoming less tight.

Fed speak will include appearances during the week from the Fed’s George and Kashkari.

Election season continues with US primary elections in Alaska and Wyoming.

EU 

Another quiet week is in store for Europe, with mostly tier two and three data being released. The standout here is the final inflation reading as traders assess interest rate expectations for September. No change is expected but of course, it could surprise.

As will remain the case over the winter, the focus will remain on the energy market and supplies of Russian gas and oil.

UK 

The UK is heading for a long period of stagflation, with the BoE forecasting five quarters of contraction from Q4 this year while inflation remains high and interest rates rise. That’s on top of the contraction in the second quarter that was confirmed on Friday. Next week offers labour market, inflation and retail sales data which could provide additional insight into how bad the situation already is.

Russia

PPI inflation is the only release of note next week. The central bank has been aggressively easing in recent months to support the economy and soften the rouble which remains around 20% higher against the dollar since the invasion. The PPI data is unlikely to alter the CBRs course.

South Africa

Another quiet week with retail sales on Wednesday the only notable release.

Turkey

At the risk of sounding repetitive, inflation was almost 80% last month and the CBRT next week is expected to leave the repo rate unchanged at 14% as it continues to cling to its misguided views on inflation and interest rates.

Switzerland

Data highlights next week include PPI on Monday, trade on Thursday and industrial production on Friday. Inflation is running at 3.4% so a 50 basis point hike could be on the cards when the SNB meets next month. Assuming it waits that long, of course. It does love a surprise.

China

On Monday, China releases July retail sales, which are expected to rise to 4.2%, up from 3.1% in June. Investment and industrial production are also expected to accelerate, pointing to a strengthening recovery. Exports have increased but the strict zero-Covid policy has dampened domestic consumption.

The People’s Bank of China sets its one-year medium-term lending facility rate this week. The central bank is expected to maintain the rate at 2.85%, where it has been pegged since January. The MLF could be cut in the next month or two, with the PBOC having previously signalled its intent to do so due to weak household spending and a desire to scale back funding costs for domestic enterprises. But with inflation running close to 3%, alternative targeted measures may be preferred.

India

The highlight next week is WPI inflation on Tuesday. It is expected to drop back slightly to 14.2% which will be welcome following the 50 basis point rate hike from the RBI last week. Further hikes may be warranted in the coming months as the central bank tries to get inflation back below target.

Australia 

On Tuesday, the RBA releases the minutes of its August meeting. The markets will be looking for insights into the RBA’s decision at the meeting to raise rates by 0.50%, bringing the cash rate to 1.85%.

Australia publishes employment change on Thursday. The labour market is expected to decelerate in July and post gains of 40,000. This follows the June gain of 88,400, which was higher than expected. The unemployment rate is expected to remain steady at 3.5%.

New Zealand

The Reserve Bank of New Zealand meets on Wednesday. The RBNZ has been at the forefront of aggressive rate hikes by central banks and is expected to raise the cash rate by 50 basis points to 3.00%. This would mark a fourth successive 50bp increase, with further rate increases expected in the coming months. Along with the rate decision, the RBNZ will publish revised growth and inflation forecasts.

Japan

Japan releases its second-quarter GDP on Monday. A strong rebound of 2.6% YoY is expected, after a disappointing -0.5% release in Q1. The modest economic recovery has been driven by post-Covid domestic demand.

A stronger economy is also producing higher inflation, and we’ll get a look at July’s Core CPI on Friday. Core CPI is forecast to rise to 2.5%, up from 2.2% in June. This would push inflation further away from the Bank of Japan’s 2% target, but the central bank is unlikely to reduce stimulus until it is convinced that inflation is not transient.

Singapore

No data or events next week.

Economic Calendar

Sunday, Aug. 14

Economic Data/Events

• India trade
• Saudi Aramco reports Q2 results

Monday, Aug. 15

Economic Data/Events

• US cross-border investment, empire manufacturing
• Canada existing home sales
• China liquidity operations, retail sales, property prices, industrial production, surveyed jobless
• Japan GDP, industrial production
• New Zealand performance services index
• Thailand GDP
• German Chancellor Scholz meets Nordic leaders in Oslo
• South Korea and North Korea celebrate Liberation Day, an annual holiday in both countries to mark their liberation in 1945 from 35 years of Japanese rule.
• Assumption Day is observed in many European countries, including Spain, France and Switzerland. Some financial markets are closed.

Tuesday, Aug. 16

Economic Data/Events

• US housing starts, industrial production
• Australia household spending
• Canada housing starts, CPI
• Germany ZEW survey expectations
• India wholesale prices
• Israel GDP, CPI
• Japan department store sales, tertiary index
• Mexico international reserves
• UK jobless claims, unemployment
• Foreign Secretary Truss and former Chancellor Sunak hold campaign events
• Alaska and Wyoming hold primary elections.

Wednesday, Aug. 17

Economic Data/Events

• US FOMC minutes, business inventories, retail sales
• Australia leading index, wage price index
• Eurozone GDP
• Hungary GDP
• Japan machinery orders, trade
• Singapore non-oil exports, electronic exports
• South Africa retail sales
• UK CPI
• New Zealand PPI
• RBNZ Rate Decision: Expected to raise rates by 50bps to 3.00%
• RBNZ Governor Orr holds a news conference after the release of the central bank’s latest monetary policy statement
• EIA crude oil inventory report

Thursday, Aug. 18

Economic Data/Events

• US existing home sales, initial jobless claims, Conference Board leading index
• Australia unemployment
• China SWIFT global payments
• Eurozone CPI
• New Zealand trade
• Norway GDP
• Norway rate decision: Expected to raise rates by 50bps to 1.75%
• Thailand car sales
• Turkey rate decision: Expected to keep rates steady at 14.00%
• Kansas City Fed President George speaks on the economic outlook
• Minneapolis Fed President Kashkari speaks

Friday, Aug. 19

Economic Data/Events

• New Zealand trade
• Canada retail sales
• Japan CPI
• New Zealand credit card spending
• Thailand forward contracts, foreign reserves

Sovereign Rating Updates

• Iceland (Moody’s)
• Cyprus (Moody’s)

After nearly two weeks of absence, central banks return to the agenda, with the Reserve Bank of New Zealand taking the torch on Wednesday, at 02:00 GMT. The Bank is widely expected to deliver another 50bps liftoff and thus, a hike of this size by itself may not excite NZD traders. Any market reaction could come from the Bank’s updated official cash rate (OCR) projections.

July decision points to willingness for more tightening

At its latest gathering, the RBNZ decided to deliver its third double hike, taking the number of consecutive liftoffs since it began this tightening cycle to six. The Committee agreed to continue lifting the OCR to a level where they are confident that inflation will settle within the 1-3% target range, staying comfortable with the rate path outlined in the May Monetary Policy Statement (MPS).

Although there was some speculation beforehand that the Bank could soften its rhetoric due to deterioration in businesses and consumer confidence, and an accelerating decline in house prices, the minutes revealed that household spending has remained resilient and that rising mortgage rates will help take house prices to more sustainable levels.

What is the data saying?

Since then, data showed that New Zealand’s CPI accelerated from 6.9% YoY to 7.3% in Q2, the fastest pace in three decades, allowing some market participants to add a few bets with regards to a 75bps liftoff. The unemployment rate ticked up just a tenth of a percentage point above its Q1 historic low of 3.2%, while the Labor Costs Index accelerated to a 14-year high of 3.4%.

Although this may have widened the smile of those betting for a triple hike, yesterday, the Real Estate Institute of New Zealand said that house prices fell 2.8% more in July compared to June, recording their first annual fall since 2011. Also, let’s not forget that the whole economy of New Zealand contracted in Q1, albeit marginally.

What does the market expect and how could it respond?

Thus, the latter data does not add credence to the idea of a triple hike, but it does not suggest that the RBNZ could turn dovish either. Indeed, market pricing implies a 12% chance for a 75bps increase, but the remaining 88% is assigned to another 50bps one. After all, officials already had the Q1 GDP data in hand when they made their minds in July, while a 1.6% YoY slide in house value may not be as concerning as a 7.3% YoY inflation rate.

A fourth double hike will not come as a surprise and is unlikely to be the reason for any reaction in the kiwi. Participants may quickly lock their gaze on the accompanying statement and especially the new projected path of the OCR. According to the May MPS, the OCR is expected to top at 3.95 in Q3 2023, with a 25bps fully priced in Q1 2025. On the other hand, the financial community sees faster hikes in the short run, expecting the same peak in April 2023, but they also expect rates to start falling just thereafter.

Thus, for the New Zealand dollar to extend its latest recovery, the RBNZ may need, not only to bring forth its rate path projections, but to also keep the timing of when it expects rates to start falling beyond that implied by the market. With the Bank itself expecting inflation to be around 4.9% YoY one year from now, and still above the upper end of its 1-3% target range in two years, that scenario appears to be very likely. Kiwi/dollar could extend its latest recovery and perhaps challenge the 0.6565 zone, marked by the peaks of May 5 and June 3. A break higher could send it towards the 0.6720 zone.

For a decent retreat to be signaled, the Bank may have to bring forth the timing of when it expects to start cutting rates and/or signal a lower peak. This could take the kiwi below the key 0.6360-dollar mark, allowing a dive towards the 0.6210 support, the break of which could set the stage for the 2-year low of July 14, at 0.6060.

There will be no shortage of data releases in the coming week and the RBNZ is poised to hike rates again. But with investors still undecided about the implications of the latest US inflation report on Fed policy, the FOMC minutes might steal the limelight. Meanwhile, thinning liquidity as more traders head for their holiday destinations increases the likelihood of big knee-jerk reactions as markets obsess about the pace of monetary tightening and the risks of a recession.

RBNZ leading the tightening race

The Reserve Bank of New Zealand is tipped to lift its official cash rate (OCR) for the seventh straight meeting on Wednesday, becoming the first major central bank to take borrowing costs as high as 3% in this cycle. However, the hawkish posturing may be reaching the end of the line and there are downside risks for the New Zealand dollar from the meeting.

Back in May, the Bank had forecast that the OCR would peak just below 4% by September 2023. That means there would only be a 100-basis-point increase remaining if it hikes rates by 50 bps in August as expected. But that is assuming that the rate path doesn’t get revised lower.

The RBNZ will publish updated forecasts in its quarterly Monetary Policy Statement and given the recent easing in energy and other commodity prices, policymakers might predict a slightly lower terminal rate. But it’s not just the inflation outlook that’s changing. Economic growth is slowing too.

Consumption in New Zealand has been subdued lately and the jobless rate unexpectedly ticked up in the second quarter, prompting policymakers to emphasize the negative risks to growth in the July policy statement.

Hence, the kiwi, whose rebound versus the US dollar picked up speed over the last week, faces the possibility of being knocked down by either a lower projection of the terminal rate or hints that the pace of tightening could soon switch to 25-bps increments, or both.

Aussie hoping for more upside before next RBA decision

In neighbouring Australia, the July employment report due Thursday will be the highlight, though wage data for the second quarter a day earlier will be important too. The Reserve Bank of Australia abandoned the use of forward guidance at its last meeting amid the uncertainty surrounding the forecasts for both inflation and growth, so the upcoming releases will likely play a significant role in swaying the odds for or against a 50-bps rate hike in September.

Investors widely believe the RBA will raise rates by only 25 bps next month so the scope for expectations to shift towards a 50-bps move is quite large if the job figures impress. There may also be some clues about the size of the next hike in the minutes of the August meeting out on Tuesday.

Having just surged back above the $0.70 handle, the Australian dollar could extend its strong gains if rate hike expectations are ratcheted up. Ahead of the domestic agenda, traders will be keeping an eye on some key metrics out of China on Monday. Growth in industrial output and retail sales is anticipated to have accelerated in July. If the data confirms that China’s recovery is gathering steam, there could be a boost for the aussie, as well as broader risk appetite at the start of the week.

Will retail sales and Fed minutes spoil the mood?

Signs of cooling inflation in America have tempered bets of a 75-bps rate rise by the Federal Reserve in September, hurting the dollar but reviving the stalled rally on Wall Street. It comes after both consumer and producer prices moderated in July. Next week’s slew of indicators will turn the attention back on the economic momentum.

The housing market is one of the sectors of the economy being closely watched right now for possible signs of a downturn. Building permits and housing starts for July are released on Tuesday, followed by existing home sales on Thursday.

There will be several clues on the manufacturing sector too as the New York and Philadelphia Feds publish their monthly surveys on Monday and Thursday, respectively, while industrial output is out on Tuesday.

However, most of the focus will be on Wednesday when the latest retail sales numbers and the minutes of the Fed’s July meeting are due. Retail sales likely decelerated substantially in July and analysts have pencilled in month-on-month growth of just 0.1%, after jumping by 1% in June.

Recent data that’s been on the soft side has had a mixed effect in dampening risk sentiment despite fuelling recession fears as the negative pressure has been countered by falling Treasury yields. However, with Fed officials standing firm on their determination to get inflation down towards their 2% target even after the CPI miss, the pullback in yields has likely gone as far as it can for now.

A poor retail sales print could therefore spark a bigger reaction this time, at least in equity markets. Though, the fallout for the dollar might be more limited as investors will probably want to wait for the Fed minutes to help them make up their minds about which way policymakers will lean in September.

The minutes are unlikely to add anything new to the rate hike debate, but if they reinforce the view that the majority of FOMC members are still keen on frontloading, it could push the odds of a 75-bps increase back up, having dipped below 40% this week, while keeping Treasury yields supported.

Pound might shrug off UK data flurry

After the US, the inflation spotlight will turn to the UK where the headline rate of the consumer price index is forecast to hit a fresh four-decade high of 9.7% y/y in July. Despite the Bank of England getting an earlier start on monetary tightening than many of its peers, Britain now boasts the highest inflation rate among the major economies.

The pain on consumers is already being felt. Retail sales have grown only once this year, in April, and are projected to have been flat in July.

With neither the CPI figures on Wednesday, nor Friday’s retail sales estimates likely providing much cheer, there might be some good news from Tuesday’s labour market report, as the unemployment rate is expected to have held steady at 3.8% in the three months to June.

Although strong employment numbers might offer some support to sterling, another jump in CPI would probably heighten the risk of stagflation following the contraction in UK GDP in the second quarter, weighing on the currency.

Canadian and Japanese inflation data on tap

Inflation readings are also due in Canada and Japan next week. The Canadian CPI data, out on Tuesday, will be followed by producer prices and retail sales figures on Friday. Japanese traders on the other hand will be watching the Q2 GDP estimate on Monday ahead of Friday’s inflation stats.

Japan’s economy is predicted to have expanded by a solid 0.6% q/q in the June quarter, helped by stronger consumption and a rebound in exports. Inflation, meanwhile, is expected to have heated up in July, with core CPI edging up to 2.4% y/y.

Nevertheless, upbeat numbers would probably do little to defend the yen when US yields are being bolstered by renewed hawkish rhetoric from the Fed. Aside from widening yield spreads, Japan’s growing trade deficit has also been a sore point for the safe-haven Japanese currency amid soaring energy costs. Trade data out on Wednesday is expected to show the deficit rose in July, with energy-driven imports far outstripping the jump in exports.

A new headache for the euro

In Europe, it’s going to be a quieter week as the only key releases are the second GDP estimate for Q2 (Wednesday) and the final CPI reading for July (Thursday). Germany’s ZEW economic sentiment gauge on Tuesday might attract some attention too, while outside of the euro area, the Norwegian krone will be on standby for a repeat by the country’s central bank of the double hike from the last meeting when it sets rates again on Thursday.

But when it comes to the euro, investors will probably be more interested in headlines concerning the Rhine River – a major transport route for Europe, particularly Germany. The worsening drought on the continent has led to shrinking water levels in European rivers and some ships have already started to reduce their loads.

If water levels continue to decline, it will become increasingly difficult to transport commodities and other raw materials across Europe, hitting coal and petrol shipments and exacerbating the energy crunch.

US CPI offered the first positive surprise on inflation in a long time being flat on the month of July versus consensus expectations of 0.2% m/m. And it was not all due to lower gasoline prices as core inflation also undershot expectations rising 0.3% m/m versus consensus of 0.5% m/m. The good news is that there are clear signs that pressure on goods prices are easing: commodity prices have come down, freight costs are lower, supply chains are easing and pricing power is weaker as demand has softened and inventories are high. We also see tentative signs that inflation expectations have peaked.

However, it is too early to declare victory over US inflation as several Fed speakers also highlighted afterwards. The labour market is still very tight and employment growth has not yet cooled down suggesting that wage growth will continue to run high. It is currently close to 6%, which is much too high to bring inflation back to 2% on a sustained way. Hence, we still look for the Fed to hike 75bp on 21 September to get rates quickly back to neutral and into restrictive area. Admittedly the probability of only 50bp has increased and the decision will most likely be determined by the next round of payrolls and inflation in early September.

In the euro zone the inflation picture has been further complicated over the summer by a strong rise in gas and electricity prices. The warm weather has increased demand for air-conditioning and curtailed electricity production due to droughts that lower water levels in reservoirs and rivers and also led to a reduction in French nuclear power production. For environmental reasons French nuclear plants face restrictions on discharging water into waterways when river temperatures get too high. French electricity prices have doubled over the past three months and are now 10 times higher than in April. The increase is set to push up inflation even further and add to recession risks, thus exacerbating the stagflationary environment.

On the geopolitical front China concluded military exercises around Taiwan in what has been the largest scale drills around Taiwan ever. It comes in response to the visit by US speaker of the House Nancy Pelosi, which in China's view is a breach of the 'One-China policy' and a further move towards supporting Taiwan independence. This week we sent out a paper looking into the background of the crisis and assessing the risk of war, see Research China: The risk of a Taiwan war and what it implies - part 1, 11 August.

Markets mainly responded to the lower-than-expected US inflation print this week by sending equities and EUR/USD higher. Bond yields initially dropped following the release but moved higher again Thursday as optimism about lower inflation and slower rate hikes faded again.

Looking into next week the main releases will be US data on retail sales, regional business surveys for August and housing data.  In Europe we get the German ZEW and the final CPI print for August, which provides more details than the flash estimate. China will publish it monthly batch of industrial production, retail sales and home sales. Especially the latter will be interesting given the continued stress in the property market. Norges Bank is set to increase rates by 50bp on Thursday.

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Daily Pivots: (S1) 132.04; (P) 132.67; (R1) 133.62; More...

Intraday bias in USD/JPY remains neutral for the moment. Overall outlook is unchanged that price actions from 139.37 are developing into a corrective pattern to larger up trend. Below 130.38 will target 100% projection of 139.37 to 130.38 from 135.57 at 126.58. But downside should be contained by 126.35 structure support. On the upside, above 135.57 will resume the rebound form 130.38 to retest 139.37, but firm break there is not expected even in this case.

In the bigger picture, fall from 139.37 medium term top is seen as correcting whole up trend from 101.18 (2020 low). While deeper decline cannot be ruled out, outlook will stays bullish as long as 55 week EMA (now at 121.84) holds. Long term up trend is expected to resume through 139.37 at a later stage, after the correction finishes.

Daily Pivots: (S1) 0.9366; (P) 0.9455; (R1) 0.9517; More...

Intraday bias in USD/CHF remains neutral for consolidation above0.9369 temporary low. Upside of recovery should be limited below 0.9648 resistance to bring another decline. Break of 0.9369 will resume larger fall to 100% projection of 0.9884 to 0.9468 from 0.9648 at 0.9232.

In the bigger picture, break of 0.9471 support turned resistance argues that medium term up trend from 0.8756 has completed with three waves up to 1.0063. Long term sideway pattern might have started another falling leg. Deeper decline would now be in favor as long as 0.9648 resistance holds, to 0.9149 structural support. Sustained break there could pave the way back to 0.8756.

Daily Pivots: (S1) 1.0275; (P) 1.0320; (R1) 1.0363; More...

Intraday bias in EUR/USD remains neutral first, with focus staying on 1.0348 support turned resistance, which is close to 55 day EMA (now at 1.0346). Decisive break there argue that rally from 0.9951 is at least correcting the fall from 1.1494. Further rise should then be seen to 38.2% retracement of 1.1494 to 0.9951 at 1.0540. On the downside, break of 1.0201 minor support will suggest that such rebound has completed and bring retest of 0.9951 low instead.

In the bigger picture, down trend from 1.6039 (2008 high) is still in progress. Next target is 100% projection of 1.3993 to 1.0339 from 1.2348 at 0.8694. In any case, outlook will stay bearish as long as 1.0773 resistance holds, in case of strong rebound.