Tonight the Reserve Bank of Australia is expected to hike interest rates by 50 bps to 1.85% and the Bank of England is expected to do the same on Thursday to 1.75%. Now that central banks outside of the Fed have picked up the pace of their monetary tightening, including the ECB, the US dollar has topped out for now. So, was the large dollar rally over the past year just an interest rate differential thing with an aggressive Fed relative to others? At least for now it seems to be the case. The euro and yen heavy DXY is at a one month low while the yen itself is at a 2 month high all of a sudden. Gold in turn is at a one month high.
Not so fast though on the belief that the Fed is almost done raising rates says former NY Fed president Bill Dudley and now playing the role of monetary critic and truth teller. In a Bloomberg opinion piece today he said “Investors have lately become strangely optimistic that the Federal Reserve won’t have to tighten monetary policy much further, bidding up stocks and bonds amid hopes that the Federal Reserve will soon get inflation under control. This wishful thinking is both unfounded and counterproductive.
All told, the outlook hasn’t changed. Inflation is too high, the labor market is too tight and the Fed must respond – most likely by pushing the economy into an actual recession, as opposed to the two quarters of minor GDP shrinkage that has occurred so far. Wishful thinking in markets only makes the job harder, by loosening financial conditions and requiring more monetary tightening to compensate,” Dudley then went on to say. The most lagging of economic indicators, the unemployment rate, has now become again the most important monthly data point, along with CPI, because it will be that rather than GDP that will more influence how much tightening the Fed has left in them. That said, and to say again, even if the Fed was done in September or soon after in raising rates, QT is doubling in size.
As for how much these interest rate increases are going to cost us, us being the federal government, my friend Luke Groman in his weekly Forest For the Trees had this interesting back of the envelope calculation. “Let us do some simple math: $23 trillion UST market x 30% of it going to re-price in the next 12 months x the Fed raising rates at a 6.75% annual rate (for sake of argument) = $465 billion more in interest expense, 12 months from now. $465 billion is ~12% of all-time record tax receipts from 2021” and would be 14% if the government saw a 20% drop in tax receipts that usually accompanies a typical US recession.
Ahead of the July US ISM at 10am est there were a bunch of PMI’s seen overseas. China’s state sector composite index fell .5 pt to 52.4 with both components down m/o/m. Its private sector one saw manufacturing down 1 pt from June to just above 50 at 50.3. Caixin said “overall growth momentum softened since June amid slower upturns in output and total new work. Relatively subdued demand conditions and efforts to contain costs led to another decline in employment, while firms were able to further reduce backlogs of work. Cost pressures meanwhile eased notably on the month, with average input costs rising at the weakest rate since last December, while prices charged were cut for the 3rd month running.” The estimate was 51. Industrial metals prices in response are mixed but overall little changed.
Elsewhere, Taiwan’s July manufacturing PMI fell all the way down to 44.6 from 49.8. Markit said “Weaker global demand conditions and rising costs weighed on performance, according to panelists, which led to sharp drops in purchasing activity and inventories. Moreover, when assessing the 12 month outlook, for output, firms were the most downbeat for over two years.” Inflation pressures eased here too.
The other really important industrial powerhouse in the region, South Korea, saw its PMI fall below 50 at 49.8 from 51.3. Markit said “Sustained price and supply pressures continued to hinder the South Korean manufacturing sector at the start of the 3rd quarter of 2022. Output volumes fell at the fastest pace for 9 months as manufacturers continued to report that material shortages and rising costs had impacted demand in the sector and placed additional strains on capacity.” Also, new orders fell below 50 for the first time since September 2020 and business confidence fell to the lowest since October 2021. The hope here too is that inflation pressures are peaking as “delivery times lengthened at the 2nd softest rate for almost a year.”
PMI’s in Vietnam and in the Philippines fell m/o/m too but rose in India, Thailand, Malaysia and Indonesia. Also out of Asia today of note was the 1.4% y/o/y contraction in the Hong Kong economy, more than the estimated .2% decline. Of course, much is self inflicted with the China covid approach.
The July Eurozone manufacturing PMI was revised up to 49.8 from the initial print of 49.6 but still down from 52.1 in June and 54.6 in May. Markit said “The downturn strengthened amid a reduction in new orders which, aside from those seen during the pandemic restrictions, was the sharpest since the Eurozone sovereign debt crisis in 2012 as steep inflation squeezed demand.” The UK manufacturing PMI was revised to 52.1 from 52.2 initially and down from 52.8 in June and 54.6 in May.
Market wise today in Europe, the Italian 10 yr yield is tightening its spread vs the German 10 yr yield as we await some resolution on the political situation in Italy at the same time Germany in particular is suffering profoundly from high natural gas prices.