Three Questions: Week of August 15

Good morning, and welcome to Three Questions - a look at the big uncertainties facing currency markets in the week ahead.

Here are some of the things we'll be watching:

1. Will Canadian inflation data bolster - or diminish - the case for rate hikes?

“A Canadian,” said the writer Pierre Berton, “is someone who knows how to make love in a canoe”. We cannot attest to that. But we do know the Bank of Canada is capable of rocking the global interest rate boat - US yields popped higher in sympathy with their Canadian equivalents when the central bank delivered hawkish surprises earlier in the year, and this week’s data could change the odds on another such move in September.

On Tuesday, Statistics Canada will release its latest inflation report, with most market participants expecting the data to broadly mirror US trends. Considerable uncertainty exists, but we think important national differences could shift the print slightly higher than anticipated, making a 75 basis point move at the Bank of Canada’s September meeting more likely than currently assumed.

According to our (admittedly flawed) straw poll estimates, the consensus expects the headline consumer price index to decelerate for a second month, slowing to 7.6 percent year-over-year in July from 8.1 percent in June on falling gasoline prices. The core common measure is seen climbing to 4.7 percent in July from 4.6 in the prior month as services become more expensive.

But gasoline makes up a smaller share of Canada’s inflation basket, and taxes are higher, reducing the degree to which prices at the pump follow rapid changes in global crude benchmarks. Natural gas remained elevated in July, and food prices look likely to have played catch-up after several months of relative stability. Although house prices have come down far more sharply on the northern side of the 49th Parallel, mortgage costs have also risen dramatically, skewing the shelter cost calculations embedded in core inflation measures.

A stronger-than-expected print could raise Canadian yields, but is unlikely to deliver much relief to the exchange rate. Oil and commodity prices are still weak. Property markets are deflating, with some banks projecting a 20-25 percent drop in prices over the next year. Households are among the most leveraged in world and are struggling under the highest debt service ratios in the Group of Seven countries.

Until deeper issues are resolved in the Canadian economy, the loonie will remain stuck — to overextend our metaphor — up a creek, without a paddle.

- KARL SCHAMOTTA, CHIEF MARKET STRATEGIST

2. How will upcoming inflation data affect the Bank of England?

Data next week is likely to intensify political and economic difficulties at the Bank of England. Markets expect Wednesday’s consumer price index to show inflation rising to 9.9 percent year-on-year in July from 9.4 percent, and Friday’s ex-fuel retail sales falling 3.1 percent.

The Bank’s problem is that it sees the outlook getting considerably worse. Its own forecasts show inflation peaking at around 13 percent in the fourth quarter and the UK suffering a recession that continues well into 2023. A preliminary estimate released yesterday showed output falling by 0.1 percent in the second quarter. In early August, policymakers hiked by 50 basis points to 1.75 percent, but chief economist Huw Pill recently suggested further hikes may not be as big.

If inflation is the rock and growth is the hard place, politics is the quicksand all around. The combination of high inflation and low growth in the middle of a Tory leadership battle has seen accusations that the bank has been behind the curve. These will only get louder if - or when - the economy tips into recession as inflation persists.

Elizabeth Truss — front-runner to succeed lame duck Prime Minister Boris Johnson — has talked of changing the bank’s mandate, though the details remain unclear. She is also threatening to overrule its regulatory authority where they conflict with the “opportunities of Brexit.” Underneath the current fracas is a post-2016 history of Conservatives blaming the bank for being too pessimistic on the consequence of Britain leaving the European Union.

This week’s numbers will be just another reminder of the UK’s problems, which in turn could become problems for the Bank and for the pound.

- KARTHIK SANKARAN, SENIOR MARKET STRATEGIST

3. What will Japanese releases mean for the yen?

The yen’s behavior after Russia invaded Ukraine has been at odds with its reputation as a safe-haven. The jump in Japan’s energy import bill has not helped, but the kicker has been the divergence between the Federal Reserve’s aggressive tightening and the Bank of Japan’s continuing asset purchases. Growth and inflation data due this week could give markets comfort on the policy stance, helping the currency cement a recent recovery.

The April-June gross domestic product release due Monday is expected to show 0.7 percent quarter-on-quarter growth. Headline prices out on Friday are seen rising 2.6 percent year-on-year, with core prices climbing just 1.1 percent, sufficient to keep the central bank on its easing course for now.

However, Governor Haruhiko Kuroda’s term ends in early 2022. Politicians are conscious of the political costs of an overly weak yen and spent much of the spring jawboning against it, suggesting they might appoint a successor more willing to declare deflation over, backing away from ultra-loose policy. And interest rate differentials are playing a more supportive role as expectations for terminal rates in the US come under pressure.

The Bank of Japan will still be far behind other central banks, but lower commodity prices and a steadier outlook for growth and inflation could help stabilize the yen and calm currency volatility elsewhere in Asia.

- KARTHIK SANKARAN, SENIOR MARKET STRATEGIST

CATALYSTS

SUNDAY

JPY Gross Domestic Product, Q2

MONDAY

CAD Existing Home Sales, July

AUD Reserve Bank of Australia, August Meeting Minutes

TUESDAY

GBP Claimant Count Rate, July

CAD Housing Starts, July

CAD Consumer Price Index, July

WEDNESDAY

GBP Consumer Price Index, July

EUR Gross Domestic Product, Q2

USD Retail Sales, July

USD Department of Energy Weekly Inventories

USD Federal Open Market Committee Meeting Minutes, July

THURSDAY

EUR Consumer Price Index, July (Final)

USD Weekly Jobless Claims

FRIDAY

CAD Retail Sales, June

USD Baker Hughes Weekly Rig Count

COUNTERPARTIES

Some of this week's most interesting and informative reads on the state of the global economy:

““That was always going to cause its own problems on prices and shortages,” said Adam Ozimek, chief economist for the Economic Innovation Group, a Washington research organization. “Businesses were never going to be like, ‘I’m going to build 10 new bicycle factories right now because we’re in a long-term bicycling boom.’” Some other shifts caused by the pandemic are likely to prove longer lasting. But it is hard for businesses to know which. “I think businesses are correct that the current state of the economy can’t really hold — something has to give,” Mr. Ozimek said.” NY Times: How This Economic Moment Rewrites the Rules

“The consequences now, as the debt crises gather pace and an already fragile global economy struggles with the fallout from the war in Ukraine, could extend far beyond these individual nations’ borders. The world faces the possibility of a series of collapses that could destabilize the lives of millions of people.” The Grid: ‘Debt Bomb’ Risks

“Argentines hold so much U.S. currency — experts believe perhaps more than anywhere outside the United States — sometimes it gets thrown away by mistake. Last month, passers-by found tens of thousands of dollars blowing around at an Argentine dump.” NY Times: Think 9% Inflation Is Bad? Try 90%.

“We showed that movements in short-run household inflation expectations have a significant impact on wage inflation. In contrast, wage inflation does not react to changes in long-run household inflation expectations. Therefore, the increase in short-run expectations since last spring point to an important upside risk to inflation, as workers negotiate higher wages that businesses could pass on to consumers in the form of higher prices.” Federal Reserve Bank of New York: Will Workers Demand Cost-of-Living Adjustments?

“In the silly Olympics in which countries compete to be “export champions”, China’s surpluses might be taken as a sign that China is “out-competing” its rivals. But, as Michael Pettis points out, the surplus is far better understood as a sign of economic weakness. Imports, driven by domestic economic activity, are lagging far behind the boom in exports as Chinese producers scramble for foreign markets to offset the lack of domestic demand.” Chartbook: Is Financial Uncoupling from China Beginning?

“To many urban Americans in the 1920s, the car and its driver were tyrants that deprived others of their freedom.” MIT Press: When Cities Treated Cars as Dangerous Intruders

“So what’s going on? And how can price changes of a single condiment — a staple of restaurants, pantries and lunchboxes across America — be so difficult to pin down? Here’s what we learned from another deep dive into the Great Mayonnaise Inflation Mystery, and what it tells us about gauging the rising cost of living in the US.” Bloomberg: What the Great Mayonnaise Inflation Mystery Can Tell Us About Prices