FX - The Week Ahead: EUR vulnerability highlighted by weak fundamentals and a potential resurgence in political risk premium

Euro area inflation and unemployment drop with the latter likely due to the Paris Olympic effect but with the German labor market sharply underperforming

• EUR: Data released Friday shows euro area headline inflation dropping to 2.2% YY in August, the lowest reading since June-2021 but pretty much in line with consensus expectations. Euro area core inflation however barely moves since last month, rounding down from 2.85% in July to 2.84% in August, mirroring into another high 0.2% MM gain, essentially in line with the last two prints. Somewhat hawkish is services inflation up more than expected, rising from 4.0% YY to 4.2% but to some extent reflecting a likely French Olympics effect while core goods HICP is slightly softer, reversing the likely seasonal distortions in June/July. Overall, euro area inflation is now at a 3-year low and not far from the ECB target.
   
• EUR: Meanwhile, euro area unemployment drops by a large 114k in July and the unemployment rate reaches a new low of 6.4% (Consensus 6.5%) and even in annual terms, unemployment is down 190k in July. The main driver of the drop in unemployment is the Paris Olympics and in Germany notably, labor market easing continues in August, albeit at a slower pace with unemployment rising by just 2k, down from a monthly average of 18k in the previous four months and leaving the unemployment rate stable at 6.0% but with hiring is slowing to trickle. Indeed, quarterly sectoral employment data up to Q2 suggests that private sector employment in Germany has been shrinking since mid-2023 with employment shrinking most in interest rate sensitive sectors such as construction and manufacturing, which is typical for recessions. Hiring intentions also continue their decline and vacancies are plunging by 10k per month to 673k in August, the lowest since May 2021. Germany’s economic weakness seems to be growing not just structurally but also the result of ECB tightening. And while the overall jobs data from the euro area may suggest that the negative turning point in the euro area which had been apparent in the data so far is less clear now, the labor market data often gets revised and therefore does not present any positive signals for now.

Slowing US core inflation sets the stage for Fed cuts

• USD: Data released Friday sees US core PCE inflation rising 0.16%MoM while the YoY reading at 2.6% is unchanged relative to June and slightly below consensus looking for 2.7%YoY. Meanwhile, headline PCE inflation rises 0.2%MoM and 2.5%YoY and  “super core” PCE (core services excluding housing) is up 0.21%MoM. The 1.9% annualized pace is close to pre-pandemic monthly prints and in line with the Fed’s 2% target while the 3-month annualized core PCE’s 1.7% rise is the slowest pace in 2024 and should be an encouraging sign for Fed officials who have signaled that they want more data before cutting in September. The components of PCE inflation are also as expected with housing inflation up 0.39%MoM, mirroring the rise in CPI with shelter inflation likely to moderate in the coming months as home price appreciation has slowed and typically leads shelter inflation by ~15 months.
   
• USD: In related data, US personal spending rises 0.5%MoM in nominal terms and 0.4%MoM in real terms but excluding one-offs, consumption growth is fairly modest. Spending is driven by a 0.7% rise in goods spending while services spending rises a more modest 0.2%MoM and is softer than expected. Meanwhile, personal income rises 0.3%MoM, driven by wages and salaries. The most interesting part of the data however, is the drop in the savings rate to 2.9% which could lead to a reversal in consumer spending at some point.

Week Ahead:

US – ISM manufacturing, services and the pivotal August jobs report in focus this week

• USD: US August nonfarm Payrolls – Citi: 125k, median: 160k, prior: 114k; Private Payrolls – Citi: 120k, median: 140k, prior: 97k; Manufacturing Payrolls – Citi: -15k, median: NA, prior: 1k; Average Hourly Earnings MoM – Citi: 0.3%, median: 0.3%, prior: 0.2%; Average Hourly Earnings YoY – Citi: 3.7%, median: NA, prior: 3.6%; Unemployment Rate – Citi: 4.3%, median: 4.2%, prior: 4.3% - after a notable slowing to 114k in July, Citi Research expect a modestly stronger but similar 125k increase to July in nonfarm payrolls in August. This would still be a solid pace of job growth but some of the continued strength likely reflects measurement issues that are known to have skewed monthly jobs figures substantially higher in the year ending in March. These measurement issues that could continue to result in too-strong job growth mean that even 125k jobs added in August could be mentally discounted by markets and Fed officials. Citi Research also expect modestly stronger average hourly earnings in August, rising 0.3%MoM (0.26% unrounded) and 3.7%YoY. Some bounce-back could occur in sectors like auto manufacturing, but risks are for hours to remain soft with a weakening labor market that should put downward pressure on wages. After a much more notable climb higher in recent months, the unemployment rate may be the most important aspect of the August employment data. Citi Research expect the unemployment rate to remain unchanged at 4.3% in August, but at 4.25% unrounded in July, there are risks it could round back down to 4.2%. While the “Sahm” rule has not officially triggered on an unrounded basis, the unemployment rate remaining above 4.10% (unrounded) would officially trigger the rule in August.
   
• USD: US July JOLTS Job Openings – Citi: 8250k, median: 8100k, prior: 8184k – Citi Research expect JOLTS job openings to move largely sideways in July, increasing modestly to 8250k. This would be consistent with high frequency data from Indeed.com that showed job postings rising slightly throughout the month. While this could initially be seen as a positive indication that the labor market is not softening further, there is increasing skepticism that job openings reflect true labor demand. Other details in the JOLTS report will also be important. The change in total hires and separations in JOLTS is intended to align with changes in nonfarm payrolls. The softer 114k jobs added in July would suggest some combination of softer hiring or rising separations. The layoff rate in June JOLTS data was particularly low. The layoff rate could rise in July as the household survey showed an increase in layoffs in July, even if this mostly reflected temporary layoffs.
   
• USD: US August ISM Manufacturing – Citi: 47.3, median: 47.5, prior: 46.8 - manufacturing survey indices have stayed in contractionary territory in recent months and regional Fed manufacturing surveys continued to generally be weak in August as well. Hard manufacturing data like industrial production were weaker in July after a couple months of surprising strength but in general data are not pointing to any sustained pick up in manufacturing activity. Citi Research expect a modest increase in the ISM Manufacturing index to 47.3 from 46.8, which would still point to continued contraction in manufacturing activity. The employment index could rebound a bit after the sharp drop in July, but expectations are for it to remain in contraction with employment diffusion indices in the regional Fed manufacturing surveys still weak. Manufacturing payrolls have also been softer in recent months and could continue to weaken in August.
   
• USD: US August ISM Services – Citi: 50.3, median: 50.9, prior: 51.4 - ISM Services has been bouncing around the 50 level this year as some of the sub-indices like business activity have been volatile potentially in part due to seasonal adjustment issues. Looking at a 3-month moving average, the overall services index has remained in expansion but has generally been on a downtrend this year. The services S&P PMI has remained at solid levels, but the employment details were weaker in the August release. The employment index in ISM Services was stronger in July but has generally been in contraction as payroll growth has slowed somewhat and the unemployment rate has been rising swiftly. Services spending continues to grow in real terms and Citi Research expect ISM Services to continue to point to modest growth in August but at a slower pace than in July, expecting it to decline to 50.3 from 51.4.

Europe – German regional elections, orders & production data and Swiss CPI and GDP in focus this week

• EUR: Germany: regional elections – on Sunday 1 September, citizens in Thuringia and Saxony in east Germany will vote, with polls suggesting a large swing to far-left and far-right parties away from the center. The cohesion of Chancellor Olaf Scholz’s coalition could be tested.
   
• EUR: German industrial data - at the end of the week, Citi Research expect that German orders, production and trade data will show that after the calendar-induced volatility in May and June, weak trends resumed in July, in line with the latest weakening in confidence indicators. Germany Factory Orders, July – Citi Forecast -2.0% MM, Consensus -1.7% MM, Prior 3.9%; German Industrial Production, July – Citi Forecast -0.3% MM, Consensus -0.2% MM, Prior 1.4%.
   
• EUR: Switzerland: weak growth and falling inflation – Citi Research expect a much lower growth outcome than consensus after the strong Q1 print. Inflation could also be lower as lower interest rates weigh down on rent increases. Switzerland CPI Inflation, August – Citi Forecast 1.1% YY, Consensus 1.2% YY, Prior 1.3% YY (Lower rents inflation after rate cuts); CPI Core, August – Citi Forecast 1.0% YY, Consensus 1.1% YY, Prior 1.2% YY; Switzerland Real GDP, Q2 – Citi Forecast 0.1% QQ, Consensus 0.6% QQ, Prior 0.5% QQ.

Japan – real household spending in focus this week

• JPY: Japan Real Household Spending, (two-or-more-person households) (July): Forecast: 1.6% YoY, Previous: -1.4% YoY - real spending of all households (consisting of two people or more) probably increased 1.6% YoY in July, up from a 1.4% YoY drop in June. The turnaround was likely driven by base effects as the impact of a plunge in volatile spending on housing in June 2023 dropped out. On a MoM basis, Citi Research pencil in a 0.3% decrease in July after a 0.1% gain in June. However, given that spring wage hikes and summer bonuses have been supporting a clear improvement in real disposable income, Citi Research expect consumer spending to rebound in Q3’2024.

Commodity Bloc – BoC board meeting, Canada employment and Australia Q2 GDP in focus this week

• CAD: Bank of Canada Rate Decision – Citi: 4.25%, median: 4.25%, prior: 4.50% - the series of BoC rate cuts should continue in September, with policy rates lowered again by 25bp to 4.25%, but with some small probability of a 50bp cut. Each of the last two policy decisions - while somewhat inherently dovish as rates were lowered - struck an even more dovish tone than expected. Citi Research expect the September decision will skew similarly dovish. In July, the most dovish development was an acknowledgement by officials that “downside risks are taking on increased weight in our monetary policy decisions.” In the weeks since the decision, domestic data have generally evolved in line with expectations. While the unemployment rate remained at 6.4% in July, there was a decline in both employment and the labor force participation rate as generally indicative of a weakening labor market. And rising unemployment and slowing job growth in the US would also increase spillover risk of weaker activity in Canada. While H2 forecasts will not be updated until October, the policy statement in September should acknowledge that downside risks to activity have increased. An in-line inflation reading in July, with headline CPI at 2.5%YoY and core measures remaining within the target range, will be highlighted as further evidence that softer demand is weighing on inflationary pressures. While the guidance in the policy statement in July did not explicitly mention the possibility for further rate cuts, this is a clear dovish risk in September.
   
• CAD: Canada Net Change in Employment (Aug) – Citi: -10k, median: 25k, prior: -2.8k, Unemployment Rate – Citi: 6.7%, median: 6.5%, prior: 6.4%, Hourly Wage Rate Permanent Employees – Citi: 4.8%, median: NA, prior: 5.2% - while labor force survey employment can be particularly volatile, and two months of declines implies risk of a bounce-back, Citi Research instead, expect another decline in employment in August of around 10k jobs. A possible rebound in participation and further job loss also imply substantial upward risks to the unemployment rate in August, which is expected to rise to 6.7%. Wage growth, which was still elevated in July, should slow to 4.8%YoY. While wage growth has remained surprisingly sticky last year, an even more accelerated weakening in the labor market should put downward pressure on wages. Overall, much clearer signs of a weakening labor market would be supportive of the Citi Research base case for a 50bp rate cut in October.
   
• AUD: Australia Q2 GDP: Citi QoQ forecast; 0.2%, Previous; 0.1%, Citi YoY forecast; 0.9%, Previous; 1.1% - GDP growth is set to remain slow in Q2, as household and business activity remain constrained by tight monetary policy and a relatively sticky GDP deflator. Citi Research forecast real activity increasing by 0.2% in Q2 to be 0.9% higher in yearly terms, the slowest since Q4’20. But this should mark the trough in yearly growth and the result should also be exactly in-line with the RBA’s forecast. Risks though are biased to the upside towards a GDP gain of 0.3%. This comes from still strong population growth and possibly more momentum in household spending. The ‘backbone’ of the expenditure side GDP data should be a 0.3% increase in domestic final demand.