The ECB meets on Thursday and is universally imagined to go for a hike of 25 bp, or not

Outlook: We wrote Friday that the strong dollar was at risk if retail sales came in robust, especially if inflation expectations from the U Michigan survey were softish. And that’s exactly what happened–retail sales up 1% m/m and the July University of Michigan survey showing longer-term inflation expectations fell from 3.1% in June to 2.8% five years out. Note these were the opposite of consensus forecasts. Then we got a bomb in the form of another one of St. Louis Fed Pres Bullard’s now-much heeded comments to the effect that broader and hotter inflation is telling the Fed to boost the Fed funds target from 3.5% at year-end to 3.75-4.0%.

Bullard is indifferent as to how the Fed gets there. “It probably doesn’t make too much difference to do 100 basis points here and less in the other three meetings of this year, or to do 75 basis points here and slightly more in the remaining three meetings for the year.” Fed Gov Waller had said the day before that not doing 100 bp is not a sign of failing to do the job. Several Feds said they still don’t see recession, including San Francisco Fed Daly.

On the whole, though, the consensus quickly settled on 75 bp at next week’s meeting, although the CME Fed Watch tool gives about a 20% chance of 100 bp.

As the probability of US recessions gets higher by the week–most recently by lousy regional Fed indices–we don’t want to take our eye off the Atlanta Fed’s GDPNow, currently showing Q2 at -1.5%, down from -1.2% the week before. As usual, it’s worsening outcomes in real personal consumption expenditures growth (from 1.9% to 1.5%) and real gross private domestic investment growth (from -13.7% to -13.8%). We get another version tomorrow.

This week contains mostly second-tier data for the US, including TICS this afternoon, housing data, and the Philly Fed. Econoday notes housing in the US is already cooling (from sky-high prices) and others note the used-car miracle is fading, too. Elsewhere, we get inflation data for the UK and Germany and the PMI’s on Friday. The ECB meets on Thursday and is universally imagined to go for a hike of 25 bp–or not. Canada reports retail sales on Friday. The UK reports labor market data on Tuesday and we shall see if it affects the Tory party voting, which is going to drag on to Thursday amid charges of cruelty and socialism.

We don’t see anything here to bend sentiment, which switched gears to risk-on pretty much at the same time US retail sales came in higher instead of validating recession fears. This is one of those perverse FX events where good news for the economy is bad news for the currency. Traders feel safer going for riskier stuff and willing to disregard the longer term, which entails far higher interest rates that “should” buttress the dollar, recession or not. The classic beneficiaries of this development, the CAD and AUD, knee-jerked higher. Weirdly, so did the Swiss franc, which is supposed to go the other way when risk appetite improves. Nobody understands it.

Equally not understood is why gold is weak. It seems to have lost its “guard against inflation” reputation, which wasn’t true to begin with but had a seemingly iron grip on the gold bugs. Explanations for weak gold prices include the rising dollar, and there the inverse relationship is on fairly solid ground. We still question it given inflation at over 9%.

The other commodity of interest these days is copper, a proxy for industrial and construction growth. Gittler at BDSwiss points out copper is also a canary in the coal mine. “The US news also helped other commodities as well, such as copper, which has had a hard time recently. Copper futures have fallen 34% over the last few months, from a high of $489.40 in March to $321.15 recently. Copper is one of the main proxies for global growth because it’s necessary for anything electric, such as the wiring in a new house or the heat exchangers in a new refrigerator. The recovery in global growth sentiment expressed in the rise in copper prices boosted AUD.” See his wonderful intraday chart.

Now it remains to be seen if the FX market at large will stick to the Goldilocks story that has resilience in the US economy keeping up imports and other activity in other countries. We doubt it. For one thing, the regional Feds’ manufacturing surveys shows a massive slowdown. For another, housing and some other sectors are slowing down fairly dramatically. Are banks going to keep offering consumers sweet deals on debt? What about that dichotomy between earnings expectations tanking but various individual companies saying “not in my patch,” as the WSJ reports.

Bottom line, a lot of the risk appetite we see today comes from a single two-factor release last week and expresses itself in the S&P. Bad data that turns around and takes the S&P down can bring the dollar back into focus. We try to stick to the trend we have and prefer not to embrace a rickety pushback. Check out the S&P chart. We are hovering around the 38% retracement line on the weekly chart. It might be over, but probably not.

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