New Optimism Lifts Sentiment Ahead of the Weekend

Overview: China's new pledge to meet its trade commitments under the Phase 1 agreement with the US coupled with signs that the virus flare-up in Beijing may have been brought under control is helping underpin risk appetites today.   Led by Chinese shares, equities in the region rose, giving the MSCI Asia Pacific Index a four-day advance to carry into next week. European stocks higher, leaving the Dow Jones Stoxx 600 in its recent ranges. US shares are also firm.  Bond markets are quiet.  The peripheral premiums over Germany narrowed 7-10 bp this week.  The US 10-year yield is little changed this week around 71 bp.  The dollar is mostly softer, sterling has been unable to recover from yesterday's slide, even though May retail sales jumped almost twice what economists had forecast. South Africa, Russia, and Mexico are leading the liquid accessible emerging market currencies higher. On the week, the JP Morgan Emerging Market Currency Index is off about 1.4%, its second consecutive weekly drop of over 1%.  Gold is firmer, but at $1730, it is little changed on the week.  Oil prices are pushing higher for the fourth session this week. July WTI finished last week near $36.25 and has pushed above $40 today to approach the high set earlier this month near $40.45.  

Asia Pacific

Although US President Trump threatened to completely de-couple from China, Secretary of State Pompeo met Chinese officials in Hawaii, and the trade deal was re-affirmed.  Through the first third of the year, China's agriculture imports from the US have reached about 13% of the goal. The depreciation of the Brazilian real has made its soy and energy exports more attractive. 

Japanese core consumer prices were 0.2% lower than a year ago in May, the same as in April.  Weakness in energy prices and weak consumer demand were the main drivers. Headline CPI remained at 0.1%.  When stripped of fresh food (core rate) and energy, Japan's CPI rose by 0.4%, up from 0.2% in April.  The BOJ's efforts, as illustrated by this week's measures, are focused on lending to the corporate sector more so than taking new steps to boost price pressures more directly.  

The dollar is in a narrow range against the yen.  It has not been much above JPY107 or below JPY106.80.  It is difficult to get excited about it between JPY106.45-JPY106.50, which holds options for around $850 mln that expire today, and JPY107.50, where a $435 mln expiring option sits.  The dollar settled near JPY107.40 last week and has finished every session this week with small losses. It fell four of five sessions last week.  The Australian dollar traded above $0.7000 much of last week but has been unable to resurface it this week. It found support in the $0.6835 area this week.  So far, today is the first session since June 2 t it has not traded above $0.6900.  An option for A$825 mln that expires today is struck there. The US dollar slipped against the Chinese yuan this week.  It is near CNY7.0725 after finishing last week around CNY7.0840. 

Europe

UK retail sales jumped 12% in May.  The median forecast in the Bloomberg survey was for a 6.3% increase. It follows an 18% decline in April. The purchase of household goods surged by 42%.  Excluding gasoline, the gain in retail sales moderates to a still impressive 10.2% after a 15% drop in the previous month.   

The BOE boost of its Gilt buying announced yesterday by GBP100 bln also included a slower pace of buying. Note that the only dissent was from the chief economist Haldane who objected to the increase ion purchases. The BOE will buy Gilts twice a week rather than three times.  Here in Q2, the Bank of England's balance sheet surged by around 6.5% of GDP (~5.5% increase in the Fed's balance sheet), and the pace will be more than halved in Q3.  The government borrowed about GBP55 bln in May, bringing its debt to GDP over 100% for the first time in more than half a century.  

The EU leaders will hold a discussion about the Recovery Fund today.  The decision needs to be unanimous, and a compromise still seems elusive.  Both Merkel and Macron have played down the chances of an agreement now but point to a deal next month.  Separately, Germany takes over the rotating EU presidency in H2, and Merkel has indicated that she will aim to finalize a digital tax, which will be a flashpoint for relations with the US. 

The euro found support near the 20-day moving average yesterday (~$1.1185), its lowest level in nearly two weeks.  It has been unable to recover above $1.1225 so far today.  There is an expiring option for 515 mln euros at $1.1235.  Another for 1.1 bln euros is struck at $1.12.  It settled last week near $1.1255. Unless the euro can resurface that area, it will be the second consecutive weekly decline.  Sterling is pinned near yesterday's lows (~$1.2400).  Options for about GBP820 mln at $1.2400-$1.2415 expire today.  A trendline drawn off the March and May lows comes in today around $1.2440.  The next downside target is near $1.2360.  

America

Foreign central banks continue to rebuild their US Treasury holdings kept on custody at the Federal Reserve. Foreign officials bought nearly $12 bln of Treasuries in the latest reporting week. It is the tenth consecutive weekly increase during which time that bought about $111 bln.  Recall during the frantic days in March and April, they sold about $130 bln of US Treasuries.  The selling was tactical as officials tried to smooth out the private sector capital outflows. Meanwhile, as funding markets normalize, foreign central banks have reduced their use of the Fed's swap lines. There are about $280 bln outstanding, down from around $450 bln. Starting next month, the seven-day facility will only be offered three times a week rather than daily. Separately, note the deluge of Treasury supply next week:  About $155 bln of coupons and around $170 bln in bills will be sold.  

Quadruple-witching may inject extra volatility in the equity market today. Stock index futures and options, and stock options and signal stock futures contracts expire today.  This includes around $1.8 trillion of S&P 500 options.  Support for the S&P 500 is seen near 3080-3085.  The week's high is around 3153.50, and then we have emphasized the 3181.50 area, the top of the gap created last week. Three Fed officials speak today include the leaders, Powell and Clarida, as well as Rosengren.  Separately, Canada reports April retail sales figures.  The most significant economic blow likely came in April, and retail sales are expected to have fallen by around 15% after a 10% decline in March. 

The US dollar has remained within Tuesday's ranges against the Canadian dollar (~CAD1.3505-CAD1.3625) in the past two sessions and has been confined to it so far today.  The greenback settled last week near CAD1.3590, leaving it net-net little changed on the week.  The dollar saw a high last week near MXN22.95 and tested it yesterday (~MXN22.83).  It is near MXN22.60 before the North American session begins.  It settled last week close to MXN22.26.  The central bank meets next week and is widely expected to deliver another 50 bp rate cut, which would bring the overnight rate to 5.0%.  The dollar soared against the Brazilian real yesterday following the central bank's 75 bp rate cut and the resignation of the Education Minister Weintraub over publicly clashing with the Supreme Court. The greenback reached almost BRL5.39. It had finished last week a little below BRL5.05.  Although the US dollar may consolidate its gains, a move above BRL5.40 would target the BRL5.55 area.  

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