Overview: The jump in prices paid in yesterday's US
ISM manufacturing coupled with the stronger eurozone inflation, with a new
cyclical high reported in the core rate, underscores the market theme of
higher-for-longer. This is seen as dollar supportive but also negative for
risk-assets, including and especially equities. European benchmark 10-year
yields are up another couple of basis points today and the 10-year US Treasury
yield is pushing above 4% for the first time since last November. European
two-year yields narrowly mixed, while the two-year US rate is reached almost
4.94%, a new high since 2007.
Asia Pacific equities were
mostly lower, with South Korea, returning from holiday, and Australia, notable
exceptions. Europe's Stoxx 600 is lower for the third consecutive session. US
equity futures are narrowly mixed. All the G10 currencies are weaker today,
with the Scandis and New Zealand dollar (which outperformed yesterday) off
around 0.6%, while the Canadian dollar and Swiss franc, the best performers
today, are off about 0.2%. Most emerging market currencies are also softer. Here,
the Korean won is a notable exception. Central European currencies are hit the
hardest. Gold, which rallied nearly $50 in the past two sessions is being
dragged lower by the rising dollar and interest rates. April WTI is trading at
an eight-day high above $78.00. Last month's high was around $80.80.
Asia Pacific
Japan reported Q422 capex
and company profits/sales. These
do not drive markets. Still, Japanese profits declined 2.8% year-over-year
from a heady pace of 18.3% year-over-year in Q3. The median forecast in
Bloomberg's survey was for an 8.4% gain. Sales growth slowed to 6.1%
year-over-year, well below expectations after an 8.3% increase in Q3. This is
still high, relative to the 1.3%-1.4% average for the five- and ten-years
before Covid.
Tomorrow is the first test
of the hypothesis that inflation in Japan has peaked. Tokyo's CPI for February
is due. Government
subsidies, the drop in energy prices, and the gains in the yen on a
trade-weighted basis should help dampen price pressures, and the Tokyo figures
give much insight into the national inflation, which is not reported until
later in the month. This should help give the new BOJ team some time to review
policy and set an exit strategy (sequence of steps).
Separately, we note that the
Ministry of Finance weekly data showed Japanese investors continued to buy
foreign bonds after having been substantial sellers last year. Last week was the fourth consecutive
week of net buys. In the first eight weeks of the year, Japanese investors have
bought JPY5.5 trillion (~$41 bln)
The dollar recovered from a
three-day low yesterday near JPY135.25 to settle around JPY136.20 and has
extended its gains to almost JPY136.80 today. The high for the year was set on Tuesday a little closer
to JPY137.00. The 200-day moving average is around JPY137.25, and the greenback
has not traded above it since the December surprise. We have noted the
correlation between the change in US yields and the exchange rate has tightened
and we project gains toward JPY140.00. The Australian dollar posted a key
reversal yesterday by trading on both sides of Tuesday range and then settling
above its high. There has been no follow-through buying today, and the
Aussie looks more likely to retest support around $0.6700. A break could signal
another leg down toward $0.6665 initially. The greenback is snapping a
three-day drop against the Chinese yuan and is up about 0.4% today. It is
trading well within yesterday's range (~CNY6.8625-CNY6.9350). The PBOC set the
dollar's reference rate a little weaker than expected at CNY6.8808 (median
projection in Bloomberg's survey was CNY6.8821).
Europe
Germany joined France and
Spain in reporting higher than expected February CPI figures. It is little wonder then that the
aggregate figure proved firmer than anticipated. The headline rose by 0.8%, the
first increase since October and offset the three-month decline. The
year-over-year pace slowed slightly to 8.5% from 8.6% in January. The core rate
rose to 5.6% from 5.3%, a new cyclical high. Looking a little ahead, in March
2022, the aggregate CPI jumped 2.4% month-over-month. As we have noted, market
expectations have ratcheted up, as they have in the US, and the terminal rate
in both areas are seen around 50 bp higher than at the start of the year, 5.50%
for the Fed and 4.0% for the ECB. The knock-on effect has been to push the
US-German two-year rate differential, which often tracks moves in the exchange
rate, toward 160 bp from the peak near 187 in early February after the strong
US employment report and service ISM. It is now near 168 bp, little changed
from where it settled last year (~170 bp).
Separately, the eurozone
reported January unemployment was steady at 6.7%, given the slight revision to
the December series (6.7% vs. 6.6%). It has been mostly at 6.7% since last April, down from 7.0% at
the end of 2021. It was at 7.5% before Covid struck. It has not been lower
since the beginning of the EMU era. The ECB sees it rising to 6.9% this year,
which matches the median forecast in Bloomberg's survey, while the OECD sees it
at 7.1%. The record from the ECB's meeting will be reported shortly. However, a
50 bp hike later this month has been strongly signaled and another 50 bp move
at the following meeting in May seems increasingly likely.
Meanwhile, the Democratic
Unionist Party of Northern Ireland continues to study the "Windsor
Framework,” but it is clearly not satisfied. The so-called "Stormont brake" does not go far
enough for the DUP. Ostensibly, it would allow the Northern Ireland Assembly,
which is not sitting now because the DUP is protesting the Northern Ireland
protocol, to reject EU rule changes on goods. However, the UK would have the
final say and the DUP fears that UK would be reluctant to exercise a veto for
fear of retaliation. Moreover, the idea is that without DUP support, a group of
Tory MPs, perhaps led by the European Research Group, will be emboldened to
oppose the proposal. The measure could still pass with Labour's support but
that would also put Prime Minister Sunak in a vulnerable position.
The euro stalled yesterday
near $1.0690, fraying the 20-day moving average, which it has not closed above
since February 2, the day before the last US jobs report. It is better offered today and bids
around $1.0620 were easily absorbed in European turnover. Support is not seen
until closer to $1.06 and then yesterday's low (~$1.0565).Initial resistance pegged in the $1.0640-60
area. For its part, sterling is also holding below the 20-day moving
average on a closing basis. It is found near $1.2050 today. Sterling
is spending more time below $1.20. At the end of last week and the start of
this week, sterling found support near $1.1925. Today's low through much of the
European morning is slightly above $1.1955.
America
The market's reveal
preferences continue to show it putting more stock in the ISM than the PMI. Recall the jump in January ISM services
(from 49.2 to 55.2) encouraged the market to take seriously the US jobs data
that had been reported a few hours before. The focus yesterday was not so much
on the ISM manufacturing index, which essentially confirmed the continued
challenges that had been identified by the PMI (ISM 47.7 vs. PMI 47.3) but the
prices paid component. It jumped to 51.3 from 44.5. It was the second
increase in a row to rise above 50 for the first time since last September. It
plays on fears that the easing of goods inflation has mostly run its course. The
next leg down in US inflation may come from shelter as lagged data the
government uses catches up to what has been happening to prices and rents.
Unit labor costs and
productivity are not measured directly but are derived from the GDP data. The downward revision to Q4 GDP will
likely translate into slower productivity and higher unit labor costs
(initially 3.0% and 1.1%, respectively). which will be reported today. Unit
labor costs, one of the most wholistic measures of labor costs because it puts
them in the context of productivity, averaged about 1.7% in the five years
before Covid. In the last three years, unit labor costs have average about 4.2%.
However, this is picking up distortions caused by Covid and policy response. They
have been consistently slowing since the 8.5% print in Q1 22. In Q2 22, they
slowed to 6.7% and then 2.0% in Q3.
The "higher for longer" rate outlook in the US and Europe does the Canadian dollar no favors as the Bank of Canada is on hold. There is practically no chance that it lifts rates at next week's meeting. Heavier equity markets take a toll as well and the S&P 500 looks poised to fall through its 200-day moving average (~3940). The greenback is likely to challenge the recent highs seen around CAD1.3660-5. The year's high, seen in early January is closer to CAD1.3685, and the December 2022 high was a little higher still (~CAD1.3705). The US dollar is steady against the Mexican peso after falling to new five-year lows yesterday, helped by reports that Tesla will spend at least $5 bln to build EV production there. Yesterday's low was near MXN18.07. Initial resistance may now be in the MXN18.20-25 band. While we have been bullish the peso, our target near MXN18.00 has been approached quicker than we expected. Technically, it looks stretched, and the political backdrop is looking a little less secure.
Disclaimer
Reviewed by Marc Chandler
on
March 02, 2023
Rating:
