Overview: The drama in Russia captured the
imaginations but failed to have much impact on the capital markets. Conventional
wisdom sees it as a sign of Putin's weakness, but he has been underestimated,
including by many Ukrainians who did not think Russia was going to invade
despite America's repeated warnings. It may take some time for the implications
for the two main protagonists, Wagner head Prigozhin and Defense Minister
Shoigu. The war in Ukraine is likely unaffected, and Kyiv's counter-offense
thus far seems rather muted. The risk is that the war escalates if Kyiv resorts
to medium- and long-range missiles to hit Russian assets in Crimea, and possibly
in Russia proper. Meanwhile the record from the Bank of Japan recent meeting
showed at least a couple of members were moving toward a change in stance. One
wanted to discuss revisions to the yield curve control "at an early
stage" and another warned of while inflation may moderate later this year,
it may not be fall back under 2%. These comments, coupled with the Vice Finance
Minister for International Affairs warning that officials will respond to if
moves were excessive.
The sell-off in equities continues.
The MSCI Asia Pacific fell for the sixth consecutive session, and so has
Europe's Stoxx 600. US equity futures are also trading with a softer profile. Benchmark
10-year yields are mostly 2-4 bp lower in Europe and the US (putting the
10-year US Treasury yield slightly below 3.70%). The yen leads the G10
currencies higher with about a 0.35% gain. The Swedish krona (central bank
meets later this week) and the Australian dollar are the chief laggards today.
Emerging market currencies are mixed. We note that the Chinese yuan and Russian
rouble are trading lower, and the Turkish lira has been tagged for another 2.5%.
Lower rates and a softer dollar have given gold a small lift. It traded near
$1910 before the weekend, a three-month low, and is near $1930 late in the
European morning. August WTI began higher near $70 before easing to almost
$68.70. It has steadied near $69.50.
Asia Pacific
Chinese markets re-opened
after being closed for holiday on Thursday and Friday last week. The MSCI Asia Pacific equity index fell
every day last week, the first time since last June, and lost about 2% while
China's mainland markets were closed. Investors continue to look for new
stimulative measures from Beijing. The CSI 300 fell by 1.4%, as it played a
little catch up. Yet, the Chinese economy still seem to be on pace to achieve
the GDP target this year of around 5%. The Politburo's semi-annual conference
at the end of next month seems to be a possible forum that new economic
initiatives. Separately, we note that the Shanghai Clearing House announced it
was launching a new initiative using the digital yuan for clearing and
settlement services for bulk commodities.
Japan's economic diary is
light in the first half of the week, but reports May retail sales, employment,
and industrial production in the second half. And ahead of the week, the Tokyo's June
CPI will be reported. It offers useful insight into the national figure, which
is reported with a few weeks lag. Meanwhile, with the dollar climbing to above JPY144,
there is more talk of intervention. Although speculators in the futures have
amassed a larger short yen position than they had last September and October
when the BOJ intervened, the sell-off is driven by policy divergence. The move
seems more about yen weakness than dollar strength. Still, the correlation of
changes in the exchange rate and US interest rates remains high. Over the past
30 sessions, the correlation with the US 10-year yield is near 0.82. It was
near 0.95 earlier this month. The correlation of changes in the exchange rate
and the US two-year yield is near 0.73. The correlation set a four-year high
near 0.86 earlier this month.
Softer US yields and some
ideas that BOJ may be closer to a policy adjustment helped steady the yen after
it fell to new lows for the year ahead of the weekend. The dollar is inside Friday's range
(~JPY142.70-JPY143.85). A break, and ideally a close below JPY142.65 is needed
to suggest more than a flatting consolidation. The Australian dollar is
pinned near the pre-weekend low (~$0.6665) and has heled below $0.6695 in quiet
turnover, which is about where the 200-day moving average is found. The
$0.6680 area corresponds to the (50%) retracement of the Aussie's gains this
month. The next retracement (61.8%) is near $0.6625. Note that the Australian
dollar is approaching the measuring objective of the double top against the New
Zealand dollar (~NZD1.0820), we have been tracking. A break of NZD1.08 can see
NZD1.0750 near-term. The PBOC set the dollar's reference rate much lower
than expected, but this did not stop the greenback from rallying to new
seven-month highs. The fix was set at CNY7.2056 compared with the median
forecast in Bloomberg's survey of CNY7.2133. The dollar rose to
CNY7.2372.
Europe
Germany's June IFO survey
showed a troubling deterioration in sentiment. The current assessment fall to 93.7 from
94.8. It was the third consecutive decline and is now below the 94.2 seen at
the end of last year. The expectations component tumbled for the second month
to 83.6 from 88.3. It finished last year at 83.3. The overall business climate
softened to 88.5 from 91.5. The Germany economy contracted by 0.5% in Q4 22 and
by 0.3% in Q1 23. The median forecast in Bloomberg's survey conducted earlier this
month (44 economists) is anticipate 0.1% growth in Q2 and 0.2% in each of
quarter in H2.
Ahead of the eurozone's
preliminary June CPI at the end of the week, it is interesting to review where
the 10-year breakevens, a measure of inflation expectations that is the
difference between the yield of the inflation-linked instrument and the
conventional yield. Germany's
10-year breakeven is near the middle of the 2.20%-2.40% range that has
dominated here in Q2. Italy's 10-year breakeven is also near the middle of its
2.10%-2.30% Q2 range. Separately, we note that the UK's 10-year breakeven is a
little below 3.80%. Last week, it spiked to nearly 3.94%, the high for the year.
It finished last week below 3.77%, the 20-day moving average for the first time
since May 22. By way of comparison, the US 10-year breakeven has mostly been
between 2.15% and about 2.30% this quarter and finished last week near
2.21%.
The euro is trading quietly
and has been confined to slightly more than 10 tick on either side of $1.09. It
had traded down to $1.0845 at the end of last week in response to the
disappointing flash PMI. This
met the (38.2%) retracement of this month's advance. The (50%) retracement is
found near $1.0825 and the 20-day moving average is a little lower at $1.0820. On
Thursday, 2.35 bln options at $1.08 expire. Sterling is trading quietly in a
half-of-a-cent range above $1.2700. The latest CFTC data, which runs
through the week ending June 20 appears to have seen a record rise in
speculative net long sterling futures position (~39.9k contracts). In that
reporting week, sterling average about $1.2765. It set a marginal new low for
the week on Friday slightly below $1.2690.
America
The gap between the market
and the Fed's Summary of Economic Projections remains stark. The futures market has a little more than
70% of a hike next month discounted. On June 13, the day before the FOMC
meeting concluded the market had a slightly higher chance of a July hike. Net-net,
it was unchanged last week despite the flurry of Fed officials that seem to
endorse the need to hike more but Atlanta Fed's Bostic, who does not vote this
year. The January Fed funds futures imply a year-end effective rate of 5.24%. The
current effective rate, which is what the contract settles is around
5.07%-5.08%. Assuming the Fed delivers two more quarter point hikes this year,
as it indicated, fair value is 5.57%-5.58%. Today's Dallas Fed's June
manufacturing survey is of little consequence for policy expectations. Last
week, roughly half of the Fed officials spoke, and this did not persuade the
market, what will? We suspect that the PCE deflator at the end of the week
could spur a market response. While the headline deflator will likely slip
below 4%, the core rate is problematic. The risk is that the year-over-year
rate move higher for the second consecutive month. The median forecast in
Bloomberg's survey is for a 0.4% increase. As we noted,
this would mean that an annualized pace, core PCE would be rising at a 4.8%
clip compared with 4.6% in the first five months of last year.
Canada reports May CPI
tomorrow. A 0.4% rise
would bring the annualized rate this year to 6%, which is less than half the
annualized pace in the Jan-May period last year. The underlying measures, which
the Bank of Canada cited in the decision to end its conditional pause earlier
this month, are proving more resilient. Consider that the weighted core median
averaged 4.6% this year through April. In the first four months of 2022, it
averaged 4.1%. The trimmed core mean has risen an average year-over-year rate
of 4.6%, unchanged from the same year ago period. The swaps market is
discounting about a 67% chance of a hike at the July 12 Bank of Canada meeting
and is fully discounted by the September 6 meeting.
The US dollar may be carving
out a small shelf against the Canadian dollar. Last Thursday, it set a nine-month low
near CAD1.3140 and the pre-weekend low was slightly above it and today's low
matches Thursday's low. The greenback settles near CAD1.3185 ahead of the
weekend and has not trading much above it so far today. The CAD1.3200-20 area
offers nearby resistance. There are options for around $935 mln that expire
Thursday at CAD1.3150. The dollar spent last week consolidating against the
Mexican peso. It set the multiyear low on June 16 near MXN17.0250. The
week's high was set on Friday by MXN17.2650. A move above MXN17.30 would
suggest a proper correction may be at hand rather than the broadly sideways
consolidation. There are options for about $535 mln struck there that expire
Wednesday.
Reviewed by Marc Chandler
on
June 26, 2023
Rating:
