Overview: The Fed's
hawkish hold and signal that it may raise rates two more time this year sent
ripples through the capital markets. Risk appetites have been dealt a blow. However,
China's rate cut and likely additional supportive measures after disappointing
data, helped lift the CSI 300 by 1.6%, the most this year. The Hang Seng rose
by nearly 2.2%, the most in three months. Europe's Stoxx 600 is snapping a
three-day advance and US index futures are trading lower. European bond yields
are mostly 4-7 bp higher ahead of the ECB meeting, which is expected to deliver
a rate hike and confirm its intentions to lift rates more. The US 10-year yield is up a couple of basis points to a little below 3.81%, while the two-year yield is up almost four basis point to nearly 4.73%.
Rising
US rates helped lift the dollar to a new high for the year against the Japanese
yen, and the second quarterly contraction in New Zealand (-0.1% in Q1 23 after
-0.7% in Q4 22) weighed on the Kiwi. More broadly, the greenback is mixed now
mostly inside yesterday's ranges. Most emerging market currencies, outside of a
few central European currencies and the Chinese yuan, are sporting softer profiles
today. Rising yields took a toll on gold, which slipped below $1930 to its
lowest level since late March. A large build of US crude inventories is helping
to keep WTI on the defensive. July WTI traded below $68 a barrel today before
stabilizing. It has not settled above $70 a barrel this week.
Asia
Pacific
The
BOJ meetings concludes tomorrow. Although previously many expected a
change in policy as this meeting, it has been pushed back due to the patience
expressed by BOJ Governor Ueda. That means a hike in the overnight cash target
from minus 0.10% is unlikely. It also means that an adjustment
to the yield curve control under which the 10-year yield is allowed to move in
a 50 bp in either side of zero is likely to be sustained. If there is going to
a surprise, we have suggested that the BOJ may eschew if easing bias for a
neutral stance. Separately, Japan reported May trade figures earlier today.
True to the seasonal pattern, the balance deteriorated in May (as it has done
in all but two years in the past 20). Still, exports were stronger than
expected, rising by 0.6% increase rather than fall by 1.2% as projected.
Imports tumbled by 9.9%, a little less than expected. It was the second
consecutive decline, and it reflected a decline in fuel prices. Earlier this
week, Japan reported a 0.7% decline in May producer prices. Japanese producer
prices have fallen at annualized rate of a little more than 1.4% in the first
five months of 2023. In comparison, US producer prices are falling at an
annualized pace of almost 0.5% through May. Eurozone producer prices have
collapsed at an annual rate of nearly 25% through April. Separately, Japan
reported core machinery orders in April were stronger than expected (5.5% vs.
3.0% median forecast in Bloomberg's survey). Lastly, standout development in
last week's portfolio flows was Japanese investors buying of foreign equities
(~JPY1.3 trillion), the third most this year.
The
PBOC delivered a small cut in the benchmark one-year medium-term lending
facility. The 10 bp cut brings the MLF rate to 2.65% and the PBOC also
increased the volume to CNY237 bln from CNY125 in May. This was widely
anticipated after the banks cut their deposit rates (in response to official
requests) and the PBOC cut the seven-day repo rate. There is still scope to
reduce reserve requirements as well. The government is believed to be working
on other measures to support the economy and property market. Separately, China
disappointing industrial output figures (unchanged at 3.6% year-to-date, year-over-year)
and while retail sales improved, it was by less than expected. Fixed asset
investment was weaker than expected and residential property sales contracted
at a faster pace.
Australia's
May jobs report was considerably stronger than expected and boosted the
prospects of additional rate hikes. After losing 28.6k full-time positions
in April, Australia reported a 61.7k increase in May, and an increase of 75.9k
jobs overall. The unemployment rate slipped back to 3.6% from 3.7% and the
participation rate jumped by to 66.9% from 66.7%. Previously, the futures
market had about a one-in-four chance of ha hike next month discounted. It is
now 50/50. The current cash rate target is 4.10% and the futures market now
sees the year-end rate at almost 4.60%, nearly 10 bp higher on the and 15 bp on
the week.
We
had suggested that the consolidation pattern in the dollar-yen rate like a
continuation pattern. And bolstered by the jump in US rates, the dollar broke
higher and reached JPY141.50, a new high for the year. It has pierced the upper
Bollinger Band (~JPY141.10). A pullback may find initial support around
JPY140.80. Despite the strong Australian jobs report and interest-rate
adjustment, the Australian dollar is trading inside yesterday's range, which
saw a nearly four-month high (~$0.6835). The next upside target is near
$0.6900. A close below $0.6800 would be disappointing. The US dollar made a
new high for the year against the Chinese yuan (~CNY7.1805) but pulled back
toward yesterday's low, slightly below CNY7.15. The PBOC set the
dollar's reference rate at CNY7.1489, weaker than the CNY7.1509 median forecast
in Bloomberg's survey.
Europe
ECB
President practically committed to hiking rates today at last month's
meeting. The market has a quarter-point hike nearly fully discounted, which
would bring the deposit rate to 3.50%. The swaps market has about an 80% chance
of another hike by early Q4 discounted. Yet, by early Q2 24, the market is
pricing in a cut. The Federal Reserve's new economic projections also see rate
cuts next year, perhaps as much as 100 bp.
There
are a couple of moving parts to the ECB's decision today outside of the rate
decision proper. First, the staff will offer updated forecasts. The
risk is that this year's growth, which was projected at 1.0% year-over-year in
March gets shaved and this may drag down next year's forecast for 1.6% growth.
The ECB's staff forecast CPI to be at 5.5% at year-end. It has risen at an
annualized pace of slightly more than 5% through May. The base effect works in
its favor in the second half of the year (unlike the US). The forecast for 2025
CPI was 2.1%, and by placing it above the 2.0% target, the ECB underscored its
hawkish stance. This could be pared and if it is below 2.0%, the market will grasp
the dovish implications. Second, the ECB will update its balance sheet
strategy. Since peaking last June, the ECB's balance sheet has been reduced by
about 13% (Fed's is off about 16% since peaking in April 2022). The reduction
is due to not fully reinvesting the maturing proceeds from its Asset Purchase
Program, which pre-dates Covid, and banks paying back their loans (Targeted
Long-Term Refinancing Operations, TLTRO). Toward the end of June around 475 bln
euros of TLTRO loans comes do. They account for about 6% of the ECB's balance
sheet and around half of the outstanding TLTRO loans.
The
euro is firm inside yesterday's range (~$1.0775-$1.0865) and has held above
$1.08 so far today. If sustained, it would be the first time in a month that it has
managed to do so. The $1.0865 area represents the (50%) retracement from the
high set near $1.11 in early May. There are options for around 640 mln euros
that expire today at $1.0875 and there are the nearly 2.5 bln euro of options
that expire tomorrow at $1.0850 that we noted yesterday. Sterling rose to a
new 12-month high yesterday, 1/100 of a cent below $1.2700. It is
consolidating today. The session low is around $1.2630, and it has not been
above $1.2675. It moves more into focus next week with the BOE meeting and CPI
figures. Note that the euro is trading a new high since 2008 against the
Japanese yen and sterling is at its best levels since 2016.
America
Recognizing
the dependence on the incoming data stream to inform the FOMC decision next
month, what is reasonable to expect? First, US headline CPI may fall
toward 3.2%-3.3% by the time the Fed meets again in late July. The core rate
may slip to almost 5%, the slowest pace in late 2021. Second, economic activity
is likely to slow from around 2% growth likely here in Q2 to, perhaps, less
than half the pace in Q3. The impact of the resumption of student loan debt
servicing, the tightening of financial conditions from the rebuilding of TGA
and slowing in bank lending, and fiscal headwinds coming as the cost of lifting
the debt ceiling all push in the same direction. Today's data may give a little
flavor, with retail sales expected to fall for the third time in four months
and manufacturing output to fall for the second time in three months. The June
Empire State manufacturing survey is expected to remain in negative territory
for the second consecutive month, while the Philadelphia Fed’s business outlook
probably deteriorated. The median forecast in Bloomberg's survey is for US GDP
to slow to less than half of the Q2 pace. Note that after today's data,
the Atlanta Fed's GDP tracker will be updated from 2.2% on June 8.
Canada
report May housing starts and existing home sales, and April manufacturing
sales. These data points typically do not have much market impact. The US
dollar recover from the dip to nearly CAD1.3270 yesterday (just ahead of the
year's low set in early February near CAD1.3265) and settled back above
CAD1.3300. The greenback reached CAD1.3355 before finding new sellers that
drove it back to the session lows in the European morning near CAD1.3320. The
lower end of the US dollar's trading range has frayed a bit but has not broken
convincingly. There are a couple of chunky option expirations tomorrow:
$630 mln at CAD1.3250 and $640 mln at CAD1.3200. The US dollar is
consolidating against the Mexican peso have setting a new multi-year low near
MXN17.08 yesterday. So far today, the dollar has held above MXN17.10
and briefly poked above MXN17.21. There are options more about $317 mln at
MXN17.25 that expire today. A close above MXN17.2070, the five-day moving
average, would be the first this month. Separately, note that S&P upgraded
the outlook to positive from stable for Brazil's credit rating, which it puts
at BB- amid improvement in the fiscal framework. Fitch also assigns a BB-
rating to Brazil, but already has a stable rating. Moody's sees Brazil as a Ba2
credit (BB) and a stable outlook.