Overview: As the market reluctantly edges toward the
Fed's guidance, the disappointing PMIs from Europe (but also Japan and
Australia) helped boost the greenback. The Dollar Index is trading at seven-day
highs above 103 after briefly dipping below 102 to set a new low since mid-May
yesterday. The unwinding of cross positions is helping the yen hold its own
today as it consolidates near its worst level of the year. The surging dollar
and risk-off mood has dragged the emerging market complex lower. The JP Morgan
Emerging Market Currency Index extended yesterday's loss and its lowest level
of the year.
China and Taiwan markets were
closed for holiday today, but the other Asia Pacific equity markets are a sea
of red. Europe's Stoxx 600 is flat after four days of losses and US equity
futures point to tough session for Wall Street. The weak flash PMI readings
spurred concerns over growth and ignited a bond rally. European benchmark
yields are mostly 10-11 bp lower and the US 10-year Treasury yield is off five
basis points to about 3.75%. The lower yields appear to be helping gold
stabilize after falling to new three-month lows (~$1910) in early Asia Pacific
turnover. It is encountering offers near $1920. Demand concerns again weigh on
oil prices. August WTI reversed yesterday from around $72.65 to below $69 and
today, fell to almost $68. The month's low was near $67.
Asia Pacific
Japan saw the flash June PMI
and May CPI. Japan's
manufacturing PMI slipped back below 50 in June after moving above it in May
for the first time since last October. The services PMI slowed to 54.2 from
55.9. The composite reached an 8 1/2-year high in April (54.3) and it eased to
52.3 in the preliminary June reading. The median forecast is for the Japanese
economy to growing 1.1% (annualized pace) in Q2 after 2.7% in Q1. The May
national CPI figures were in line with expectations. The headline and core
measures slowed to 3.2% from 3.5% and 3.4%, respectively. The bigger issue is
that measure that excludes fresh food and energy edged up to a new cyclical
high of 4.3% from 4.1%. Still, next week will see Tokyo's June CPI, which may
be more important ahead of next month's BOJ meeting when macro forecasts will
be updated.
Australia's flash PMI is
also not as important as next week's May CPI and retail sales reports. The PMI showed that the manufacturing
sector remains challenged at 48.6 from 48.4 (below 50 for the fourth
consecutive month). Services slowed to 50.7 from 52 and the composite eased to
50.5 from 51.6 in May. Forward looking new orders were notably softer. The
futures market has downgraded the odds of a hike next month to less than 30%
from over 50% at the end of last week. Meanwhile, May's CPI expected to slow to
6.1% from 6.8%.
Rising US rates and the
divergence of policy lifted the greenback to new highs for the year against the
Japanese yen. Despite the
higher underlying inflation measure, Japan's five-year yield fell to a new
seven-month low today. There is little to deter a move toward JPY145-JPY146. The
note of caution comes from the dollar trading above its upper Bollinger Band
(~JPY143). Yen weakness is not only about dollar strength, as it has been
crushed on the crosses. Of particular note, it has fallen to a record low
against the Swiss franc. The franc has gained nearly 11.4% against the yen so
far this year, and about 1.5% over the past week. Here the carry seems
secondary to the momentum. The Australian dollar's attempt to rally was
stymied near $0.6800 yesterday after having been turned back from $0.6900 at
the end of last week. It has been sold through support near $0.6730
area and into the $0.6680-$0.6700 area, which houses the 20- and 200-day moving
averages and the (50%) retracement of this month's rally. Below there brings
the next retracement objective (61.8%) into view (~$0.6625). Meanwhile, the
greenback's broad strength and policy divergence will make it hard to for
Chinese officials to stabilize the yuan even if they wanted. The risk
is growing that the dollar challenges last year's high near CNY7.3275. Mainland
markets remains on holiday, and the dollar rose to almost CNH7.23
offshore.
Europe
The eurozone flash PMI
disappointed and the euro is being hit the hardest here in Q2, losing around
1%. The
manufacturing PMI eased to 43.6 from 44.8. The last time it was about 50 was in
June 2022. The services PMI fell for the second consecutive month. It is now at
52.4 from 55.1 in May. and is below the Q1 23 average of 52.8. The composite
fell to 50.3 from 52.8. It spent H2 22 below 50 and spent H1 23 above 50. Like
the services PMI, it slowed for the second month in a row. This was the general
pattern seen in the German and France readings. The manufacturing sector is
contracting while services are slowing. French services PMI fell below 50 for
the first time since January, and at 47.3, the composite is at its lowest level
since February 2021.
Wrapping up a disappointing
week that saw inflation defying expectations for moderation, a new cyclical
high in the core rate, a budget deficit in the first two months of the fiscal
year running at twice the rate of last year's shortfall, and a 50 bp hike by
the Bank of England. The
BOE's assessment that the persistence of inflation requires further tightening
helped encourage the market to discount around a 75% chance of another half
point move at the next MPC meeting on August 3. Today, the UK has seen the
flash PMI point to a slowing economy. The manufacturing PMI contraction
deepened to 46.2, a new low for the year, and the service PMI slowed (53.7 vs.
55.2). The composite now stands at 52.8 drown from 54.0, after stalling in
April at 54.9, the highest since April 2022. Separately, UK May retail sales
held up better than expected. Rather than slip 0.2%, retail sales rose by 0.3%.
They were flattered by gasoline sales, without which a 0.1% gain was recorded.
The euro reached a new high
since May 8 yesterday (~$1.1015) before retreating. We have been suspecting a top was
being formed and yesterday's advance was frustrating. We had
anticipated a move toward $1.0860 and it looked unlikely until today's
disappointing news. It was sold to $1.0845 in the European morning. The next
target is around $1.0825 and then $1.0780. While the euro took out last
week's highs yesterday, sterling failed to do so, and after a knee-jerk move
higher (~$1.2835) on the BOE's 50 bp hike, it sold off nearly a cent. It
traded below the $1.2690-$1.2700 support band in Europe today. There may be
scope for a move toward $1.2570-80 in the coming days.
America
After extending its losses
initially yesterday, the dollar reversed higher, supported by a further firming
of US rates. It did
not seem to be spurred by US data, which was mixed. While existing homes sales
were stronger than expected, the Leading Economic Indicators Index continued to
tumble and weekly jobs claims ticked up, with its four-week moving average
rising to a new high (255k) since November 2021. As we have noted, the
six-month annualized pace of the decline in the LEI has only been seen in a
recession. Instead, we suggest two other things are taking place. First,
Atlanta Fed President Bostic notwithstanding, Fed Chair Powell's assessment
that a strong majority favor additional tightening seems to be a fair read of
the table. Chicago Fed President Goolsbee is the only voting member of the FOMC
that could dissent from a hike next month, yet even he said that the decision
to pause was close for him, meaning that he too thought a case for another hike
was reasonable.
Second, the market is
gradually coming around to the FOMC's signal. The implied yield of the January 2024 Fed
funds futures contract has risen for the past four sessions and at 5.27 is
about 12 bp higher than it was on the eve of last week's FOMC decision. With
the current effective average Fed funds rate around 5.08%, it still has not
fully priced in one, let alone the two hikes the median dot indicated. From the
Fed's point of view, the economy and the labor market are sufficiently robust
and resilient that barring a significant surprise, a weak high-frequency data
point will not derail is campaign.
As the market once again
convergences to the Fed, rather than the other way around, the two-year yield
is likely to climb back toward the March high (almost 5.10%) and the dollar
will likely retrace its recent losses against the G10 currencies, while
extending its gains against the Japanese yen. That said, as US rates rise, the other
side of the scissors begins to cut. The KBW bank indices have rolled over. Both
the bank index and the regional bank index settled below their 20-day moving
averages for the first time in a month. Many fear that higher interest rates
will exacerbate the pressure on banks, especially regional banks, emanating
from exposure to commercial real estate. At least part of the skepticism of the
Fed's forward guidance comes from the belief that what financial instability
will prevent the Fed from doing what it says it will.
The broad strength of the US
dollar has lifted it back above CAD1.3200 after probing a six-month low near
CAD1.3140 yesterday. There
is initial potential toward CAD1.3225-CAD1.3250 in the near-near term. The
week's high was set Tuesday around CAD1.3270. The CAD1.3175-80 may offer the
first level of support. As widely expected, Mexico's central bank stood pat
yesterday. Increasingly, it seems the greenback is set to correct higher
against the Mexican peso. A bottoming pattern seems to be in the process of
being carved. A move above the MXN17.30-33 area could spur a move toward
MXN17.50-60.
Reviewed by Marc Chandler
on
June 23, 2023
Rating:
