Overview: A key development in recent days has been the market's convergence with the Federal Reserve's forward guidance regarding scope for two quarter-point hikes in the second half. The US two-yield is up about six basis points today, extending yesterday's 15 bp increase. It is approaching 5%. The Fed funds futures strip implies one hike has been fully priced in and about a third of the next one. The dollar has risen against all the G10 currencies this week but the Norwegian krone. It is mixed today (+/- ~0.20%) ahead of US data, and especially the PCE deflator. The weakness in China's PMI and Japan's industrial output contrasts with the string of stronger than expected US economic data.
Asia Pacific equities were
mixed, while Europe's Stoxx 600 is advancing for the fourth consecutive
session, which snapped a six-day down draft that ended on Monday. US index
futures enjoy a firmer bias. Among the large bourses, the S&P 500 is up
nearly 7% this quarter compared with less than 1% gain of the Stoxx 600. The Nikkei
leads with a nearly 18.4% surge. China's CSI 300 is off a little more than 5%.
Europe's 10-year yields are mostly 2-3 bp firmer, but the Gilt yield has jumped
seven basis points bringing the Q2 increase to more than 90 bp. The 10-year US
Treasury yield is up five basis points near 3.89%, a 34 bp rise this quarter. Gold
recovered from the first dip below $1900 in three months but stalled near $1910
and is now below $1905. August WTI is firm and reached a new high for the week
near $70.75. It is up about 1.5% this week after falling almost 4% last week. For
the quarter, it is off almost 7% after falling nearly 5% in Q1.
Asia Pacific
China's June PMI was in
line with expectations. The manufacturing PMI was little changed at 49.0
(48.8 in May). It spent Q4 22 below the 50 boom/bust level and the re-opening
helped lift the manufacturing PMI above 50 in Q1 and it disappointingly spent
Q2 back below 50. The non-manufacturing PMI slowed for the third consecutive
month (53.2 from 54.5) after improving in Q1 from below 50 in Q4 22. The
composite PMI also eased for the third consecutive month (52.3 vs. 52.9). Early
Monday, the Caixin PMI will be reported. Investors seem to be chomping at the
bit for new supportive measures for the economy, which may not be forthcoming
until later next month. In the meantime, from sentiment remains poor.
There were three
high-frequency data points from Japan. First, for the first time in four months,
Japan's May industrial output fell. The 1.6% decline was greater than expected
(median forecast in Bloomberg's survey was for a 1.0% pullback. Softer export
volumes were a drag. This likely reflects weaker demand, but also sanctions as
chip fabrication equipment shipments fell. Second, the labor market was little
change with the unemployment rate steady at 2.6% and the job-to-applicant
ration unchanged at 1.31 (from 1.32). Third, and most importantly, was Tokyo's
June CPI, which does a good job anticipating the national figures. The headline
pace eased to 3.1% from 3.2% and the core measure that excludes fresh food
stands at 3.2% (from a revised 3.1% in May). Excluding both fresh food and
energy, consumer prices eased to 3.8% from the cyclical high of 3.9% previously.
Economists had expected a small increase. Bank of Japan Governor Ueda said two
things of note in at the Sintra confab this week. First, he revealed that the
central bank estimates that underlying inflation is lower than 2%. Second, that
if it had confidence in the price outlook for 2024, it would adjust policy. At
the BOJ meeting next month (July 28), the BOJ will update its forecasts. Its
latest forecast was for 2% core CPI (excluding fresh food) in 2024 and 1.6% in
2025. Note that the first thing Monday, Japan's Tankan survey results will be
published. Sentiment is expected to improve slightly while capex plans may show
a sharp increase.
The dollar pushed to a new
seven-month high against the Japanese yen. This will be the third consecutive
weekly advance but around 0.80%, it is the smallest. The dollar has fallen in only
four weeks here in Q2. With the BOJ still convinced that inflation is
sustained, the policy divergence is significant. What made last October
intervention by the successful was that it coincided with a top US 10-year
rates. Japanese officials may be playing for time. Ironically, the dollar may
come off and intervention would be more effective if rates were near a peak. The
US 10-year Treasury yield settled at its highest level (3.85%) since the first
part of March. The year's high was set in early March before the banking stress
a little below 4.10%. Last year's high, coinciding with BOJ intervention on
October 21 was nearly 4.35%. The trend line connecting the Oct 22 and March 23
highs comes in slightly above 3.85%. Even though Japanese officials have made
it clear that they are more concerned about the pace of the move than the
level, many market participants are wary as the JPY146 area is approached
because it is seen as the level of the first intervention last year.
The dollar rose to almost
JPY145 yesterday and to a little above JPY145.05 today. It is making higher
highs and higher lows, i.e., it is trending higher. After punching above
JPY145, the dollar was sold back to about JPY144.45 where it found new bids.
The five-day moving average, now near JPY144.30, may offer a metric of the
momentum. It has not closed below it nearly three weeks and when it does, it
will be as momentum flags. The Australian dollar found support around
$0.6660 for the third consecutive session. However, the bounce has
been unimpressive, having stalled near $0.6640, which is not quite the (38.2%)
retracement of the sell-off from Tuesday's high around $0.6720. The five-day
moving average is closer to $0.6655 and the (50%) retracement is about $0.6660.
The high before the soft CPI figures was a little shy of $0.6700. The odds of a
rate hike are around 33%, which is a little above where it finished last week
(~29%). Chinese officials are also leaning against the tide, trying to
manage the yuan's decline. Given their opacity, the signal needs to be
clear and consistent. For the fourth time this week the dollar's reference rate
was set lower than the market projected (CNY7.2258 vs CNY7.2485). Still with a
broadly firm dollar and rising US rates, if Chinese officials want to steady
the yuan, it will have to step up its game. The dollar is trading a new high
for the year and reached CNY7.2685. The high from last year, set in November,
was almost CNY7.3275. It is less than 1% away.
Europe
The preliminary estimate
for the June eurozone CPI was in line with expectations, rising 0.3% on the
month for a 5.5% year-over-year rate (from 6.1% in May). It stood at 9.2% at the
end of last year and 6.9% at the end of Q1. The 0.3% month-over-month gain
means that in H1 23, eurozone CPI rose at an annualized rate of about 4.8%.
Meanwhile, the core rate increased to 5.4% from 5.3%. The cyclical high was set
in March at 5.7%. ECB's Lagarde gave no reason not to expect a hike at the July
27 meeting. The swaps market leans toward a September hike (~56%) but seems to
be pricing in the first cut around mid-2024. Separately, the May eurozone
unemployment was unchanged at 6.5%. It has not been lower during monetary
union. Lastly, note that early Monday, the final June manufacturing PMI is due.
The euro sold offer in response to the preliminary report on June 23 (43.6 from
44.8). It has not been above 50 since last June.
In the UK, Nationwide
reported house prices eked out a 0.1% gain in June, rather than a 0.2% decline
that was expected. The year-over-year decline of 3.5% (vs. -4.0% that was
forecast) is the most since 2009. Houses are work less as mortgage servicing
rises. Revisions to Q1 GDP details showed less government spending and more
business investment but are old to impact the capital markets. Moreover, after
0.1% quarter-over-quarter growth in Q1, the median forecast in Bloomberg's
survey sees the UK economy stagnating here in Q2. The UK will also see its
final manufacturing PMI on early Monday. It has not been above 50 since last
August. Meanwhile, the swaps market is pricing in about an 82% chance that the
Bank of England lifts the base rate by another 50 bp at the next meeting on
August 3, which would take it to 5.50%. The terminal rate is seen between 6.00%
and 6.25%.
The jump in US rates sent
the euro to new lows for the week, after closing yesterday at its lowest level
since June 14 (Fed Day). The euro has been sold through the 20-day moving average
(~$1.0855) for the first time June 12 and through last week's low around
$1.0845 to $1.0835. Below there, the $1.0825 is the (50%) retracement of the
rally from May 31 low near $1.0635. The momentum indicators have turned down,
and we suspect there is potential toward $1.0780 (61.8%) retracement in the week
ahead, and possibly $1.0725 (assuming a solid even if not spectacular US jobs
report). Sterling nearly retraced half of its gains since the May 25
(~$1.2310) found around $1.2580. It is trading quietly in roughly a have a
cent range today above $1.2600. A break of $1.2580 targets $1.2515 next and
then the $1.2400-30 support area. The momentum indicators have rolled over and
the five-day moving average are set to cross over next week. It is difficult to
envision the market pricing in a more aggressive BOE trajectory without more
data. The next employment report is July 11, and the June CPI is on July
19.
America
The string of stronger
than expected US economic data continues. US Q1 GDP was revised to
2% (from 1.3%) helped by a 4.2% (from 3.8%) rise in consumption. That is the
largest increase since H1 21 which was bolstered by government assistance. The
26k decline in weekly initial jobless claims was the largest fall since October
2021. It is not necessarily a clean read as it covers the Juneteenth holiday,
but the decline was more than expected. The US 2-year yield shot up around 18
bp at its best to nearly 4.90% and is higher today (4.93%), the highest since
the banking stress hit in March. The yield of the January Fed funds futures
contract rose almost 15 bp and is now about 5.40%. This means that the market
has priced in one more hike in full and has about a third of a second
quarter-point hike discounted.
Ahead of what for many in
the US will be a long holiday weekend, the focus is on the personal income and
consumption reports. We expect two takeaways. First, spending likely slowed in
nominal and real terms after increasing by 0.8% and 0.5%, respectively in
April. Indeed, we think this is part of a key development we expect to emerge
in H2: slower growth led by a pullback in the consumer. Second, while the
headline deflator is set to fall further (below 4% from 4.4% in April) and the
base effect suggests another step decline this month. However, the core rate,
is likely to be steady to firmer (4.7%). Assuming the deflators are in line
with expectation, it will mean that the headline rate is rising at around half
of last January-May's pace (~3.6% vs. 7.0%), while the core may be rising
slightly faster (~4.8% vs. 4.6%).
The Bank of Canada meets
on July 12. Ahead
of the meeting there are two high-frequency data points that can help shape
expectations. The first is today's April's GDP. It is "old,” but the Bank
of Canada was surprised by the strength of the economy in Q1, and this will
give a sense of how the economy was doing at the start of Q2. The median
forecast in Bloomberg's survey calls for a 0.2% increase after a flat showing
in March. The second important data point is next week's employment report.
Canada lost full-time positions in both April and May. It was the first
back-to-back loss of full-time jobs in two years. The Bank of Canada's decision
to hike rate on June 7 was made two days before the May jobs data were
reported. The swaps market is pricing in about a 60% chance of a hike next month,
the most this week. Last week's peak was closer to 70%.
The greenback
surged from the nine-month low on Tuesday near CAD1.3115 and stalled yesterday
slightly beyond a retracement objective and the 20-day moving average near
CAD1.3280. It
was sold to a new session low as Europe was closing yesterday near CAD1.3240.
However, the risk is that the upside correction for US dollar is not over. The
next technical target is near CAD1.3300-20 Meanwhile, the dollar
remains pinned near its trough against the Mexican peso. It has not
traded above its 20-day moving average since June 1. It is found a little above
MXN17.20. Last week's high was near MXN17.2650 and this week's high, set Monday
was about MXN17.18. Separately, the US dollar closed above the 20-day moving
average (~BRL4.8485) against the Brazilian real yesterday for the first time
since June 1. A trough was carved over the past week-and-a-half near BRL4.75. A
move above BRL4.90 could retarget BRL5.00.
Reviewed by Marc Chandler
on
June 30, 2023
Rating:
