The week ahead is less eventful than the week that just passed, which saw the anticipated hike by the ECB and the small cut by the PBOC. The Fed delivered the widely tipped hawkish hold and the US CPI continued to decelerate. The dollar fell against the G10 currencies last week but the yen. Sterling, and the Canadian dollar rose to new highs for the year, Momentum indicators are stretched. This coupled with risk-reward considerations suggest that the dollar could bounce in the coming days.
The week ahead features the flash PMI readings and the Bank of England meeting (June 22) a day after its May CPI report. Norway's central bank also meets on June 22. Norway's inflation is running at a 7.2% annualized rate through May, though it was one of the earliest G10 central banks to embark on a tightening cycle (six months before the Fed). Its policy rate sits a 3.25%. A 50 bp hike would command attention. Fed Chair Powell delivers his semi-annual economic update to Congress. His prepared remarks have already been published and the message well known. Among emerging market central banks, Turkey's rate decision under new leadership draws interest. The one-week repo rate (8.50%) may be hiked for the first time since March 2022. In Latam, Mexico's central bank is on hold, probably until Q4, while Brazil's central bank seems closer to cutting the 13.75% Selic rate.
United States: The Fed's hawkish hold means that the bar to a hike next month is low. The upcoming data will be judged through that vantage point. Still, the market seems a bit skeptical of the median Fed forecast for two more hikes this year. The Fed funds futures imply an effective rate (weighted average) of about 5.20%, up 12 bp from current prevailing levels. Fed Chair Powell's message in his congressional testimony (June 21-22) will be the same as the FOMC statement and press conference. The market, which had been pricing in cuts this year until late May still needs to be convinced that the Fed will in fact deliver two more hikes this year.
In this
context, the flash June PMI does not seem particularly important. On the other
hand, the housing market may have stabilized, but is still seems fragile.
Permits have risen by an average of 0.3% a month this year through April (2.6%
average decline in 2022) while starts themselves have risen by an average of
0.9% a month (falling 2% a month on average last year). The index of Leading
Economic Indicators has been on a sharp decline since the end of Q1 22. Here,
economists look at the six-month pace, which has accelerated this year to -8.7%
in April compared with 7.5% at the end of last year and +1.2% in April 2022. It
had reached -9.1% in March. When the LEI fell at such a pace previously the US
was in a recession since the late 1960s. That said, this late in the quarter,
the Atlanta Fed's GDP tracker does a fair job, and it now sees Q2 GDP a 1.8%.
The US reports its current account balance for Q1. At least in the short run, the
market is non-plussed, but the chronic deficit is a key consideration for some
long-term dollar bears. In any event, we already know that the trade deficit
narrowed slightly in Q1 ($12 bln), and this suggests the possibility of a
quarterly shortfall of less than $200 bln for the first time in two years.
The Dollar Index fell for the
third consecutive week and its 1.25% decline was the largest in five months. The
five-day moving average crossed below the 20-day moving average early last week
for the first time since mid-May. It recorded lower highs and lower lows for
the past four sessions. The downside momentum is strong, but maybe too much. The
Dollar Index settled below its lower Bollinger Band (~102.40) for the second consecutive
session before the weekend. The 101-102 congestion band may be sufficient to
keep steeper losses in check.
United Kingdom: The firm inflation readings, strength of
the labor market, and official verbal guidance has convinced the market that
the Bank of England will lift rates 125 bp before the end of the year. The
swaps market now envisions a 5.75%+ terminal base rate. Early in Q2, it was
briefly seen below 4.40%. UK Gilt yields have risen sharply as well. Consider
that during the government crisis and pension crisis last Sept/Oct, the 10-year
Gilt yield jumped from around 2% in the middle of August to a peak near 4.65%.
Fast-forward, the yield tested the 200-day moving average in late March
(~3.15%) and rose in April and May by almost 70 bp combined to nearly 4.20%. It
is now yielding almost 4.40%. Part of this can be explained by the
higher-than-expected inflation. In the first four months of the year, the UK's
CPI has risen at a 10% annualized pace (after a 13.2% annualized clip in the
last four months of 2022). The May figures will be released the day before the
BOE meeting. Inflation is high but the shift in inflation expectations
(measured by the 10-year breakeven, the difference between the conventional and
inflation-linked bonds) accounts for about half of the rise in the nominal yield.
The day after the BOE meeting, the UK reports May retail sales. Another modest
increase after April's 0.5% rise is likely. UK retail sales fell by an average
of 0.6% a month last year, but in the first four months of the year, they have
risen by an average of 0.4%.
The prospects of a hawkish BOE have
helped sterling shine. Its 2% advance last week was the biggest since
last October. Sterling rose to near $1.2850, its best level since April 2022. It
peaked near $1.4250 in June 2021, and with last week's advance through $1.2760
it surpassed the (61.8%) retracement objective. There are two hurdles ahead of
$1.30. First, sterling has settled the past three sessions above its upper
Bollinger Band (~$1.2765) and other momentum indicators are getting stretched. Second,
chart resistance may be encountered in the $1.2880 area. The $1.2650-80 area
should offer initial support.
Japan: In addition to the preliminary PMI,
Japan reports the May CPI figures. The Tokyo CPI figures released a few weeks
ago have already foretold what will likely happen. The headline and core
measure (excludes fresh food) may slow toward 3.2% (from 3.4%-3.5%). However,
the measure that excludes fresh good and energy, may have ticked up. It was
4.1% year-over-year in April. The BOJ is signaling no strong urgency to change
policy, but many expect an adjustment in the second half of the fiscal year
that begins in October. The stark divergence in policy has weighed on the yen. And
it is not just against the dollar. The yen is at its lowest level against the
euro since 2008 and is the weakest against sterling since 2015. On a
trade-weighted basis, the yen has depreciated by more than 10.5% from its January high and has pushed through the low from Q4 22, which itself was the lowest in more than a couple of decades.
According to the OECD's measure of purchasing power parity, the yen is around
47% under-valued. That is more than twice the overshoot experienced ahead of
the Plaza Agreement in 1985.
The ongoing policy divergence
continues to weigh on the Japanese yen. It was the only G10 currency to fall
against the dollar last week. Its roughly 1.75% decline offset the 0.85% gain
recorded in the previous two weeks. While the momentum indicators look
constructive for the dollar, the caveat is that it settled above its upper
Bollinger Band. Initial support now may be near JPY141.25. We have been targeting JPY142.50. With it in sight, note that above it, the next important chart area is JPY145-JPY146.
Eurozone: The ECB hiked rates last week, as
widely expected, and confirmed that barring a significant surprise it would
hike again next month. In fact, the markets are more confident of an ECB move
in July than a Fed hike. The week ahead economic diary includes the April current account
and construction spending, and then, the flash PMI at the end of the week. The
eurozone's current account surplus has swung dramatically back into surplus
this year. The average monthly surplus in Q1 was 24.6 bln euros. The surplus
averaged about 200 mln euros in Q1 22 and but recorded an almost 150 bln euro deficit for the entire year. Before the pandemic and Russia's invasion of Ukraine, the
surplus averaged around 30.1 bln euros a month in Q1 19. Last April, the
eurozone recorded a 17.9 bln euro deficit. Given the unexpected April trade
deficit reported last week (7.1 bln euros rather a 17.5 bln euro surplus the
median expected in Bloomberg's survey), a small current account surplus is
likely. Lastly, the eurozone's construction sector is broadly keeping pace with
the US this year. In the eurozone, construction spending rose an average of
1.0% a month in Q1 after falling for the previous three quarters. Through
April, in comparison, US construction spending rose by an average of 0.9%.
However, unlike the eurozone, the US has not experienced a quarterly
contraction in construction spending since Q2 20.
The euro rose almost 1.8% last week,
its strongest performance since last November. The five-day moving average
crossed above the 20-day early last week for the first time since May 10. The
momentum indicators allow for additional gains, but the euro settled above its
upper Bollinger Band (~$1.0905) for the second consecutive session ahead of the
weekend. It is in needs of some consolidation. Initially, a pullback toward
$1.0860 seems reasonable.
China: It seems a bit like following the
breadcrumbs. Chinese officials first used informal (soft?) power to get the banks to
cut deposit rates. Then the PBOC cut the cost of funds via a 10 bp reduction in
the seven-day repo rate. That was followed by a 10 bp cut in the benchmark
one-year medium-term lending facility to 2.65%. In turn, it should be followed
by a similar reduction in the one-year prime loan rate from 3.65%, which is has
been since last August. Although the five-year prime loan rate does not follow
the moves on the one-year rate precisely, they both are 50 bp below the rates
that prevailed at the end of 2019. There continues to be talk that Beijing is
considering other stimulative measures including more support for property
market. The anticipation of policy support may encourage global investors to
look again at Chinese assets. The CSI 300 rose 3.3% last week, the most since
last November.
The yuan snapped a five-week
slide last week and eked out a minor gain against the dollar. It is only the
third weekly gain since the end of Q1. The greenback posted a key downside
reversal on June 15 by making a new high for the year (~CNY7.1810) and then
reversing and settling below the June 14 low. Follow-through dollar selling
ahead of the weekend saw the greenback approach CNY7.1050, a seven-day low and
just ahead of the 20-day moving average. It has not traded below the 20-day
moving average in nearly two months. A break can see a test on CNY7.07 and then
CNY7.0350, ahead of CNY7.0. However, the striking weakness of the yen before the weekend and the stalling of the euro's rally in North America could point to a weaker yuan at the start of next week's trading.
Canada: The market is about as confident
that the Bank of Canada hikes rates at the July meeting as it is that the
Federal Reserve does (~60%). Retail sales fell in February and March and likely
rebounded in April. It may support even if not materially so, that the Bank of
Canada's recent rate hike (to 4.75%) was not a one-off move. The swaps market
is pricing in about a 60% chance of the hike at the July 12 meeting and it is
fully discounted by the September 6 meeting. The expectation for the year-end
rate is between 5.0% and 5.25%. It was near 4% as recently as May 12.
The US dollar fell to
nine-month lows below CAD1.3200 ahead of the weekend. The drivers include belief
that the Bank of Canada's tightening cycle has resumed, a risk-on environment
that has seen equities rally, and oil has recovered, at least in part of the
Chinese stimulus expectation and increased oil import quotas for the refiners. The
momentum indicators are stretched suggesting that further US dollar losses may not be deep or sustained before a corrective phase. Initial
resistance is likely near CAD1.3250 and a move above it could spur a move back
toward CAD1.3350. On the downside, there is little below CAD1.3200, there is little of technical significance until closer to CAD1.30.
Australia: There has been a dramatic swing in
Australian rate expectations. After the quarter-point hike earlier this month
the target rate sits at 4.10%. In the futures market, the implied year-end rate
has risen to about 4.65% from around 3.40% at the end of Q1 and 3.80% in the
middle of May. The strong recovery in the labor market in May pushed on the
open door. The implied year-end rate has risen in 21 of the past 25
sessions. The minutes from this month's meeting, where the hike took the market
by surprise, will be released on June 20. The Australian dollar's rally this
month has been dramatic. From the May 31 low (~$0.6460, the low for the year)
it 6.8% to a four-month high ahead of the weekend ($0.6900). This met the
(61.8%) retracement of the Aussie's slide from the early February high
(~$0.7160) to that May 31 low. The momentum indicators are stretched, as one
would expect, though it settled below the upper Bollinger Band (~$0.6885). Initially,
a pullback could see the $0.6800 area as the previous resistance area becomes support.
Mexico: The central bank has signaled its
monetary tightening cycle is over and the continued sequential easing of price
pressures in May give no reason for it to have second thoughts at its June 22
meeting. The issue in the market has changed to the timing of the first cut,
not only in Mexico, but in Brazil and Colombia too. Comments by Banxico
officials suggest the overnight target rate of 11.25% will likely be maintained
through Q3. The swaps market is pricing in a quarter-point cut in Q4. For
Brazil, the swaps market seems divided between a rate cut of 25 bp and 50 bp in
Q3 and around 100 bp in Q4. The swaps market favors a quarter-point cut in Q3,
but it is not fully discounted. However, by the end of the year, the swaps
market is pricing in 100-125 bp of cuts.
The dollar recorded a new low
since April 2016 in the middle of last week (~MXN17.08). and bounced about one percent higher before being greeted by fresh selling that drove it to MXN17.0250 ahead of the weekend. The greenback finished lower for the
fourth consecutive week. It has risen in only three weeks here in Q2
after rising five weeks in Q1. The momentum indicators are extended and the
first sign that a correction may be at hand would be a close above the five-day
moving average (~MXN17.1530), which it has not done since May 23. We had been
looking for a move to MXN17.00 and it is taking place faster than expected. A
convincing break of it could target the MXN16.50 area next.
Reviewed by Marc Chandler
on
June 17, 2023
Rating:
