New Day, Same Story

The news stream continues to be dollar negative. The minutes from the FOMC meeting may not have been as dovish as many had expected, but the subsequent economic data has also been disappointing. The deterioration of the May trade deficit in real terms is prompting economists to lower their Q2 GDP forecasts. Some are suggesting that the retail sales report may also prompt a downward revision, but it is not immediately clear why as the core-core component (excludes autos, gasoline and building materials) which is used by the Commerce Department to calculate GDP actually rose 0.2%. The soft economic reports are set to continue today with an expected decline in June industrial output.

Hope that the soft patch in the US economy may be a May-June phenomenon will be tested today with the July Empire manufacturing index and the Philadelphia Fed survey. At the same time, as soft PPI report will do nothing to ease deflation fears.

On the other hand, this week’s successful Greek bill auction and Spain’s successful sales in recent weeks, culminating with today’s 15-year bond sale signals the end of the immediate liquidity concerns. As the ECB weans the market off of its long-term operations, drains excess liquidity and slows, if not stops, its bond purchases, the FOMC discussed the possibility that may have to consider additional actions. Although it seems clear to us that such action is not imminent, the direction of developments is notable.

Short-term interest rate differentials continue to move in Europe’s favor. The US-German 2-year swap rate has widened out to 18 bp in Germany’s favor. That is a shift of 7 bp over the past five days and 42 bp swing over the past month. The same pattern is seen in the Euribor-Eurodollar spreads. The first phase of the decline in US rates came as a function of safe haven demand, but in recent weeks, it is seen more as a reflection of the weakness in the US real and monetary data. The rise in short-term European rates alongside the now nearly 7% appreciation of the euro is unlikely to be doing much for the growth prospects in Europe, but in the immediate term it provides another incentive to reduce long dollar/short euro positions.

The UK inflation linked bond auction today was noteworthy. It is the first such sale since the government indicated it would base state employee pension increases to the consumer price index rather than the retail price index. The CPI tends to average about 0.7% less than RPI. The Gilt linker is “linked” to RPI not CPI. This apparently impacted demand. The bid-to-cover of the GBP1.22 bln (1.875% 2022 index-linked gilt) was a soft 1.76, down from 2.49 at the last auction in mid-May despite a substantial increase in the real yield to 0.947% from 0.765%. This did not stand in the way of sterling, which made a new session high after the results. The next important objective for cable is seen near $1.55. Support is seen in the $1.5200-50 area.

On a slightly different front, we note that although the BOE’s Sentence continues to brandish hawkish talons, fellow MPC member Miles took the opposite tack. This is noteworthy because some identified Miles a dove than can be turned. Not yet. In contrast to the disappointing reception of the UK inflation linked bond, the reception of France’s sale of inflation-linked bonds was significantly better and was part of a multi-tranche offering today. The 1.3% July 2019 issue was priced to yield 0.98% compared with 1.19% at the last auction in mid-March and enjoyed a better bid-cover (2.38 vs 1.72).

China’s economic data does not resolve the uncertainty surrounding the growth trajectory of what could be the world’s second largest economy. Growth in Q2 moderated to 10.3% from 11.9% in Q1. This is still strong by any metric. Industrial production and retail sales were less than forecast, but also posting strong year-over-year gains (13.7% and 18.3% respectively). As some reports had suggested, pressure on consumer prices eased to 2.9% from 3.1% in May. One important take away from the data is that Chinese officials are going to feel less urgency about tightening monetary policy through rate hikes or increases in required reserves. Short-term yields fell in China and the 12-month non-deliverable forward slipped marginally to imply 1.7% appreciation over the next year. Commodity prices and the Baltic Dry Freight Index are unlikely to draw much comfort from today’s data. This same sense is reflected by the fact that the Australian dollar is trading lower despite the heavier US dollar tone.