Corrective Forces Grip Markets

The light news stream has spurred some position squaring by short-term momentum traders.  This is giving the dollar a somewhat heavier tone, and weighing on European equity markets.  European bonds and Treasuries are little changed, though slightly firmer.  

The general narrative of the dollar's firmer tone is that the market feels more confident that the Fed will raise rates this year.   We have sketched out a similar view, yet it is important to recognize that this is not fully reflected in market pricing.  Specifically, the healthy June employment report in early July and Yellen's remarks have produced a net 1.5 bp increase in the implied yield of the September Fed funds contract since the end of June. It now implies 18 bp effective Fed funds rate in September.  That is a five bp increase from the current average of 13 bp.  

The FOMC dot plot shows a slight majority of members saw scope for two hikes this year, which seems to imply a September hike.  The recent Wall Street Survey found over 80% of economists expected a hike then.  Yesterday's the Fed's Bullard suggested a 50/50 chance of a September hike.  The pricing in the futures market suggests the market is still not convinced.  

Next week's FOMC statement may show the economy is evolving in line with Fed expectations.  The first look at Q2 GDP will also confirm a modest recovery after the stagnation in the first quarter. There are still two employment reports the FOMC will see before making the decision in September. 

Minutes from the recent Bank of Japan and Reserve Bank of Australia meetings were released.  There is an important take-away from each.  From the BOJ, the key point is that officials are still voicing confidence that inflation is trending in the right direction.  This, especially in the context of the recent downward revision in the central bank's multi-year inflation forecasts, suggests that there is no urgency about easing further.  Many economists expect the low inflation to prompt the BOJ into expanding its asset purchases.  The expectations originally for mid-2015 has been pushed into the second half of the fiscal year (beginning in October), but even this seems somewhat less likely. 

For its part, the RBA's minutes were slightly dovish.  It did not rule out a further rate cut but did not signal that investors should expect it next month.  It did recognize that growth in Q2 likely slowed sequentially.  The RBA underscored the importance of the upcoming data.  Tomorrow Australia reports Q2 CPI and RBA Governor Stevens speaks.   

The Reserve Bank of New Zealand is expected to cut the official cash rate 25 bp to 3.0%.  It is expected to signal scope for additional rate cuts.  After talking the Kiwi lower, recent comments noting the speed of its decline, and suggestion that milk prices will rebound, have helped spur a bounce in the currency.  It is nearly 2% off the lows seen yesterday to near $0.6620.  We suspect that  as it nears $0.6700 sellers will re-emerge.  

 Asian equities followed the US advance.  The MSCI Asia-Pacific Index gained about 0.5%.  The Nikkei's advance stretched into its eighth consecutive session.  Chinese stocks were higher, with the Shanghai Composite up 0.6% and the Shenzhen Composite up 1.6%.  It is the fourth session that the Shanghai market has advanced.  It closed above the 4000 level for the first time since July 1.  Companies continue to re-open trading in their shares.  Some 543 companies were still suspended, about 5% fewer than yesterday.  This represents about 19% of all listings. 

European shares are narrowly mixed.  What is at stake is the nine-session advancing streak in the France's CAC.  This appears to be among the largest advancing streaks in its history.  It has risen almost 13% over this period to test a two-month high.   Over the same period, the German DAX is up 10.6%. 

The corrective pressures in the foreign exchange market can persist a bit longer.  Above yesterday's $1.0870 high lies the $1.0900-10 cap.  If this is no sufficient to check the short-covering rally, there is technical scope for another half cent or so advance.  While the Nikkei has been rallying, the dollar has been recording higher highs against the yen. Today is the eighth consecutive session for this.  The greenback edged higher to almost JPY124.50 and remains poised to retest.  Sterling is in less than half a cent range inside yesterday's price action.    A break of $1.5540 could see slippage toward $1.55 were better bids likely lurk. 

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