Sterling Takes it On the Chin

Projections showing that the UK Tories could lose their outright majority in Parliament in next week's election spurred sterling sales, which snapped a two-day advance.  Polls at the end of last week showed a sharp narrowing of the contest, and this saw sterling shed 1.3% last Thursday and Friday.  It recouped about 0.35% in the past two sessions before today's 0.6% drop to $1.2770, the lowest level since April 21.  

It was May's election to lose, and she is doing her best.  A combination of reversal, a hapless campaign, against what by all reckoning was a weak opponent.   The real risk may lie not so much May's outright defeat, but rather the appearance of a weaker leader could haunt her term.  

The $1.2780 area corresponds to the 50% retracement objective of sterling's advance since the election announcement.  The 61.8% retracement is near $1.2720.    Technical indicators favor additional losses.  Technical indicators (e.g. MACDS, RSI) did not confirm sterling's high from the middle of the month, creating bearish divergence.  In a word, sterling's technical tone was fragile before the threat of a "hung parliament" spurred the sales.  

The euro barely responded to the soft preliminary May CPI report.  Germany, France, and Italy reported less price pressures than expected, which may have stolen whatever potential thunder today's aggregate report had.  The headline pace fell to 1.4% from 1.9%, and the core eased to 0.9% from 1.2%.  This underscores the points Draghi (and several other ECB officials) have made about the lack of a sustainable inflation path toward the target and the need for continued extensive monetary support.  Even the Bundesbank's Weidmann has acknowledged the need for support monetary policy presently.  

The ECB may formally recognize what has long been recognized by investors.  The risk of lower rates has diminished considerably.  The downside risks to the economy have materially eased.   It was also reported that April unemployment fell to 9.3% from a revised 9.4% (was 9.5%) in March.  It is the lowest rate since 2009.  The economic expansion is a necessary but not sufficient pre-condition of the end the unorthodox monetary policy.  Political risks have diminished, but clearly not entirely gone away, with German, Austrian, and probably Italian elections, this year, and the UK vote and Brexit, coupled protectionist and nationalist thrust of US policy.  

The euro is little changed against the dollar, though gaining on a trade-weighted basis.  It is consolidating in about a third a cent below $1.12.  Support is seen near $1.1160 on an intraday basis.  The euro continues to be a major beneficiary of the unwinding of the so-called Trump trade.    Investment advisers, banks, and the media have advocated equity investments in Europe over the US, and for all the fund flow trackers, the Dow Jones Stoxx 600, flat today, is up 0.8% this month.  The S&P 50 is up 1.2% coming into today's session.  

There were two notable economic reports from Asia.  Japan reported its strongest rise in industrial production in six years, with a 4.0% rise in April.  It followed a 1.9% decline in March.  While rising manufacturing exports helped, auto production surged (16.3% year-over-year from a revised 4.5% pace in March).  Housing starts were also stronger than expected.  And the Japanese economy appears to have begun Q2 on firm footing.  

The dollar is trading within yesterday's range against the yen.  It has been confined to about a quarter of a yen both sides of JPY111.00.  The JPY110.50 area is the 61.8% retracement objective of the dollar's bounce from the middle of last month.  The low from May 18 was near JPY110.25, which also corresponds to the 200-day moving average.     

The other report from Asia was China's PMI.  The manufacturing PMI was unchanged at 51.2, while the non-manufacturing PMI rose from 54.0 to 54.5.  One takeaway, ahead of the Caixin readings due tomorrow, is that the world's second-largest economy may not be slowing as much as had been feared.  On the margins, this may, in turn, help keep the debt concerns at bay a little longer.  

Meanwhile, the yuan has strengthened.  It is at its best level since last November, appreciating by 1% over the past three sessions.  Spurred in part by a funding squeeze in Hong Kong, the offshore yuan (CNH) has rallied 1.5% in the same time.  Note that China's officials have also formally introduced a new element (counter-cyclical adjustment) to the black box of the fixing.  The suspicion is that officials want a stronger yuan to deter capital outflows, and allow the kind of reforms that would address some MSCI concerns. Officials have also introduced a new benchmark fixings for one, seven, and 14-day reports.

One of the reasons that dollar is having difficulty gaining much traction, we argue, is that interest rates remain unexpectedly low. Fed Governor Brainard seemed to capture the sense in the markets at the moment.  She said that while it may be appropriate to soon remove some accommodation (her signal of agreement for a hike in two weeks), she express some caution if inflation was not longer moving toward its target.  The US 10-year yield tested 2.20% yesterday, having been near 2.60% when the Fed hiked in December 2016 and March 2017.   

The US reports the Chicago PMI, pending home sales, while the Fed releases the Beige Book.  The EIA updates its monthly supply reports today.  Late today, Brazil's central bank is expected to cut the 11.25% Selic Rate.  Many are looking for a 100 bp cut; there is some risk of a smaller move.  

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