Bank of Canada's Turn

Overview: The recent equity rally is stalling. Asia Pacific equities were mixed, with Japan, South Korea, and Australia, among the major bourses posting gains. Europe’s Dow Jones Stoxx 500 is slipping lower for the second consecutive session, ending a four-day bounce. US equity futures are little changed. The US 10-year yield is edging higher at 2.86%, while European yields are slightly lower. The greenback is firm against most of the major currencies. The Australian and Canadian dollars are the most resilient, while the yen and Swiss franc are laggards. Most emerging market currencies heavier, but the South African rand and Hungarian forint are firmer. Turning to commodities, gold is breaking down. Near $1830, it is near a two-week low. A break of the $1828 area could add another $10 drop. It peaked near $1870 last week. July WTI is firmer near $116.30. There was no follow-through selling after yesterday’s reversal. US natgas prices are up almost 3% to stem the more than 9% drop in the past three sessions. Europe’s benchmark is up about 2.6% after rising slightly yesterday. Iron ore prices firmed to recoup yesterday’s minor loss. July copper is heavy for a second session. It has a two-week rally in tow. July wheat fell to two-week lows yesterday to bring the decline since the May 17 peak to around 15%.

 Asia Pacific

Japan's final May manufacturing PMI was revised slightly higher to 53.3 from 53.2. Its recovery appears to be intact, though the mid-March earthquake and lockdowns in China is adversely impacted, as reflected in the sharp drop in April's industrial output figures released earlier this week. Exports and imports to China, its biggest trading partner fell. Still, the 2% year-over-year increase in March wage deals were the most in four years and helped underpin retail sales.

Australia's economy grew by 0.8% in Q1, which was slightly faster than expected. The final manufacturing PMI edged higher to 55.7 from the flash reading but still is at four-month lows after reaching 58.8 in April. The Reserve Bank of Australia meets next week, and the swaps market is pricing in a 30 bp rate hike.

China's Caixin manufacturing PMI improved to 48.1 from 46.0, which was a little disappointing. Recall that the "official" version rose to 49.6 from 47.4. With Shanghai and Beijing gradually re-opening, the worst may be passed. The new stimulus measures will help, but when the World Bank releases its new forecasts tomorrow, growth projections will likely be cut. With the zero-Covid policy to remain, many economists do not expect the powerful V-shaped recovery seen in many other countries. A positive note, however, came from South Korea's May trade figures, which showed a larger than expected jump in both exports (21.3% year-over-year from 12.9% in April) and imports (32% vs. 18.6%).

The dollar is rising against the Japanese yen for the third consecutive session. If sustained, it would be the longest advance since mid-April, and has lifted the dollar to two-week highs near JPY129.55. The gains, helped by a 16-17 bp increase in the US 10-year yield this week, have met the (61.8%) retracement objective of the pullback since the May 9 high (~JPY131.35) found by JPY129.45. The intraday momentum readings are stretched. The Australian dollar is trading within yesterday's range (~$0.7150-$0.7205). It needs to close above $0.7200 to sustain the momentum. Otherwise, the risk is off a pullback after rallying around 5.5% off the May 12 low (~$0.6830). The dollar is bid against the Chinese yuan. It found support this week near CNY6.6465. It is finding ahead of CNY6.70. The PBOC set the dollar's reference rate at CNY6.6651 compared with the expectation (Bloomberg survey) for CNY6.6648.

Europe

Even after the upside CPI surprise from Germany and Spain on Monday, yesterday's Eurozone aggregate CPI jumped to 8.1% from 7.5% and still shocked many. The core rate was also stronger than expected at 3.8%, up from 3.5%. The swaps market now sees the year-end rate a little more than 0.60%. It was straddling 30 bp in early May. While the ECB's leadership has tried to stake out a gradual course of 25 bp at the next two meetings, in an unusually explicit way, central bankers from three countries (Netherlands, Austria, and Latvia) do not want to close the door to a larger move. Note that some countries, including Spain, are introducing measures that will offset some of the increase in gas and/or electricity starting this month. Separately, note that the ECB and EU issue reports today on Croatia's readiness to join the monetary union.

As attention turns to real sector data, the hawks may not fare as well. Yesterday, France revised Q1 GDP to show a small contraction and a 0.4% decline in April consumer spending. The median forecast in Bloomberg's survey was for a 0.5% gain and after it was revised it showed a 1.4% fall in March (from -1.3%). German April retail sales was even more disappointing. A small decline was expected after a 0.9% surge in March, but instead German consumption evaporated and retail sales slumps 5.4%. On the other hand, the aggregate final manufacturing PMI was revised to 54.6 from 54.4, which sounds like a moderate expansion is in the works. Yet it is the fourth consecutive decline. Recall that it averaged 46.4 in H2 19, before Covid. German and French national figures were revised slightly higher, and Spain surprised to the upside (53.8 from 53.3), while economists had looked for a decline. Italy disappointed. Italy's manufacturing PMI slipped to 51.9 from 55.8. Lastly, the UK's manufacturing PMI was left unchanged at 54.6. It is the lowest reading since January 2021.

It has taken numerous compromises and carve-outs for the EU to find a way to cut it oil imports from Russia. OPEC+ will announce its production goals for July tomorrow and another 430k barrel increase likely will be allowed. There are press reports suggesting that some OPEC members are considering exempting Russian output from the agreement. If it does materialize, it does not look imminent. Ostensibly, excluding Russian oil would allow other producers more leeway to boost output. However, few outside of Saudi Arabia and UAE have much capacity. 

The euro is trading quietly, within yesterday's range (~$1.0680-$10.780). It is in about a third of a cent range above $1.07 so far today. The 1.6 bln euros in expiring options in $1.0760-$1.0770 range seems too far away to be impactful today. After the big run up from the $1.0350 on May 13, the single currency is consolidating. It needs to resurface above $1.08 soon or the late longs may move to the sidelines. Sterling also appears to be consolidating after its recover from the May 13 low (~$1.2155) stalled last week near $1.2665. A break today of the $1.2560 area would target $1.2475 initially and then $1.24. The BOE meets on May 16, and the Chancellor Sunak's new fiscal measures may give the central bank greater scope to hike rates. The swaps market has a small chance of a 50 bp hike discounted.

America

The Bank of Canada meets today. While economists seem nearly universal in seeing a 50 bp move, the swaps market is pricing in little more than a 50% chance of a 75 bp move. The economy is booming, with March GDP reported yesterday coming in at 0.7% rather than the 0.5% the median forecast in Bloomberg's survey anticipated. On Monday, Canada reported a C$5 bln Q1 current account surplus, the largest since Q2 2008. Headline CPI is running a little less than 7% year-over-year in April and has averaged 1.0% increases a month this year, which is twice the average seen in the first four months of last year. It is not clear that inflation has peaked yet. Criticism of Bank of Canada Governor Macklem has increased from several Conservative leaders, which may have helped spur the wagers of a 75 bp move. The Canadian dollar is trading at five-week highs, leaving the greenback below its 200-day moving average (~CAD1.2660). The push down from the almost CAD1.3080 in mid-May, which was the highest since November 2020, is stretching the momentum indicators and the lower Bollinger Band was approached yesterday (~CAD1.2620). The greenback's slump may have coincided with short covering in the Canadian dollar futures market. As we noted in the our June monthly, the exchange rate remains very sensitive to the general risk appetite (~0.70% correlation over the past 30 and 60 days between the exchange rate and the S&P 500).

There are six gubernatorial elections in Mexico today. Mexico's politics are in flux. The traditional three parties, PRI, PRD, and PAN are coming together in four of the contests to show common front against the insurgency led by Morena (AMLO's party) and Movimiento Ciudadano. Strict term limits prevent the incumbents from running for re-election, which creates more space for the political dynamics. Mexico also reports April worker remittances, the manufacturing PMI, and IMEF surveys. Worker remittances have been a surprisingly strong source of capital imports. Consider that in Q1 19, they averaged almost $3 bln a month. In Q1 21, they averaged $3.5 bln and in the first three months of this year averaged nearly $4.2 bln. In terms of the current account, the worker remittances more than compensate for the deterioration of trade balance (averaged nearly -$600 bln a month in Q1 19 and -$1.6 bln a month in Q1 22). Meanwhile, the manufacturing PMI has been above the 50 boom/bust threshold since October 2019. On the other hand, the IMEF manufacturing survey has risen for the past three months at 52.5 in April, was a little below the year-end reading slightly below 53.0. The non-manufacturing IMEF survey reached 53.6 in March (before slipping to 53.0 in April), which was its highest level since last June.

The implied yield of the December Fed funds futures peaked on May 5 at 2.89%. By the end of last week, it had fallen to 2.50%, encouraged by some disappointing data and a suggestion by Atlanta Fed's Bostic that a pause in the cycle is possible as early as September. However, that pendulum has swung far enough and there is scope for it to swing back over the next week or so. The May employment report is likely to show that the US labor market is still robust with 300k jobs expected to have been grown. Next week, the May CPI will likely prove sticky, which is to say that the decline is likely to prove quite modest. Many in the media seemed to jump on Fed Governor Waller's remarks, where he seems to advocate 50 bp moves until inflation was convincingly coming closer to the 2% average target. Ironically, what seemed to have been overlooked was that Waller explicitly said that his views were roughly in line with the market. The Fed funds futures strip is pricing in 175-200 bp of hikes still to be delivered. Of this, 100 bp will most likely be delivered in June and July, allowing 3-4 25 bp hikes in the last four meetings of the year. Lastly, we note that the US reports PMI and ISM manufacturing surveys, construction spending April JOLTS, and late in the session, the Fed's Beige Book. During the day, May auto sales will be reported. A combination of higher prices (sticker shock) and tight inventory of new vehicles are expected to have weighed on sales. Industry watchers say that demand is still outstripping supply amid limited deliveries to retailers. The short supply is distributed through rising prices. New vehicle prices are up around 12.6% from a year ago. In the first four months of the year, US auto sales are running a little more than 18% year-over-year.

The Canadian dollar is little changed ahead of the central bank meeting. The US dollar is hovering around CAD1.2650. It held below CAD1.27 yesterday and has not been able to resurface above the old support area today too. There are options for $750 mln struck there that expire today. The $485 mln expiring option at CAD1.2660 has likely been neutralized. A break of the CAD1.26-CAD1.27 range may set up the next trading opportunity. The greenback slumped to its lowest level since March 2020 against the Mexican peso on Monday (~MXN19.4135) and snapped back to MXN19.7355 yesterday. It is consolidating in a narrow range thus far today. We expect support ahead of MXN19.60 to hold and for the greenback to probe the recent highs. The daily momentum indicators are stretched and poised to turn higher.

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