Overview: The euro is over a cent lower from yesterday’s peak, pressured by the drop in the flash PMI composite below 50 for the first time since early last year. More generally, the flash PMIs have shown the global economic momentum is waning, and the bond markets have responded accordingly. The US 10-year yield is flirting with 2.80%, its lowest level in more than two weeks. European yields are 15-20 bp lower and the spread between Italian and German bonds has stabilized. Equities in the Asia Pacific region were mixed. Of the major markets, only China’s CSI 300 finished lower on the week. Europe’s Stoxx 600 is up about 0.5%. If it holds on to these gains, it will be the best week (~3.1%) since March. US futures are softer. Most of the major currencies, led by the euro, are trading lower against the greenback. The Canadian dollar joins the Swiss franc and yen to be the most resilient today. The euro’s weakness is a drag on central European currencies. The South African rand is the strongest among emerging market currencies today, helped by the larger than expected 75 bp hike yesterday. Gold posted a key upside reversal yesterday and is extending its recovery today. Technically, it looks constructive. September WTI is consolidating at little changed levels. After falling almost 6.9% last week, it is up around 1.8% this week. US natgas has drifted slightly lower after falling nearly 1% yesterday. Still, with the heatwave it is not surprising it is up 12% this week after a 16% gain last week. Europe’s natgas benchmark is up 4% today, which brings the week’s advance to 3.5%. There are fears Russia will cut gas shipments next week. Iron ore surged nearly 6.5%, the most this month. It was up about 0.5% for the week coming into today. September copper has recouped yesterday 0.8% decline. Assuming it does not stage a major reversal today, it will snap a six-week, 28% drop. Wheat prices are off 2.5%, pressed by Turkey, Ukraine, Russia agreement to re-open grain exports.
Asia Pacific
Japan's June CPI headline
inflation slipped to 2.4% from 2.5%. However, the underlying measures ticked up. The core, which
excludes fresh food, edged up to 2.2% from 2.1%. Excluding fresh food and
energy the measure rose to 1.0% from a year ago, a tad more than expected. It is
unlikely to move the BOJ's needle. Separately, Japan's flash PMIs show a loss
of economic momentum. The manufacturing PMI slipped to 52.2 from 52.7 and
service activity moderated to 51.2 from 54.0. The composite stands at 50.6,
down from 53.0. Lastly, with the focus on the CPI and PMI, many will not notice
the continued surge in foreign buying of Japanese bonds. Last week, foreign
investors bought JPY1.75 trillion on top of JPY2.07 trillion in the previous
week. The JPY3.8 trillion (~$27.6 bln) over the two weeks appears to be a
record. To put it in context, the foreign bond buying over the two weeks
covered the June trade deficit three times.
Australia's flash PMI
reflects slower activity. The
manufacturing PMI eased to 55.7 from 56.2, but the service PMI fell to 50.4
from 52.6. The composite PMI is at 50.6, down from 52.6. Next week, Australia
report Q2 inflation (headline is expected to accelerate above 6% from 5.1% in
Q1. June retail sales growth is slowing. May's 0.9% rise may have been halved
in June.
The dollar fell to a
seven-day low against the Japanese yen near JPY137.00. The decline in the US 10-year yield to
2.81%, the lowest since July 6 appeared to be the driver. The greenback
approached the 20-day moving average (~JPY136.85), but it has not closed below
it since May 31. This suggests that the dollar has not broken down yet, which in
turn warns, of a return to JPY138.00-JPY138.50 is likely. The Australian
dollar is in a narrow range around yesterday's ~$0.6935 high. The low
has been just above the 5-day moving average (~$0.6890). We suspect the A$1.2
bln set of options that expire today at $0.6900 may been neutralized. After
gapping higher yesterday against the Chinese yuan, the dollar traded sideways
today in almost same range. However, today, the greenback did not trade
below CNY6.76. The dollar is trading near its best level since mid-May. The
PBOC fixed the dollar at CNY6.7522, a bit stronger than the median projection
(Bloomberg survey) of CNY6.7508. Separately, but likely related, the seven-day
repo rate slipped to 1.52%, the lowest since December 2020.
Europe
The ECB delivered the 50 bp
rate hike that had been hinted at earlier in the week. The deposit rate had been below zero since
2014. As we surmised, a larger rate hike was partly made possibly by an
agreement on what will now be called the Transmission Protection Instrument. Besides
being open-ended in size, and with extensive discretion of the ECB, which
ostensibly can be used preemptively, there is little we know about it and key
details the ECB will keep that way. Sometimes, strategic ambiguity can be
useful. Still, in a separate note the ECB laid out very light conditionality,
and essentially, all that is needed is for the member to be in good standing
with the EU and have sustainable debt levels.
This is also important, and
underscores point we have made: Draghi's Open Market Transactions, which
was also meant to address interest-rate fragmentation in the union, the onus
was on the weak country to trigger it. The conditionality was so severe that it has not been triggered. This
did not mean the problem has gone away. This time, under Lagarde, the ECB
argues that the fragmentation could hamper the conduct of monetary policy. Therefore,
the new tool, it is argued is necessary for monetary policy (when the monetary
and economic union is incomplete).
After signaling that future
hikes were coming, Lagarde said there was no forward guidance for the next
meeting. The market did
not believe that and quickly priced in not only another 50 bp hike - but more
than an 80% chance of a 75 bp hike. ECB's chief economist Lane proposed the 50
bp hike and, with his staff will provide new inflation and growth forecasts at
the September 8 meeting. The likely direction of revisions is clear: this
year's inflation forecast now at 6.8%, probably needs a 7-handle, and growth
may need to be revised down. The year-over-year pace this year was thought to
be 2.8% in June and 2.1% next year. This year's project ions may be shaved a
little but next year's seems too optimistic. In addition to higher current
inflation, Lagarde noted that the euro's decline also encouraged the larger
rate hike. The euro has trended lower since the June meeting. The impact on
inflation comes not from a single point but from an average. We do not know,
but we imagine the ECB's economists would look at a three-month or six-month
moving average. Since the June 9 ECB meeting both moving averages have fallen
by about 3%.
The ECB finally raised
rates, and just as the flash PMI warns that the economic contraction may not be
far behind. The German
manufacturing, services, and composite PMIs fell below the 50 boom/bust level.
France fared slightly better. The manufacturing PMI slipped below 50, but the
services PMI held in better, and the composite fell to 50.6 from 52.5. The
aggregate composite fell for the third consecutive month and is below 50 (49.4)
for the first time since February 2021.
Today's UK data was soft but
not as weak as economists expected. June retail sales slipped 0.1% and excluding gasoline,
surprisingly rose by 0.4%. The May series was revised lower, with headline
retail sales falling by 0.8% rather than 0.5%. Excluding gasoline, retail sales
rose for the first time since last October. The flash manufacturing PMI eased
to 52.2 from 52.8, while the services PMI fell to 53.3 from 54.3. Both were better
than expected, and the same with the composite, at 52.8 (vs. 53.7). This is the
lowest composite reading since February 2021.
For the first time in
Italy's modern history, a general election will be held in the autumn: September 25. Draghi will remain as caretaker Prime Minister until then. The polls show that the Brothers of Italy
is ahead in the polls to lead the next government, likely center-right in
orientation. The 10-year premium over Italy jumped nearly 19 bp, the most since
April 2020. It has steadied today and is below 230 bp in Europe. Last month's
high was 242 bp) and the Covid peak was almost 280 bp. The two-year premium
finished yesterday a little above 131 bp and is little changed today. It was
near 50 bp at the end of last month.
The euro made a marginal new
high for the week yesterday and drew closer to $1.0280 but has come back
offered today. The weak
PMI did not help. The euro traded at three-day lows near $1.0130, which likely
saw any last-minute hedging of the roughly 620 mln euros in expiring options
today at $1.0140. Note that the $1.0115 area is the halfway point of the rally
off last week's low near $0.9950. Below there, the (61.8%) retracement is
around $1.0075. As the market's attention turns to next week's FOMC meeting, we
expect the euro to drift lower. Sterling closed well yesterday, just below
$1.20. However, it has wilted in the face of the broadly firmer dollar. The
$1.2000-$1.2010 cap needs to be overcome to lift the tone. Support is seen in
the $1.1900-$1.1920 area. The euro rose to GBP0.8585 yesterday, its best level
since July 6, but has come off hard today and is near GBP0.8485. A break of
GBP0.8470 could spur another 1% pullback.
America
Last week's July Empire
State manufacturing survey was better than expected, coming in at 11.1 after
June's -1.2. Economists
had forecast further deterioration. The Philadelphia Fed's survey was dreadful.
It fell from -3.3 to -12.3, its lowest level since May 2020. What is worse is
that the outlook for business conditions six months from now and the future
index of new orders fell to their lowest levels since 1979. Around a third of
the manufacturing are anticipating a decline in new orders half a year from now.
Capex plans are being re-examined. Although rising prices boost can boost the
attractiveness of carrying higher inventories, it will have to be balanced with
the weaker outlook for demand. A steady composite flash PMI today may help
neutralize the poor Philadelphia Fed survey. A disappointing report is unlikely
to sway the market from expecting a 75 bp hike by the Fed next week.
Weekly jobless claims rose
by 7k to 251k in the week ending July 16, which also covered the week that is
the reference period for the July employment report (August 5). The four-week average, used to smooth out
some of the noise, rose to a new high for the year of 240.5k, to edge above the
level from late 2019. Continuing claims rose by 51k to 1.38 mln, which is the
biggest rise since last November. The low in continuing claims was in late May
a little below 1.31 mln. To put the number in another context, consider where
it was before Covid:1.8-1.9 mln. The real question is not is the labor
market slowing; it clearly is. The issue for investors and businesses has it been
sufficient to ease the tightness of the labor market? Is it sufficient to
appease the Federal Reserve? The answer to both questions is not yet.
Canada reports May retail
sales today. A
strong 1.6% gain is expected, and a bit stronger without auto sales. The June
CPI was softer than expected but from a big picture and policymaking view, is
there really a significant difference between actual 8.1% and the median
forecast in Bloomberg's survey for 8.4%. Isn't the key takeaway that prices are
still accelerating, and this coupled with strong demand (retail sales). The
swaps market has about a 60% chance of a 75 bp hike discounted. Mexico reported
May retail sales rose by 0.5% after a 0.4% gain in April, in line with
expectations. Today, it reports inflation for the first half of July. It likely
drifted a little higher, further above 8%. Banxico meets on August 11. Another
75 bp hike is likely.
Disclaimer
Reviewed by Marc Chandler
on
July 22, 2022
Rating:
