Fed Day

Overview: Better US news from the likes of Google, Microsoft, and Texas Instruments has helped lift sentiment today and is encouraging a more risk-on mood ahead of the FOMC meeting. News that US President Biden and China’s Xi will talk tomorrow for the second time this year may be notable but does not appear to be impactful in the capital markets. China’s CSI 300 and the Hang Seng were exceptions to the general advance of equities in the Asia Pacific region today. Europe’s Stoxx 600 that slipped less than 0.05% yesterday is almost 0.45% higher today. If these gains are maintained, it would be the seventh advance in nine sessions. US futures are 1.0%-1.5% higher, while the 10-year Treasury yield is hovering around 2.80%. European benchmark yields are mostly 3-5 bp higher, Italian bonds are selling off harder. The US dollar is softer against all the major currencies. The Norwegian krone is the strongest, gaining almost 0.9%, followed by sterling, nearly 0.4% better. The Antipodeans are the laggards, up around 0.10-0.15%. Emerging market currencies are not faring as well, though the rand, a handful of central European currencies, the Mexican peso, and Chinese yuan firmer. Gold has steadied (~$1720-$1725), after slipping in the past two sessions, though it is a third day of lower highs. September WTI is slightly firmer (~0.30%). It fell nearly 1.8% yesterday. US natgas is higher for the fourth consecutive session. It reached its highest level yesterday since 2008 (set near $9.75). Europe’s benchmark jumped 14.75% yesterday and is up another 2.25% today. It is the sixth consecutive advance, during which time it has risen by more than a third. Iron ore prices extended their advance for a fourth consecutive session and are approaching the month’s high. September copper is also rising for a fourth session. It is up around 10% from the mid-month lows. September wheat is edging higher to bring this week’s rise to nearly 6.5%. 

Asia Pacific

Australia's Q2 CPI rose 1.8% quarter--over-quarter, a tad less than the 1.9% median forecast in Bloomberg's survey. The cash rare futures seemed to have an exaggerated response to the small miss. Yesterday the market had about a 14% chance of a 75 bp hike at next week's central bank meeting and now has about a 75% chance of a 50 bp hike discounted. The Australian dollar initially slipped through yesterday's lows but has rebounded to little changed. The year-over-year inflation is 6.1% from 5.1% in Q1. The median forecast was 6.3%. It does not seem like that is a material difference. The trimmed mean rose 4.9% from a year ago. The market had looked for 4.7% after 3.7% in Q1. The weighted median rose from a revised 3.0% (initially 3.2%) to 4.2%. Tomorrow, Australia reports retail sales (0.5% is the median forecast in Bloomberg's survey) after rising 0.9% in May. 

The IMF cut its forecasts for this year and next year's growth and strongly warned the risks are on the downside. In January, it had forecast this year's world growth at 4.4%. It cut it to 3.6% in April, and now to 3.2%. With this year's tighter financial conditions weighing on activity next year, the IMF now forecasts 2.9% growth next year, down from 3.6% in April. The US and China forecasts were cut sharply. The US growth projection for 2022 was cut to 2.3% from 3.7% and next year's to 1.0% from 2.3%. This is mostly catch-up for the IMF. The median forecasts in Bloomberg's survey are for 2.0% growth this year and 1.3% for next. The IMF slashed its forecast for China's growth this year to 3.3% from 4.4%, well below the median in the Bloomberg survey (4.0%) and the World Bank's recent forecast that put it at 4.3%. The IMF shaved its April projection for 2023 by 0.5% to 4.6%. This is still more pessimistic than what the World Bank and median economist forecast in Blomberg's survey which converged at 5.2%. The IMF shaved its forecast for the eurozone's growth to 2.6% this year from 2.8%. However, next year's project was chopped to 1.2% from 2.3%. Economists (median) in Bloomberg's survey has the eurozone growing 2.7% this year and 1.3% next. 

The US dollar is trading in an exceptionally narrow range of less than half a yen against the Japanese currency. The session low near JPY136.75 was set in the European morning after a high near JPY137.15 was reached in early Asian turnover. Three-month implied volatility eased to 10.3% yesterday, the lowest since June 6 yesterday and is consolidating today. It peaked in mid-June near 14%. We suspect that a new range is trying to form. The JPY134.50-JPY135.00 looks like the lower end of the possible new range. The upside is less clear but as a working hypothesis, JPY139.50-JPY140.00 seems reasonable. The Australian dollar is trading within the range seen in recent days and continues to flirt with the downtrend line drawn off April and June highs. It comes in today around $0.6950, where A$400 mln options expire today. The options have likely been neutralized. The greenback initially rose to a three-day high against the Chinese yuan to almost CNY6.77 but has come off to around CNY6.7550 as it has softened against most of the major currencies. The PBOC set the dollar's reference rate at CNY6.7731, a little firmer than the CNY6.7718 median projection in Bloomberg's survey. 

Europe

Italy's unelected prime minister resigned last week but will continue to be prime minister until the election in late September. While being a caretaker limits what Draghi can do, it does not stop him completely. In fact, his first act as caretaker will be to enact a new 14.3 bln euro assistance package to households and businesses to help cushion the blow of inflation and higher energy costs. It will be funded with the higher-than-expected revenues in H1, which reduced the deficit by around 0.8% (of GDP). The initiative is on top of the 30 bln euros in relief measures already enacted. Citing Draghi's resignation and the uncertainty around policy after the late September election, S&P downgraded the outlook for Italian debt to stable from positive. Italy's 10-year bond yield is up nearly 10 bp today and the premium over Germany is challenge last month's high (242 bp), which itself was the highest in two years. Italy's premium over Germany on two-year money has risen to 137 bp today, a new two-year high. Including today, it has widened for 11 of the past 13 sessions. It was around 55 bp at the end of June.

Germany, France, and Italy reported confidence surveys today and all three were weaker. In Germany, the GfK measures fell to -30.6 from a revised -27.7 (initially -27.4). To put it in perspective, consider that the low when Covid struck was around -23. French consumer confidence slipped to 80 from 82. It has fallen every month this year and is the lowest since mid-2013. In Italy, economic sentiment weakened, and the consumer confidence index fell to 94.8 from 98.3. It as a bigger decline than projected. It has fallen in eight of the last ten months and is at its lowest level since May 2020. 

Separately, the EU struck an agreement to voluntarily reduce gas consumption as a complete cut-off from Russia is feared. The first EU effort was opposed by several members. However, as is the European way, numerous compromises were struck that made possible the approval. These compromises included making it somewhat more difficult to make the cuts mandatory. There were other considerations, including taking into account the gas storage facilities within individual countries, the possibility some industries could be excluded from mandatory cuts, and even the duration of the cuts (from two years to one).

The euro has stabilized after being sold yesterday from $1.0250 to a little below $1.0110. There are options for nearly 1.85 bln euros at $1.01 that expire today, but seems safe, as the euro has recovered toward $1.0160. The euro can rise toward $1.0185-90, without changing the technical picture. We note that the $1.0115 area is the (50%) retracement of the euro's bounce from the twenty-year low set in mid-July near $0.9950. The (61.8%) retracement is closer to $1.0075. Sterling is firm a little below the week's high (~$1.2085-$1.2090), which is the best level since July 4. It has settled the past two sessions above the 20-day moving average (~$1.1985) for the first time since mid-June. The next upside target is near $1.2115. While the $1.20 area may offer initial support now, a better shelf is seen closer to the $1.1960.

America

While there is some uncertainty around it, the market is generally looking for a 75 bp hike by the Fed today, the second in a row. The 150 bp hike in two months is the most aggressive pace in a bit more than 40 years. The Fed funds futures has a slight leaning (~14%) toward 100 bp rather than a smaller move. Chair Powell is also likely to reiterate that 75 bp increments are unusual, and most look for a 50 bp hike in September followed by two quarter-point moves in Q4. The FOMC statement is likely to acknowledge that the Fed's course has been successful, and that economic activity has moderated. Core CPI and average hourly earnings have slowed for three consecutive months. The labor market, still robust, is also cooling. The interest rate-sensitive housing market is also losing some momentum. From the Fed's point of view this is all desirable. The Chair may be questioned about whether the US is in a recession, which the Fed, like Treasury Secretary Yellen, will deny, even if some Econ 101 definition of a recession is trotted out. More importantly, he ought to be asked about the market pricing out a hike in next year and instead is beginning to price in a cut (the implied yield of the June 2023 Fed funds futures is 19 bp below the implied yield of the December 2022 contract), and a total of 55 bp of cuts next are pricing into the futures strip.

We had anticipated the euro to rally into last week's ECB meeting and sell-off as attention shifted to this week's FOMC meeting. However, the best for the dollar may come with the FOMC statement. The market often hears/reads Powell to be dovish even though the Fed is engaged in a historic tightening process. The risk, then, seems to be that the dollar will sell-off into the press conference and ahead of the Q2 GDP report the following day. The Atlanta Fed's GDPNow tracker will be updated after the flurry of US data today (durable goods orders, preliminary June merchandise trade, and inventories, and the risk seems to be on the downside of its estimate of a 1.6% contraction in Q2. The latest forecasts have seen the median in Bloomberg's survey slip to 0.4% growth. Arguments that the US is not in a recession are based on two observations: unemployment has not increased, and in Q1, the Gross Domestic Income rose by 1.8%. Income and output changes should jive, but there is often a small gap, but in Q1 it was large, and as Harvard's Professor Frankel observed the average of the two (gross domestic output) was also positive.

The US dollar recorded a marginal new low for the month yesterday against the Canadian dollar slightly above CAD1.2815 but recovered by to CAD1.29 by the end of the end of the session. With the stronger earnings/guidance lifting US equity futures the greenback has drifted steadily lower today through the European morning to test the CAD1.2850 area. There are two sets of expiring options to note. The first set is for around $650 mln at CAD1.2855 and the other is for about $500 mln at CAD1.2910. Support is seen in the CAD1.2820-40 area. Mexico reports the June trade balance. It is expected to have been nearly halved from the $2.2 bln May deficit. The highlight of the week, Q2 GDP, is due ahead of the weekend. It is expected to have expanded by 0.9% quarter-over-quarter after a 1.0% growth in Q1. The greenback is trading near six-day lows, slipping through MXN20.40. A break of the MXN20.32 area may confirm a technical topping pattern for the US dollar to at least the MXN20.00 area. Lastly, on the back of a slightly lower than expected IPCA inflation report yesterday (11.39% vs. 12.04% in June and expectations for 11.41%), the Brazilian real strengthened. The dollar closed below its 20-day moving average for the second consecutive session for the first time since early June. The next big target is the month's low, which converges with the 200-day moving average around BRL5.2550.

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