Recession Fears Mount

Overview:  Equities fell hard in the Asia Pacific region, with Taiwan’s 3.25% drop leading the move. Its manufacturing PMI fell below 50 for the first time since mid-2020. Europe’s Stoxx 600 is trying to stabilize after a weaker opening, while US futures are under modest pressure. The US 10-year Treasury yield slipped below 3.0% yesterday and is a couple basis points lower today. European bonds are weaker, and benchmark yields are mostly 4-5 bp higher. The US dollar is broadly higher. The Antipodeans are off around 1% to pace the move. The yen is the only major currency that is firm against the greenback. Emerging market currencies are also under pressure. The South Korean won and Chinese yuan are the only two posting gains against the dollar and they are minor upticks at that. Gold has been sold below $1800 for the first time since mid-May when it bottomed near $1787. The year’s low is closer to $1780. August WTI sold-off by around $9 in the past two sessions and slipped a bit more today before recovering. It is approaching $108 near midday in Europe. The week’s high set in the middle of the week was slightly above $114.00. US natgas cratered yesterday, plummeting by 16.5%. It is up about 5% today. Europe’s benchmark is up 1.5% today to bring the weekly rise to 13%. It rose 65% last month. Iron ore fell 3.5% today. It was the third consecutive loss amid concerns about surplus steel in China. After a quiet first part of the week, copper’s decline accelerated. It fell almost 1.9% yesterday and is off nearly 3% today. The September futures contract is testing last year’s lows. September wheat fell by about 5% yesterday, its largest loss of the month. It is stabilizing today and up around 1%.

Asia Pacific

Tokyo's CPI, which leads the national figure, was little changed in June, and will not sway the BOJ from its course. Headline CPI slipped to 2.3% from 2.4%, while the core, which excludes fresh food edged up to 2.1% from 1.9%. Still, energy prices rose 21.7%, and excluding energy and fresh food, leaves the CPI up a mild 1.0% from a year ago (vs. 0.9% in May). The gasoline subsidies are helping, but processed food producers have already announced price increases. Japan also reported an unexpected tick up in unemployment to 2.6% from 2.5%. The final manufacturing PMI was unchanged from the flash estimate of 52.7, down from 53.3 in May. Lastly, the Tankan survey showed small deterioration in sentiment among the large manufacturers and an improvement in the large non-manufacturers, which is what one would expect as the economy recovers from the pandemic. Small non-manufacturers improved while the small manufacturers did not and in both the pessimists over weigh the optimists. The most constructive element was the jump in capex plans.  Large companies expected to boost capex by 18.6%, which is more than twice expectations and follows a 2.2% increase in Q1.

China's Caixin manufacturing PMI rose to 51.7 from 48.1 in May, confirming recovery indicated by the earlier national figures. It is the first reading above the 50 boom/bust level since February and it is the highest level since May 2021. The non-manufacturing and composite Caixin PMI will be reported the first thing Tuesday. Separately, China has approved CNY300 bln (~$44.8 bln) of funding for infrastructure projects. Reports suggest that the lending could be levered as much as four times.

South Korea's central bank reported that it sold $8.3 bln of its reserves to support the Korean won in the first quarter. This is the most in three years. The US Treasury data (TIC) shows South Korean holdings of Treasuries fell by almost $12 bln in Q1. Reserves fell about $5.3 bln. The won fell by a little less than 2% in Q1. However, it tumbled by 6.7% in Q2 despite what appears to have been more intervention. June reserve holdings will be reported Monday. As of May, South Korean reserves had fallen by $10.1 bln since the end of March.

The dollar initially extended yesterday's decline against the yen and traded below the 20-day moving average (~JPY134.80), albeit briefly, for the first time in a month. However, as the US 10-year yield stabilizes after slipping below 2.94%, its lowest level since June 6, the greenback approached JPY135.70 in the European morning. Nearby resistance is seen around JPY136.00. The dollar closed last week around JPY135.25. It was the fourth consecutive weekly advance. News that Australia's manufacturing PMI was revised up to 56.2 from 55.8 of the flash and 55.7 in May failed to lend support to the Australian dollar. It has been sold to a new two-year low of $0.6790 amid global growth concerns. The previous support in the $0.6830-$0.6850 range now may offer resistance. The intraday momentum indicator suggests a test is possible in North America. The greenback is little changed against the Chinese yuan, hovering around CNY6.70. On the week, the dollar rose an inconsequential 0.15%. For the first time this week, the PBOC set the dollar's reference rate a little softer than the models expected. The fix was at CNY6.6863 compared with median projections (Bloomberg survey) for CNY6.6892.

Europe

Consumer prices rose by 0.8% last month in the eurozone, the same as in May, and slightly more than expected. The year-over-year rate accelerated to a new high of 8.6% (8.1% in May). Unexpectedly, the core rate eased to 3.7% from 3.8%. Economists expected a small rise. It is the first decline in the core rate since January and may be related to some government efforts (see Germany) to ease pressure on households. Separately, the final June manufacturing PMI was revised to 52.1 from 52.0 on the aggregate level, which still leaves the downtrend intact for the fifth consecutive month. It was 54.6 in May.

There are two developments in the UK to note. First, its manufacturing PMI was also revised lower from the flash reading, suggesting the economy is deteriorating. The final reading is 52.8 from 53.4 flash estimate and 54.6 in May. The June report is the weakest since June 2020. Separately, shortly after two separate Tory sex scandals forced byelections, which the Conservative lost, the Deputy Chief Whip resigned his post admitting to excessive drinking and poor behavior. Prime Minister Johnson was on the international stage this week, but his domestic problems have not abated.

There were two concrete illustrations on how China's lockdowns and Russia's invasion of Ukraine have sent ripples across other economies. The blowout 7.2% month-over-month decline in Japan's preliminary estimate of May industrial output is the fourth worst in at least 30 years--(January 2009--GFC, March 2011--earthquake and tsunami, April 2020--pandemic). China's lockdowns first compelled business to draw down inventories of part and products and then this did not prove sufficient output had to be cut. It means that growth in the world's third-largest economy is likely to be weaker than previously thought. Germany, the world's fourth-largest economy, reported a whopping 133k increase in unemployment in June. Many Ukrainians fled when Russia invaded. The refugees were included in the number of people looking for work. The ECB said last month that the eurozone's labor force could increase by as many as 1.3 mln refugees. Poland hosts more Ukrainians, but they do not appear to have shown up in the labor market statistics yet.

The euro's recovery yesterday, rebounding from a little below $1.0385 to almost $1.0490 has gone for nought. The selling pressure returned today and knocked the single currency back to around $1.0435. The euro settled last week near $1.0550. It has not been above there since Tuesday. Last month's low was by $1.0360, and the May low was closer to $1.0350. Sterling is slipping below yesterday's low near $1.2090. Last month it fell to a two-year low around $1.1935. There seems to be little in the way to deter a return to there, though the $1.2000-$1.2040 area may slow things down.

America

The aggressively hawkish case at the Federal Reserve stood on two legs, and both were chipped away at yesterday. The first leg is the acceleration of inflation. The PCE deflator, which the Fed targets was unchanged at 6.3%. The median forecast in Bloomberg's survey had ticking up to 6.4%. The core rate, to which the headline converges, fell for the third consecutive month, and it too was softer than expected. The second leg is the strength of the labor market. The four-week moving average rose to almost 232k, the highest since the middle of last December. At the end of 2019, the four-week average was at 238k, which then was a two-year high. The ironic observation by the Bundesbank in its monthly report applies in good measure to the US: while businesses in some industries continue struggling to find qualified workers, employment growth is slowing.

The implied yield of the December 2023 Fed funds futures is 27 bp below the implied yield of the December 2022 contract, suggesting that a quarter point rate cut is fully discounted. Looking at the futures strip, the market is beginning to price in the risk of a cut in late Q3. The 10-year breakeven (difference between the yield of the inflation-protected security and the conventional note) fell to about 2.35% yesterday. It is a five-month low. The low for the year was set on January 21 near 2.30%. The two-year break even has fallen by nearly 125 bp since reaching 4.5% in the session after the CPI print on June 10. It is at four-month lows.

The Atlanta Fed updated its GDPNow tracker to -1.0% after yesterday's consumption data and recent housing starts and trade figures. It will be updated later today. Also on tap today is the final manufacturing PMI. Recall that the flash reading fell by 4.6-points to 52.4, the biggest drop since April 2020 and the lowest level in two years. The ISM manufacturing survey will also weaken. The 54.5 that the median forecast in Bloomberg's survey projects, would be the lowest since July 2020. Price and new orders are expected to have slipped. June auto sales will trickle in during the sessions. After a horrendous May (12.68 mln vehicles, SAAR), a small recovery is expected to around 13.3 mln. The average for the first five months of the year is almost 13.9 mln vehicles. The average was 17.1 mln vehicles in the same period last year.

The Canadian dollar recovered yesterday but it is giving it back today amid the risk-off mood spurred by recession fears. The greenback tested support near CAD1.2860 yesterday, but it is trading above CAD1.2920 in Europe. A move above CAD1.2950 could spur a move toward CAD1.3000-CAD1.3020. The US dollar settled around CAD1.2900 at the end of last week. Yesterday's Mexican peso recovery has also been reversed today, but the greenback is trading inside Thursday's range (~MXN20.0620-MXN20.2650). A push above MXN20.2650 could signal a move into the MXN20.36-MXN20.4250 band. Separately, note that Colombia's central bank greeted the newly elected president with a 150 bp hike (to 7.50%). The large move was expected by around 60% of the economists in Bloomberg's survey. It June CPI is due next week, and it is expected to rise toward 9.75% from a little more than 9.05% in May. With yesterday's move, the central bank has hiked its policy rate by 575 bp since last September. 

Disclaimer