Bank shares rose in Japan and Europe for the second consecutive week, but the KBW US bank index fell nearly 2% after increasing 4.6% in the last week of March. Emergency borrowing from the Fed remains elevated ($149 bln vs. $153 bln). Bank lending has fallen sharply (~$105 bln) in the two weeks through March 29. This appears to be a record two-week decline. Commercial and industrial loans had fallen a little in the first two months of the year (before the bank stress become apparent). At the same time, the Fed's balance sheet continues to shrink. Over the past two weeks, it has fallen by a little more than $100 bln.
The US two-year
yield was above 5% before the flare-up of banking stress and dropped to 3.55%. It
bounced to peak near 4.17% at the end of March but tumbled back to around 3.65%
last week on disappointing US data and the banking pressure. The Fed funds
futures imply a year-end rate of about 4.18%, up from the 3.37% low
reached in mid-March but still sharply below the 5.55% peak seen on March 9. The
dollar found less traction than we had expected, given the recovery in
short-term rates. Still, we expect the dollar to correct
higher in the coming days.
The week ahead highlights
include US March CPI. The headline may slip below 5.5% from 6% in February as
last March's 1.0% monthly gain drops out of the 12-month comparison. However, the core
rate looks poised to rise year-over-year for the first time since
last September. China reports its inflation gauges and the politically
sensitive trade balance. Consumer price pressures may tick up a little but remain
modest, around 1.2%, while deflationary forces likely strengthened producer
prices. China's exports have been falling year-over-year since the
start of Q4 22, and the March surplus may be 10% smaller than reported for March
2022. The Bank of Canada meets on April 12, and there is little reason to expect
a change from its standpat stance articulated in late January. Lastly,
Australia's labor market report is unlikely to repeat the strength seen in
February when it created almost 75k full-time positions after averaging nearly
43k a month in 2022.
United States: A 0.3% increase in March CPI would
mean that US consumer prices rose at an annualized rate of about 4.8% in Q1 23
after a 3.2% pace in Q4 22 and 2.4% in Q3 22. Fed officials will be unhappy
with the lack of improvement in the core measure. A 0.4% increase in March translates into a 5.2% annualized rate in Q1, accelerating from 4.0% in Q4 22. The year-over-year rate would edged back to 5.6% from 5.5%. Retail sales are expected to
have fallen in March for the fourth time in the past five months. While the PMI
and ISM surveys warn of a contracting manufacturing sector, industrial output is
expected to have edged up in March, but even with a 0.1-0.2% increase, the gain
in Q1 23 is not sufficient to offset the decline in Q4 23 (~1.6% vs. -2.5%). The US
also reports producer prices and import/export prices, which typically are less
impactful than the CPI. Still, unchanged producer prices in March (which
translates into about a 0.8% annualized pace in Q1) could see the
year-over-year rate fall to around 3.5%, the lowest since February 2021. The
University of Michigan publishes its preliminary April results. The long-term
(5-10 year) inflation expectation (median) has been stable at 2.9% since
mid-2022, including the last four months. It seems anchored, though it averaged 2.5% in 2018 through 2020. Meanwhile, the US banking stress continues to
appear contained. Still, the knock-on effect from reduced lending is a crucial transmission channel to other parts of the economy. The
March employment report showed slower job growth and a downward trend in average hourly earnings.
The Dollar Index has been
trending lower since reaching 105.90 on March 8. It recorded a low last
week near 101.40. It has fallen for four consecutive weeks and five of
the previous six. And the week that it rose (the week ending March 10), it posted a gain
of less than 0.1%. So it is "due" for a bounce. The momentum indicators
are beginning to turn higher. A move above 102.50 targets 103.00-25.
China: Data from the world's second-largest
economy is notable, but not because of its market impact. Indeed, the currency
is managed in a way that seems immune to the vagaries of high-frequency
economic data. China may have been spared most of the volatility stemming from
the banking stress in the US and Europe, but it is not because it does not have
its own banking/debt challenges, as the property market illustrates. Lending
appears to have soared in Q1 23 to a record of CNY13.8 trillion (~$2 trillion)
and may have exceeded Q1 22 by as much as 15%. It has also deviated from the
other large countries by not experiencing a sustained rise in inflation. Indeed,
it was temporary. CPI peaked at 2.8% last September and fell to 1.0% in
February. Food prices are the key driver. Prices are expected to have a
1.2% year-over-year gain in March, which means inflation does not stand in the
way of monetary easing should the recovery falter. Meanwhile, producer price
deflation is expected to have deepened in March. Producer prices on a
year-over-year basis turned negative in Q4 22, and the March print is expected
to be -2.4%, matching the biggest decline since June 2020. No longer are people
trying to link China's PPI to US CPI. Falling producer prices, though, warn of a
squeeze on income for an important part of the economy.
Chinese exports have lost
momentum and have fallen on a year-over-year basis, likely declining for a sixth
consecutive month in March. Still, think about the performance. In March 2021,
exports rose nearly a third from the previous March. It was a recovery in
foreign demand after the Covid shock and supply chain disruption. In March
2022, exports were another 14% higher year-over-year. Last month,
exports were expected to have declined by nearly 7.5% year-over-year. In yuan terms, exports have still softened but less dramatically. In fact, they were up 5.2% from a year ago in February. China's trade balance tends to be
noisy in the first part of the year but often improves. Still, the weakness
seen in the manufacturing PMI, especially the Caixin iteration, suggests the softness of exports continued. The median forecast in Bloomberg's survey calls for a $40 bln
March surplus, broadly in line with the March 2022 surplus of almost $44.4
bln.
The Chinese yuan was virtually
flat last week, and the dollar was confined to a narrow trading range
(~CNY6.8660-CNY6.8945). In fact, over the past two weeks, the greenback has
been remarkably steady. The dollar has fallen for six consecutive weeks against
the euro and five of the past six weeks against the Japanese yen. Moreover, it has fallen
in four of the past six weeks against the yuan. Still, the rolling 30-day
correlations between the yuan, euro, and yen changes remain notable at
0.63 and 0.54, respectively. This is off their best levels but still suggests
the PBOC is allowing the yuan to mostly shadow the broad dollar movement.
Canada: The Bank of Canada meets on April
12. It acknowledges that the economy has begun the new year more resilient than
expected but, apparently, not sufficiently to prompt it to change interest
rates. The March employment data were mostly better than expected. The 34.7k
increase in employment was nearly five-fold higher than the median forecast in the Bloomberg survey, and it was almost evenly split between full- and part-time
positions. Although the participation rate unexpectedly slipped (65.6% vs.
65.7%), the unemployment rate held steady at 5.0%. The hourly wage for
permanent employees slowed to 5.2% year-over-year from 5.4%. The stimulative
fiscal efforts by the government (central and provincial) are seen hampering the
central bank's efforts to rein in inflation. Still, the swaps market thinks
that the Bank of Canada is done raising rates and has the first cut fully
priced in by early Q4.
The US dollar snapped a six-day
decline on Tuesday and will take a four-day advance into the start of next week. It reached CAD1.3530 after the US employment report. The momentum indicators
are curling up. A move above the CAD1.3550-60 area could spur gains toward
CAD1.3600-20.
Eurozone: Aggregate February retail sales and industrial
output figures are due for release, but they are not market movers. In volume
terms, retail sales look soft after a 0.3% gain in January. On the other hand, industrial output could surprise on the upside after stronger readings from
Germany (2.0%) and France (1.2%). That said, the reports lend
credence to our view that the market is too pessimistic about activity here in
Q1. The Bloomberg survey from mid-March found a median forecast of a 0.1%
quarter-over-quarter contraction in the eurozone in Q1. This is an improvement
from -0.2% in the previous survey, but so far, most data points to expansion. As a result, the swaps market sees another 50 bp of hikes by the end of Q3.
The euro recovered from last
Monday's low, slightly below $1.0790, to approach $1.0975 before stalling. That
was its best level since the Q1 high was recorded on February 2, near $1.1035. The
rally from the March 15 low (~$1.0515) has stretched the momentum indicators,
which are turning lower. The initial target is near $1.08, where the
20-day moving average is found and the (38.2%) retracement of the advance from
mid-March. A convincing break of $1.07 weakens the technical outlook.
Japan: The Tankan survey and the PMI show
Japan's manufacturing sector is struggling. However, the service sector is improving, and capex is improving. The 60-day rolling correlation
between changes in the exchange rate and the 2-year US yield remains firm,
around the middle of a 0.45-0.55 range that has largely been in place since
last August. The correlation with the US 10-year yield has risen to about 0.47, this year's high, from almost 0.35 in late January, the lowest since
early Q2 21. The week's data highlights include March machine tool orders and
bank lending figures. Japanese bank shares continued to recover. Recall that
after the multiyear high was set on March 9, the Topix bank index tumbled
nearly 19% the following week. It has recouped more than a third of those
losses. Japan will report its February current account to start the new week. It
has not failed to improve from January since at least 1996. Japan's trade
balance (on the balance of payments basis) posted a record deficit in January
(~JPY3.18 trillion or ~$24 bln). A new era will begin on April 8 as BOJ
Kuroda's 10-year (two terms) ends. The new leadership, led by Ueda, is expected
to adjust policy with many seeing the first moves in June-July. The swaps
market is pricing in a year-end overnight rate of almost 10 bp compared with
the current target of -10 bp and an effective rate about half of a basis point.
The dollar peaked at the start
of last week near JPY133.80, the (50%) retracement of its decline from the
March 8 high (almost JPY138). Although it pulled back (~JPY130.65 at midweek),
the upside correction does not appear over. A push above last week's high could
signal a test on the upper end of the recent range
(~JPY134.75-JPY135.00).
United Kingdom: Economists were most pessimistic
about the outlook for the UK economy among the G10 countries. Yet, it has been
surprisingly resilient, and after spending six months through January below the
50 boom/bust level, the composite PMI rose to 52.2 in March, its best level
since last June. January's monthly GDP surprised on the upside (0.3% vs. the
median forecast in Bloomberg's survey for 0.1%). The UK reports February GDP
figures and details on April 13. Recall that in February 2022, the British
economy contracted by 0.1% and stagnated for the following two months. The
market is pricing about a 70% chance of another hike by the Bank of England
when it meets next on May 11. Sterling rose last week to its best since June 2022, pushing up to $1.2525 after stalling near $1.2450 for
the past few months. Sterling drifted lower in the second half of last week and
slipped to $1.2390 in thin pre-weekend activity. It nevertheless closed higher
for the fourth consecutive week. It has come a long way since setting the low
in Q1 on March 8, near $1.18. The momentum indicators are stretched and rolling
over. The $1.2300-30 area may offer initial support and then $1.2250-70.
Australia: The Reserve Bank of Australia did
not hike rates last week, and the market thinks it is done, even if the central
bank preserved some wiggle room. The most important high-frequency report in
the week ahead will be the jobs data on April 13. Full-time job growth averaged
43k a month last year. It is expected to slow this year. The RBA sees inflation
falling from 6.6% last year to 4.8% at the end of this year. It stood at 6.8%
in February after peaking at 8.4% in December 2022. The Australian dollar was
turned back last week slightly below $0.6800, which met the (38.2%) retracement
objective of its drop since the February 2 high (~$0.7160), its best level
since last June. It recorded a new low for the week in thin pre-weekend
activity near $0.6640 after the US employment. We suspect the risk is on the
downside and anticipate a test on the four-month lows set in March (~$0.6565). A
convincing break of the $0.6550 could initially target the $0.6400 area.
Mexico: Minutes from last month's Banxico
meeting will be scrutinized for the shift to a more neutral setting that some
saw accompanying the 25 bp hike to 11.25%. The minutes will be released on April 13. Last week, March's CPI slowed to 6.85% (from 7.62%), and the core eased to 8.09%
(from 8.29%). The governor of the central bank had suggested that the core rate
peaked. The central bank meets on May 18. The swaps market has about
a 1-in-4 chance of a hike discounted, which is less than the odds of
another Fed hike. Still, given the high rates, carry-trade strategies may
remain attractive, especially if implied volatility falls further. Three-month
implied volatility jumped to almost 15.4% in the mid-March frenzy but pulled
back to 12% last week and finished near 12.4% before the weekend. It averaged
slightly below 11% in February. Volatility and the dollar are tending to move
in the same direction. The greenback found support at the start of last week, slightly below MXN18.00. What appears to have been a short squeeze lifted it
to MXN18.40 in the middle of the week. It fell back to almost MXN18.10 before
the weekend, a slightly deeper retracement than we expected. Still, the
momentum indicators warn that the corrective pressures have yet to be exhausted. The next upside target is in the MXN18.45-55 area.
Disclaimer
Reviewed by Marc Chandler
on
April 08, 2023
Rating:
