Overview: The UK surprised with higher-than-expected consumer
inflation and budget deficit, and the odds of a 50 bp hike tomorrow edged
higher. Sterling has been sold on the news and is the weakest of the G10
currencies, off about 0.5%. The dollar is mixed with the euro, Swedish krona,
Canadian dollar, and Swiss franc posting small gains. Emerging market
currencies are lower, including the Chinese yuan, which is at new lows since
last November. The Mexican peso, Hungarian forint, and Indonesian rupiah are
firmer. Brazil's central bank meets late today, while most economists look for
it to standpat, the risk for a rate cut.
US yields are edging higher ahead of Fed
Chairman Powell's congressional testimony today, at which he is expected to
reiterate the need to do more to ensure inflation returns to target and
resilience of the labor market and economy indicate space to do so. European
benchmark yields are mostly slightly firmer, while UK 10-year Gilt yields are
about six basis points higher. Equity markets are heavy. Japan and Taiwan are
exceptions, while Chinese and Hong Kong shares tumbled 1-2%. Europe's Stoxx 600
is off for the third session running and US equity futures are posting small
losses. Gold is trading in about a $4 range on either side of $1935. A
three-month low was recorded last week near $1925. August WTI is trading
quietly around $71.
Asia Pacific
As the dollar climbed against the Japanese
yen, three Japanese officials have commented on exchange rates in recent days,
the cabinet secretary, the finance minister, and yesterday, the industry
minister. Yet, and even though
the yen is made new lows for the year, and is terribly under-valued,
intervention is not imminent. The main driver is macro in the form of the
policy divergence. "Higher for longer" in most of the G10 offers
stark contrast with the Bank of Japan, which apparently is reluctant to even
adopt a neutral bias, let alone hike the policy rate from minus 0.10%.
Japan's economy grew at an annualized rate of 2.7% in Q1 and yesterday's upward
revision to April's industrial output figures from -0.4% to 0.7% points to a
better start to Q2 than had been feared. Yet, comments from BOJ Governor Ueda
and board member Adachi seemed to play down the likelihood of a change in
policy next month, which had been the subject of speculation as the central
bank will update its economic projections.
Japan's flash June PMI due Friday is
likely to confirm the continued recovery. The May composite reading of 54.3 was the highest since October
2013. New orders hit a record high of 54.7. Friday also sees the release of the
May national CPI figures. While the headline and core (excluding fresh food)
rates may slip a little, the measures that excludes fresh food and energy, is
seen rising to a new cyclical high of 4.2% (from 4.1%). It stood at 0.8% in May
2022. The incongruence of monetary policy with the economic expansion and
underlying price pressures has pressured the yen lower. The verbal intervention
seems more like an attempt to moderate the pace, like blowing air under a
parachute, and indicating to its trading partners that is not seeking trade
advantage.
That said, the dollar reversed lower
yesterday after setting a new high for the year against the Japanese yen near
JPY142.25. It was sold through
Monday's low (~JPY141.45) but settled 1/100 of a yen above it, and unable to
meet the technical definition of a key reversal. And the dollar bounced back
today, resurfacing above JPY142.00, where there are expiring options for $870
mln. Above yesterday's high, the JPY142.50 is (61.8%) retracement of the
dollar's decline from multiyear high set last year near JPY152.00. The
Australian dollar fell to about $0.6755 yesterday and recovered to almost
$0.6800 today where it was greeted with fresh sales. It is testing
yesterday's low in the European morning and a break of it suggests a move to
$0.6730, the (38.2%) retracement objective of this month's rally. Below there,
the next target is $0.6680-$0.6700. The US dollar approached CNY7.10 at the
end of last week and today is knocking on CNY7.20, a new high since last
November. The policy divergence, and the broad strength of the
greenback is the main driver. Meanwhile, whatever goodwill and optimism there
may have been following US Secretary of State Blinken's visit to China seems to
have been eroded by Beijing's objections to President Biden referring to Xi as
a dictator and the US amending that Taiwan Relations Act and the so-called Six
Assurances. The PBOC set the dollar's reference rate stronger than expected (CNY7.1795
vs. CNY7.1774) and this was seen as indicating lack of concern about the yuan's
weakness.
Europe
The UK's May inflation was another shocker.
The CPI rose 0.7% in May instead of
0.5% that had been expected, after jumping 1.2% in April. That meant that there
was no improvement in the year-over-year rate at 8.7%. At an annualized rate
through May, UK CPI has risen by 7.7%. Moreover, the core rate rose to a new
cyclical high of 7.1% from May. Used car prices, air travel, and recreation
prices helped lift the core rate. The fact that producer prices fell more than
expected offered little consolation. Moreover, the UK reported a larger than
expected budget deficit. The net result was an increase in the risk of a 50 bp
hike tomorrow to near 30% and a higher trajectory. The year-end rate is now
seen near 5.85% (4.50% currently), which is up from around 4.85% at the end of
April and 5.35% at the end of May.
Sterling has found little comfort from the
higher interest rate expectations and has been sold a little through
yesterday's low ($1.2715). A break of
$1.2700 targets $1.2650-75 but warns of a deeper retracement that could extend
toward $1.2550. The euro is sidelined, confined to a narrow range
(~$1.0905-$1.0935). Options for about 735 mln euros at $1.0950 expirer
today. Monday and yesterday's high was about $1.0945. We suspect cross rate
demand (against sterling and the yen) have helped prop up the euro. That said,
hawkish comments from Fed's Powell in congressional testimony could see the euro
test yesterday's lows near $1.0890 and then our initial target around $1.0860.
America
Many observers see the housing market as
key element of the larger business cycle. It is among the most interest rate sensitive sectors.
Higher interest rates lead to higher mortgage rates and a decline in activity.
However, with existing homeowners reluctant to sell and give up their low-rate
mortgages, supply of homes on the market is limited, and this has helped boost
sentiment among home builders. And boom, May housing starts surged 21.7%, the
most in seven years. Even with the downward revision to the April series (-2.9%
from +2.2%), the absolute level of starts (SAAR) was 1.63 mln. That is the
highest since April 2022 peak (~1.80 mln). Housing starts have recovered about
2/3 of the slowdown.
Half of the Federal Reserve governors and
regional presidents speak in this holiday-shortened week. Fed Governor Barr and Fed presidents Williams and
Bullard spoke yesterday. We will hear from Williams and Bullard later this week
again. Fed Chair Powell is center stage today as he begins his semi-annual
testimony before the House Financial Services Committee today and goes before
the Senate Banking Committee tomorrow. Chicago Fed's Goolsbee also speaks
today. He is a voting member of the FOMC this year, and although he is seen as
among the more dovish members, he has yet to dissent from the rating hiking
decisions this year. For now, it seems like officials are reading from the same
sheet. The decision to pause last week has no implication for the July meeting.
Still, the pricing of the Fed funds futures is consistent with around a 70%
chance of a hike. Yet, the January 2024 Fed funds futures contract, which,
without an FOMC meeting in January, offers a clean read of expectations for the
year-end effective rate (weighted average, which is where the contract settles)
is 5.21%. The current effective rate is 5.08%. This means the future market is
pricing in about a 50% chance of one hike left alone two that the Fed has
signaled. Looking a little downfield, next week's PCE deflator is likely to
show that at an annualized pace headline inflation is running about half the
pace seen in the first five months of last year, while the core measure is flat
to maybe even slightly higher.
Canada is expected to report that April
retail sales increased for the first time since January. In fact, the February and March declines (-0.2% and
-1.4%, respectively), which offset January's 1.4% advance in full. There has
been a significant backing up of Canadian two-year yield and it began before
the central bank's quarter-point hike earlier this month. The recent low yield
print was on May 11 near 3.60%. It reached a high to start the week slightly
above 4.60%. The swaps market has an almost 60% chance of quarter-point hike at
the July 12 meeting discounted. The Canadian dollar reached a new nine-month
high on Monday near $0.7590 (~CAD1. 3175). The greenback tested the resistance
we identified near CAD1 3265 (high was CAD1. 3270) yesterday and is consolidating
today. A move outside the CAD1.3200-CAD1.3300 range would suggest the end of
the consolidative phase. Mexico’s April retail sales reported yesterday
jumped 1.5%, well above expectations (~0.2%) but was neutralized by the sharp
downward revision to March. It was revised to -1.2% from flat.
Net-net, retail sales were close to forecasts. Still barring a dramatic
surprise from the CPI readings for the first half of June, released Thursday
morning, Banxico is expected to standpat at its meeting later that day. Chile
and Brazil are seen cutting rates ahead of Mexico, but the swaps market is
pricing a cut from Banxico in Q4. The dollar settled above its five-day moving
average against the Mexican peso for the first time since May 25. It saw
follow-through gains toward almost MXN17.26 before easing again. A break of
MXN17.30 could spur another leg higher. Lastly, Brazil's central bank meets
late in the session. While a rate cut is coming, most economists see today's
meeting as more groundwork. On Monday, the dollar recorded the low for the year
slightly below BRL4.76.
Reviewed by Marc Chandler
on
June 21, 2023
Rating:
