The dollar appears at an inflection point. Its
failure to draw much traction even as US rates rose may be an important tell. The
US 2-year yield rose to a new multiyear high near 5.12%, while the 10-year
yield set a new high for the year around 4.09% after the
employment report. The dollar's broad gains in the second half of last month
look corrective. The underlying downtrend, which we argue began last September
and October, looks set to resume. Moreover, the base effect warns of another
large drop in the headline CPI on July 12. This coupled with the disappointing
jobs report (209k and a downward revision of 110k in April and May) will
reinforce market skepticism of not the hike later this month, but the one after
that, which the Fed signaled in June.
Japan's verbal intervention and threats of
action succeeded in arresting the dollar's rally near JPY145. The Tankan survey
showed business inflation expectations remained over 2% over the next three
years, and then the wage data was double expectations, and this helped spur a
further short covering of the yen. Chinese officials appeared to use formal
(the setting of the dollar's reference rate) and informal (getting banks to cut
dollar deposit rate) channels to express its displeasure. According to
Bard, the Google AI, the yen, and yuan have moved in the same direction against
the dollar about 2/3 of the time recently (100 sessions) and longer-term (1000
sessions). China is expected to report lending and price data in the coming
days, but the key to the yuan may be the greenback's overall direction.
The Reserve Bank of New Zealand and the Bank of
Canada meet (July 12). The RBNZ is most assuredly on hold. The central bank has
signaled as much, and the economy has entered a prolonged slump and the median
forecast in Bloomberg's survey does not see quarterly growth returning until Q1
24. The Bank of Canada is a closer call. Until the outsized 109.6k surge in
full-time employment reported before the weekend, the odds seemed to have been
fading. We do not think there is a compelling case for back-to-back hikes and
lean toward it standing pat. However, after being surprised last month, no one
wants to be bitten by the same dog twice.
United States: The issue is not about rising prices in the US but the pace
of moderation. The Federal Reserve is not satisfied with the pace and hence
have signaled the likelihood of two more rate hikes. The ongoing resilience of
the labor market gives them scope to act. The economic highlight in the week
ahead is the US June CPI. The median forecast in Bloomberg's survey looks for a
0.3% increase. That would bring the H1 annualized pace to about 3.6%. Owing to the fact that last June's 1.2% surge drops out of the 12-month
comparison, the year-over-year rate is expected to drop from 4.0% to 3.1%, which
would be the lowest since March 2021. Recall it peaked in June 2022 at 9.1%.
The June report in some ways marks the end of the low hanging fruit.
Year-over-year comparisons will be more difficult in the second half of the
year. In H2 22, US CPI rose at an annualized rate of about 2.8%. The core rate
has not softened as much. The 12-month pace peaked at 6.6% last September. It
had slowed to 5.3% in May and is expected to have slipped to 5.0% last month.
If so, it would the slowest pace since November 2021. The median forecast calls
for a 0.3% increase, which would put the annualized pace in H1 to a little more
than 4.8%, unimpressively below the 5.0% annualized pace of H2 22.
Disinflationary forces are most evident in producer prices. The year-over-year rates
peaked in March 2022 at 11.7%. It stood at 1.1% in May. It could fall below
0.5% in June, given the base effect. Comparisons will prove more difficult. In
H2 22, PPI rose at an annualized rate of 0.8%, with two negative monthly prints
and one unchanged month.
China: There are three reports from China in the week ahead
that are important for different reasons. First, the June lending figures will
likely improve sharply from May. Shadow lending dried up in May. It can be
estimated by subtracting new yuan loans (CNY1.362 trillion) from the aggregate
financing (CNY1.555 trillion). Shadow lending is likely to have recovered. Bank
lending is also expected to have improved, but even if it meets the median
forecast in Bloomberg's survey of CNY2 trillion), it will remain below average
monthly gain in Q1 of CNY3.5 trillion. Still, the takeaway is lending is
increasing. Second, and the reason China has scope to boost lending and ease
financial conditions is that inflation is not a problem. To the contrary, deflationary
forces clear. Producer prices have been falling on a year-over-year basis
beginning last October. China's consumer price increases have slowed sharply
from the 1.8% year-over-year pace last December to less than 1% in the three
months through May, when it stood at 0.2%. The price of housing on a
year-over-year basis has been falling since last October. Transportation and
communication prices fell for three months through May. Food prices rose 1%
year-over-year in May. While the conventional view is that low inflation
reflects weak demand, but the story may be more complicated. Excess capacity is
spurring competition in some sector, like autos. The modest rise in food prices
seems more supply driven than demand. Housing costs are likely a reflection of
the weak real estate market, which is also ailed by oversupply. The takeaway is
that inflation does not stand in the way additional economic support. Third,
China reports its politically sensitive trade numbers for June. Its trade
surplus through May is more than a quarter larger for the first five months of
2022. This is happening despite weak exports. On a year-over-year basis,
exports fell in three of the first five months of the year and the average pace
has been 0.8%. Imports have been even weaker and have fallen on a
year-over-year basis for seven of the past eight months. This may be picking up
the impact of sanctions, falling prices, and import-substitution.
The yuan rose by a little more than 0.4% last
week. It is only the fourth weekly increase since the end of Q1. Chinese
officials have stepped up their defense of the yuan via the daily fix and
through informal channels to get banks to cut their dollar deposit rates. The
recovery of the yen on jawboning may have also helped the yuan's recovery. Still,
the greenback needs to fall back below CNY7.1940-CNY7.2020 to signal anything
important. The former is the 20-day moving average, which the dollar has not traded
below since late April. The latter is a two-week dollar low. Recall that the dollar reached a multiyear high last
November near CNY7.3275.
Canada: The Bank of Canada meets on July 12. The market was
surprised by the quarter-point hike in June, which ended the "conditional
pause" announced in January. Until the 109.6k surge in full-time jobs was
reported at the end of last week, there did not appear to be a strong case for
back-to-back hikes. The jump in full-time jobs more than offset the declines in
April and May. April's GDP was flat, and if anything, May CPI was slightly
softer than expected and the three-month averages of the underling core rates,
which Governor Macklem referred to, drifted lower. Still, the employment data
saw the swaps market increase the likelihood of a quarter-point hike to 67%, the
most in two weeks.
The US dollar had fallen to nine-month lows in
late June near CAD1.3115. Poor Canadian news and constructive US developments
helped the greenback recoup about half of last month's losses (~CAD1.3385) that
was seen a few hours before the diverging employment reports. The Loonie
recovered quickly. The US dollar slipped below CAD1.3270. The next area of support is in the CAD1.3220-50 area. But the Canadian dollar is
vulnerable if the central bank stands pat.
Eurozone: May industrial production and trade figures will be
reported on July 13 and 14, respectively. Of the four largest EMU members, all
but Italy reported their figures in recent days. After rising by 1.0% in April,
industrial production likely stagnated in July. On the other hand, the eurozone
trade balance has been improving on a trend basis. Consider that in the first
four months of the year, its trade deficit has averaged about 1.42 bln euros a
month. In the Jan-Apr 2022 period, the average shortfall was 21.4 bln euros a
month. It seems reasonable not to expect a significant market reaction to
either report. The data is unlikely to change views of the trajectory of the
ECB. The swaps market has 90% of a quarter-point hike discounted and it is
nearly as convinced of another 25 bp hike in Q4. These expectations do not
hinge a view of the real economy, within reason, but prices and the will of the
ECB.
Since peaking near $1.1010 on June 22 (last
month's high), the euro trended lower and recorded a three-week low near
$1.0835 on July 6. The disappointing US employment report saw the euro recover
and close above the downtrend line (~$1.0895). It surpassed the
(61.8%) retracement objective of the losses since late June (~$1.0945). It
looks poised to retest last month's high. Indeed, a move above the June high would
give more evidence that the euro's pullback from $1.1100 approached in late
April and early May was corrective in nature, meaning that new euro highs
should be expected in the second half of the year. To be sure, it is not so
much about the euro itself as it is the largest and most liquid alternative to
the dollar.
Japan:
Producer price inflation in Japan has evaporated. It rose at annual pace of
slightly more than 10% in Q4 22 and fell at annualized rate of almost 1.5% in
the first five months of 2023. The manufacturing PMI show a drop in the input
price index to a 28-month low. Consumer prices, which is the focus of policy
are different story. The Tankan survey showed expectations for CPI to be above 2%
in from the one-year outlook to five years. Meanwhile, Japanese officials are
gradually climbing the intervention escalation ladder. After last year's
intervention that was criticized by some US officials, Tokyo and the US
Treasury are reportedly discussion the pros and cons of intervention. This
seems like a diplomatic courtesy. What made last October's intervention
successful was arguably the astute tactics that dovetailed with the peak in US
10-year yield. The yield remains below that peak (~4.33%) but are near the best
level since the March bank stress (~3.85%) and could rise toward the year's
high a little below 4.10%. While intervention is thought to be more effective
if it signals a policy change, in Japan that was not the case last year. The
move to widen that band took place last December and by then the dollar was
around 10% below its late October peak (~JPY152). Much to the annoyance of
Beijing, NATO will establish an office in Tokyo, and Prime Minister Kishida has
been invited to this week's NATO Summit (July 11-12) in Lithuania.
Jawboning by Japanese officials, raising the
specter of material intervention, began to deter the market from pushing the US
dollar above JPY145, which is near where the BOJ is believed to have intervened
last September. A strong rise in May wages (2.5% year-over-year vs. 1.2%
expected) spurred speculation that the BOJ may adjust policy at the meeting
later this month. The disappointing US employment report pushed on the open
door and sent the greenback to almost JPY142.00. The dollar settled below the
20-day moving average (~JPY142.75) for the first time in nearly two months. The
momentum indicators have turned down, and the risk is more yen shorts are
covered. This could drive the dollar into the JPY138.75-JPY140 area. Tactically,
this would be an opportunity for the BOJ to intervene, with the wind at their
backs and the US 10-year near its highest yield in nearly eight months. However,
a break in the yen's downtrend may make it difficult to explain an intervention
decision to the US, with whom they are consulting.
United Kingdom: Sentiment toward the UK economy appears to be
deteriorating. The recession that economists, including those at the Bank of
England, warned of, has been revised away. However, it seems to be returning as
UK rates rise and policy is set to tighten further in the coming months.
Indeed, the swaps market has 125 bp of additional tightening discounted for H2
23. It is 90 bp higher than at the end of May. The UK reports its latest
employment figures on July 11. The labor market and wage growth remain robust.
Average weekly earnings, excluding bonus payments, rose by 7.2% in the
three-months through April compared the year ago period. It has increased in
all but two months since April 2022. The UK's monthly GDP estimate for May is
due July 13. The economy eked out 0.1% growth in Q1. The economy grew by 0.2%
in April. The median forecast in Bloomberg's survey is for the UK economy to
have stagnated in Q2.
Even if falling house prices, the most in a decade,
rising mortgage rates, and elevated inflation sours the outlook for the
economy, sterling rose by a little more than 1% last week. It erased the losses
of the previous two week. It reached a marginal new high since April 2022. Momentum
indicators have curled up from mid-range, never having gotten to oversold
territory. A move above $1.2880 likely clears the deck for $1.30. A convincing
move above there would target the $1.3200-$1.3300 area. That said, a break of
the $1.2725 area would be disappointing.
Australia: It is a light week for official Australian economic data. The RBA's decision last week to stand pat, the downward revision to the flash June PMI (composite now 50.1, a four-month low) and falling exports this year through May, have discouraged speculation of a hike at the next meeting on August 1. Still, a hike is fully discount in the futures market by the end of the quarter. have also been downgraded. A hike is now fully priced in for early Q4 and the year-end target rate is seen slightly a little above 4.65%, . Separately, note that the Reserve Bank of New Zealand meets on July 12. It has hiked rates at ever meeting beginning in October 2021. It has taken the case target rate from 0.25% to 5.50%. With the May hike, the RBNZ signaled the cycle is over. The swaps market has the first cut penciled in for Q2 24. Over the past fortnight, the Australian dollar has carved a shelf near $0.6600. It is flirted with $0.6700 but has been unable to settle above it since June 22. The momentum indicators have begun turning and a move through $0.6700 targets $0.6785-$0.6800 initially. At this point, only a break of $0.6600 weakens the constructive near-term outlook.
Mexico: The peso rose by nearly 5.3% in 2022 and is up 13.7% so far here in 2023. The dollar traded below MXN17.00 last week for the first time since December 2015. The appreciation of the peso has not seen the trade balance deteriorate. Exports in May were up 5.8% year-over-year, while imports were less than 1.5% higher. Exports are near record levels and worker remittance set their own record ($5.69 bln in May), up 10.7% year-over-year. Real sector data has surprised to the upside, while price pressures continue to ebb. Meanwhile, Mexico's inflation is trending lower, though still above the 3% (+/- 1%) target. The swaps market sees the first cut in Q4. On July 6, the peso slumped by more than 2% at its worst which is the most since the bank stress of early March. The combination of the jump in US rates and the strengthening of the yen spurred a sharp drop in the peso. Short yen/long Mexican peso positions have been a favorite money maker for several months for levered accounts.
Profit-taking on some of these positions also
appear to help explain the dramatic price action that lifted the greenback to
nearly MXN17.40 before the US jobs data, from a multiyear low near MXN16.98 on
July 5. This met the (38.2%) retracement objective of the dollar's decline from
the May 23 high near MXN18.00. The fundamental drivers of the peso's strength
remain in place and the peso was snapped up on the setback. The dollar fell to MXN17.0730 ahead of the weekend but finished above the 20-day moving average The US dollar
finished the week back below the 20-day moving average (~MXN17.1340). Some consolidation may be seen near-term. The yen's performance also may be important for re-establishing carry trades. Still, we suspect that an significant dollar low is not in place. It is difficult to talk about
support or important chart points given that the dollar has not seen these
levels in 6-7 years. That said, our guess is that the next leg down could see the MXN16.80-90 area.
Reviewed by Marc Chandler
on
July 08, 2023
Rating:
