Yen's Surge Continues, while PBOC Surprises with Another Rate Cut, and US 2-30 Year Yield Curve Ends Inversion

Overview: The capital markets are in flux. The powerful short-covering rally of the yen and unwinding of carry trades continues. For the second time this week, the PBOC has surprised by cutting interest rates. The dramatic sell-off of equities continues. The unexpected contraction of South Korea's Q2 GSP (-0.2%) is seen as confirmation of broader economic weakness Speculation of a more aggressive Federal Reserve is gaining ground. It is not that the odds of a cut next week have improved much (~10%), but the derivative markets are pricing in about 25% chance of a 50 bp cut in September. The US 2-10-year yield curve is the least inverted in two years (~-13 bp), while 2-30-year curve is positive sloped by the most in two years (+14 bp). The dollar-bloc currencies and Scandis are bearing the brunt of the downside adjustment among the G10 currencies. 

Equities are a sea of red after the sharp losses in the US yesterday. The Nikkei was of nearly 3.3% today and most of the bourses, with the notable exception of India were off more than 1%. Taiwan's market remains closed due to the typhoon. Europe's Stoxx 600 is off about 1.5%, which, if sustained, would be the largest loss in three months. US index futures are sporting a softer profile. However, bonds are rallying. European benchmark 10-year yields are more 1-4 bp lower and periphery-core premiums are widening. The 10-year US Treasury yield is off nearly six basis points to a little below 4.23%. The two-year yield is off about seven basis points to slightly below 4.36%. Gold is extending is retreat. It set a record a week ago near $2484 and is now about $110 lower. Nearby support is seen near $2350. September WTI is under pressure. It approached $76 earlier today, its lowest level since early June. Its recent peak was on July 5 around $83.60. 

Asia Pacific

The yen's surge continues. It may have begun with the covert intervention, but it has taken on a life of its own. To put the move in perspective, consider that in the last six weeks of 2023, the dollar. fell by nearly 7.7% against the yen (~JPY151.90 to JPY140.25). Now, in a little more than three weeks, the dollar has fallen about 6.1% against the yen (~JPY161.80 to JPY151.95). The Nikkei was little changed, but slightly lower in the last six weeks of 2023. It has declined by almost 11% since July 11. Tokyo’s July CPI tomorrow will give BOJ officials the last insight into prices ahead of next week's meeting, where the odds of a rate hike have risen from around 40% to 70% over the last few days. The headline CPI is expected to be flat at 2.3%, while the core rate, which excludes fresh food, may tick up to 2.2% from 2.1%. The core rate averaged 2.0% in H1 24 after a 2.3% average in H2 23. Tokyo's headline and core rates were about 0.5% lower than the national readings in June. In China, the PBOC surprised the market for the second time this week by cutting the one-year Medium-Term Lending Facility by 20 bp to 2.3%, the first such cut since last August, and injected CNY200 bln (~$27.5 bln). On Monday, the PBOC cut its seven-day reverse repo rate by 10 bp. Chinese banks responded by cutting their prime lending rates, and today, several large banks cut their deposit rates. 

After settling the session low near JPY153.10 yesterday in the North American morning, it recovered but recovered back above JPY154.00. The move has been extremely dramatic. The dollar has now retraced around 40% of this year's gains. Continued short covering of the yen saw further gains today and the dollar slipped slightly below JPY152. The 50% retracement of this year's gains is near JPY151.00. The immediate move is getting stretched as illustrated by the dollar settling below its lower Bollinger Band (found ~JPY153.40 today). Recall that the dollar settled near JPY157.50 at the end of last week. Unwinding of long Australian dollar positions against both the dollar and yen took the exchange rate to slightly below $0.6580 yesterday and to nearly $0.6525 today. This met the (61.8%) retracement of the rally from the year's low in mid-April near $0.6365. The Aussie is below 200-day moving average for the first time since early May. It settled below its lower Bollinger Band too (found ~$0.6570 today). The stronger yen finally seemed to help lift the Chinese yuan, despite the rate cuts. The greenback fell to almost CNH7.20 today, its lowest level since mid-May. The PBOC set the dollar's reference rate at CNY7.1321 (CNY7.1358 yesterday). If sustained the dollar's roughly 0.50% loss today against the onshore yuan would be the largest of the year. 

Europe

Following on the heels of a disappointing July PMI yesterday, Germany's IFO reported further deterioration in investor confidence today. The measure of the business climate fell to 87.0 from 88.6 the third consecutive decline and the weakest since February. Both the current assessment and expectations deteriorated. Next week, the eurozone reports Q2 GDP (expect 0.2%-0.3% quarter-over-quarter) and the preliminary July CPI. Given the base effect, a 0.2% increase, matching the May and June rise, would put the year-over-year rate around 2.8%, matching the high for the year. However, by the time the ECB meets again, it will have the August CPI in hand, and it will likely pullback toward 2.5%. Still after the PMI data, the odds of September cut by the ECB rose in the swaps market to about 94% from slightly less than 80% on Tuesday. The Bank of England meets on August 1. The swaps market has about a 55% chance of a cut discounted. It does not have cut fully discounted until November.

The euro recorded the session low yesterday in early Europe near $1.0825 and recovered to new session highs before European markets closed around $1.0865. The euro is trading within yesterday's range so far today. How the euro acts in the $1.0875-$1.0900 area may be key to the near-term technical outlook. A rise back above $1.09 suggests the euro's downside correction may be over. However, the momentum indicators have only recent turned down from overextended territory. Sterling made a marginal new low today near $1.2875. It met the (38.2%) retracement objective of the rally from the June 2 low (~$1.2615). A move above $1.2960-80 is needed to be of significance, otherwise, here too, the momentum indicators warn of downside risks. The next retracement (50%) is near $1.2830 and the (61.8%) retracement is slightly below $1.2780. 

America

The first estimate of US Q2 GDP is today's highlight. The Atlanta Fed's tracker slipped to 2.5% from 2.7% the latest iteration yesterday, while the median in Bloomberg's survey is 2.0% (range 1.2% to 3.0%). Bloomberg's monthly survey shows the median forecast for Q3 and Q4 GDP slowing to 1.5%. Weekly jobless claims may also attract attention after last week's jump of 20k (to match the year's high of 243k) was the same week as the nonfarm payroll survey was conducted. The early call is for nonfarm payrolls to have risen by 180-190k, slightly slower than the initial estimate of 206k in June. Meanwhile, the Bank of Canada delivered the quarter-point cut as widely expected, and the swaps market upgraded the chance of a September cut to a little more than 60%. Mexico reports June goods trade figures today. In the first five months of the year, Mexico recorded a $4.46 bln trade deficit. The deficit in the January-May 2023 period was $6.56 bln. Last weekend, Finance Minister Ramirez, who will retain his post in the new administration, expressed concern about Mexico's large trade deficit with China and seemed to align Mexico more with the US, advocating protective measures. In April, Mexico implemented new tariffs on more than 500 Chinese products. AMLO has encouraged Chinese investment in Mexico, though Ramirez hinted that this is under review, and that China may be blocked from investing in some sectors.

Following the Bank of Canada's dovish rate cut, the greenback has extended its gains to nearly CAD1.3840 today. It has taken out the trendline (Nov 2023 and April 2024) found near CAD1.3820, which is also where the upper Bollinger Band is found today. The April high was near CAD1.3845 and a break could spur a move to the last November's high (~CAD1.39). The US dollar continued to push higher against the Mexican peso. The dollar, which finished last week near MXN18.05, reached MXN18.54 today. The next target is the MXN18.60-65 area. Recall that the post-Mexican election high was near MXN19.00. There is a strong correlation for the last 100 sessions between changes in the dollar-peso exchange rate and the peso-yen exchange rate (~0.85). This is consistent with the unwinding of the carry trades. At the same time, we note that other favorites for carry trades also performed poorly, led by Colombia, Brazil, and Hungary. The positioning of the momentum indicators the peso's slump is not over. 

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