• We are seeing a quiet start to an eventful week; U.S. yields at the short end are edging higher ahead of the Fed decision; May budget statement is the only data to reported today
  
• We would fine it remiss not to mention several events in the European political sphere; BOE MPC member Haskel sounded hawkish;
  
• Japan reported weak May machine tool orders; data continue to come in weak ahead of the BOJ decision Friday

The dollar is drifting lower as an important week begins. DXY is trading lower near 103.314 but we suspect the downside will be limited ahead of CPI tomorrow and the FOMC decision Wednesday. The euro is trading higher near $1.0785 and continues to meet stiff resistance near the $1.08 level. Sterling is trading higher near $1.26 and is on track to test the early May high near $1.2680. USD/JPY is trading heavy near 139 but we expect a dovish BOJ decision Friday and still look for a test of the late May high near 141. The headwinds on the dollar (banking sector weakness, debt ceiling battle) have been resolved even as the tailwinds (strong economy and robust labor market) remain in play. We look for the post-NFP rally to resume as markets continue to underestimate the risks of Fed tightening.

AMERICAS

We are seeing a quiet start to an eventful week. Yet the big takeaway from last week stands and that is global interest rates are going even higher for even longer. Both the RBA and BOC delivered hawkish surprises and hiked rates after pausing their tightening cycles earlier this year. Both banks highlighted persistent price pressures and resilient economies as factors behind the hikes. The SNB delivered a hawkish message and Norway reported much higher than expected inflation in May, leading to increased tightening expectations for both of these banks. Does this all sound familiar? It should, as the exact same factors are in play here in the U.S. The cumulative impact was that expected terminal rates for virtually every major central bank are now at the cycle highs.

U.S. yields at the short end are edging higher ahead of the Fed decision. The 2-year yield traded near 4.63% today and is testing the late May high near 4.64%. It is on track to test the early March high near 5.08%. The 10-year yield is lagging and traded near 3.77% today, well below the late May high near 3.86% and the early March high near 4.09%. Tomorrow’s May CPI data and Wednesday’s FOMC decision are key factors behind whether these yields can maintain upward momentum. Consensus sees rates kept steady this Wednesday after several Fed officials highlighted a skip, though a few analysts look for a 25 bp hike. Elsewhere, WIRP suggests 25% odds of a hike that rise to near 80% in July. Rate cuts are no longer priced in by year-end, which is long overdue. Forward guidance at this meeting will be key. We see risks of a hawkish surprise but if rates are kept on hold, we would expect fairly explicit language highlighting a hike at the next meeting and the Dot Plots would have to be adjusted higher.

May budget statement is the only data to reported today. The deficit is expected at -$236.0 bln vs. a $176.2 bln surplus in April.

EUROPE/MIDDLE EAST/AFRICA

We would fine it remiss not to mention several events in the European political sphere. While none have any direct market implications, they both signal the end of an era. Late Friday, former U.K. Prime Minister Boris Johnson resigned his parliamentary seat after an investigation found that he had misled Parliament with regards to “Partygate.” Two of Johnson’s allies also resigned as MPs, which means the Tories will have to face the voters in three by-elections when the party’s popularity remains under water. North of Hadrian’s Wall, former Scottish National Party head Nicola Sturgeon was arrested over the weekend as part of an investigation into the party’s finances. Lastly, former Italian Prime Minister Silvio Berlusconi passed away today.

Bank of England MPC member Haskel sounded hawkish. In a column, he wrote “We are monitoring indicators of inflation momentum and persistence closely. My own view is that it’s important we continue to lean against the risks of inflation momentum, and therefore that further increases in interest rates cannot be ruled out.” Mann speaks later today and is likely to generate some hawkish headlines as well. BOE tightening expectations remain elevated ahead of next week’s meeting. WIRP suggests a 25 bp hike is fully priced in, with nearly 15% odds of a larger 50 bp move. Hikes are priced in for August, September, and November that would see the policy rate peak near 5.5%.

ASIA

Japan reported weak May machine tool orders. Total orders came in at -22.2% y/y, the weakest since August 2020. The weakness was spread evenly between domestic and foreign orders, suggesting broad-based headwinds on the economy are picking up. April core machine orders will be reported Thursday and are expected at -8.5% y/y vs. -3.5% in March.

The data continue to come in weak ahead of the Bank of Japan decision Friday. PPI came in at 5.1% y/y vs. 5.6% expected and a revised 5.9% (was 5.8%) in April. This was the lowest since June 2021 and offers some hope that price pressures are easing. With Governor Ueda and his colleagues firmly in the dovish camp, WIRP suggests less than 10% odds of liftoff this week, rising to around 10% in July, 25% in September, 40% in October, and 55% in December.