U.S. yields are edging higher as markets digest last week’s FOMC decision; Fed tightening expectations remain elevated; with recession fears rising, May Chicago Fed NAI takes center stage; housing data will remain in focus as weakness in that sector persists; Canada reports April retail sales; BOC tightening expectations remain elevated; Brazil COPOM minutes will be released
ECB President Lagarde affirmed liftoff next month; ECB tightening expectations remain elevated; Chief Economist Pill said the BOE is prepared to sacrifice growth in order to bring down inflation; indeed, BOE tightening expectations remain elevated; U.K. CBI began releasing the results of its June surveys
The RBA released the findings of its review of YCC; Korea reported trade data for the first 20 days of June
The dollar is soft as the U.S. returns from holiday. DXY is trading back near 104 after making a new cycle high last week near 105.788. The euro is testing $1.06 again on ECB hawkishness and optimism regarding the new crisis tool. The weakening trend in the yen continues, with USD/JPY making a marginal new high for this cycle 135.85 today. As risk-off impulses fade and BOJ dovishness is maintained, we believe the pair will eventually test the August 1998 high near 147.65. Sterling has recovered on recent BOE hawkishness (see below) but is having trouble sustaining a move above $1.23. With the Fed maintaining a very hawkish stance yesterday, higher U.S. yields should continue to underpin the dollar.
U.S. yields are edging higher as markets digest last week’s FOMC decision. The 10-year yield is trading near 3.27% after ending the week near 3.23%, up from Thursday’s low near 3.18% but well below last week’s peak near 3.50%. Elsewhere, the 2-year yield is trading near 3.21% after ending the week near 3.18%, up from Thursday’s low near 3.08% but well below last week’s peak near 3.45%. While we acknowledge that this month’s run up in yields was getting a bit overdone in terms of the pace, we continue to believe that the direction remains intact. When all is said and done, we believe monetary policy divergences remain the dominant driver for FX. As the U.S. economic outlook remains the strongest and the Fed the most hawkish relative to its DM peers, the dollar uptrend should remain intact.
Fed tightening expectations remain elevated. WIRP suggests a 75 bp hike at the next meeting July 27 is nearly 90% priced in, while 50 bp hikes at the subsequent meetings September 21 and November 2 are fully priced in. Looking ahead, the swaps market is pricing in 225 bp of tightening over the next 12 months that would see the policy rate peak near 4.0%, up from 3.75% at the start of last week and 3.0% at the start of this month.
There is a full slate of Fed speakers this week and all should sound hawkish. Barkin and Mester speak today. Yesterday, Bullard noted that markets have priced in a lot of Fed tightening and stressed that "The Fed still has to follow through to ratify the forward guidance previously given, but the effects on the economy and on inflation are already taking hold." Over the weekend, Waller said he backs a 75 bp hike at the July meeting and stressed that “The Fed is ‘all in’ on re-establishing price stability.”
With recession fears rising, May Chicago Fed National Activity Index takes center stage. It is expected to remain steady at 0.47. If so, the 3-month average would fall slightly to 0.43 vs. 0.48 in April. Still, it would remain far above the -0.7 threshold that would signal an imminent recession.
Housing data will remain in focus as weakness in that sector persists. May existing home sales will be reported and are expected at -3.7% m/m vs. -2.4% in April. May new home sales will be reported Friday and are expected at 0.2% m/m vs. -16.6% in April. Of note, supply of both new and existing homes sales are rising as supply outstrips demand. This should result in lower prices in the months ahead. Last week, May building permits came in at -7.0% m/m and housing starts came in at -14.4% m/m. Yet that's what Fed tightening is supposed to do and should come as no surprise with mortgage rates rising sharply.
Canada reports April retail sales data. Headline sales are expected at 0.8% m/m vs. 0.0% in March, while sales ex-autos are expected at 0.6% m/m vs. 2.4% in March. Jobs growth remained strong in May and should continue to support consumption. May CPI data will be reported tomorrow, with headline inflation expected to accelerate to 7.3% y/y. With the economy running hot and inflation still rising, the Bank of Canada will continue tightening aggressively.
Bank of Canada tightening expectations remain elevated. A 50 bp hike at the next meeting July 13 is fully priced in, with nearly 80% odds of a 75 bp move. Follow-up 50 bp hikes are also fully priced in for September, October, and December. Looking ahead, the swaps market is pricing in 250 bp of tightening over the next 12 months that would see the policy rate peak near 4.0%, steady from last week but up from 3.0% at the start of this month.
Brazil COPOM minutes will be released. It hiked 50 bp to 13.25% last week and signaled it would be appropriate to tighten policy “significantly into even more restrictive territory” and added that “For its next meeting, the Committee foresees a new adjustment, of the same or lower magnitude.” The swaps market is pricing in 50 bp of further tightening over the next 6 months that would see the policy rate peak near 13.75% vs. 13.50% last week. Mid-June IPCA inflation will be reported Friday. Headline is expected at 12.01% y/y vs. 12.20% in mid-May. Deceleration would be welcome but it would still be well above the 2-5% target range. There are also upside risks ahead after Petrobras hiked gasoline prices at its refineries by 5.2% and hiked diesel prices by 14%, ignoring warnings from President Bolsonaro.
European Central Bank President Lagarde affirmed liftoff next month. She said “We intend to raise the key ECB interest rates by 25 bp at our July monetary policy meeting,” and said it will hike again in September, without committing to an amount. Lagarde stressed that the bank continues to work on its crisis tool, adding “Suffice to say that fragmentation will be addressed if the risk of it arises. And it will be done so with the appropriate instruments, with the adequate flexibility, it will be effective, it will be proportionate, it will be within our mandate. And anybody who doubts that determination will be making a big mistake.” Rehn speaks today.
ECB tightening expectations remain elevated. WIRP suggests a 25 bp hike July 21 is fully priced in. Then, 50 bp hikes are priced in for the subsequent three meetings on September 8, October 27, and December 15 that would take the deposit rate to near 1.25% by year-end. Looking ahead, the swaps market is now pricing in 275 bp of tightening over the next 24 months that would see the deposit rate peak near 2.25% vs. 2.0% at the start of last week and 1.75% before the ECB meeting.
Chief Economist Pill said the Bank of England is prepared to sacrifice growth in order to bring down inflation. While that may seem like an obvious statement, the bank is doing a better job of addressing the tradeoffs involved than it did earlier this year, when it seemed reluctant to hike rates. Pill added that the bank was prepared to act “more aggressively.” Of note, Saunders, Mann, and Haskel dissented last week in favor of a larger 50 bp move. We suspect that 6-3 vote has already shifted to at least 5-4 in favor of a 50 bp hike at the next meeting.
Indeed, Bank of England tightening expectations remain elevated. WIRP suggests a 50 bp hike move at the August 4 meeting is fully priced in, with low (20%) odds of a 75 bp move. Follow-up 50 bp hikes are fully priced in for the subsequent meetings September 15 and November 3. Looking ahead, the swaps market is now pricing in 225-250 bp of tightening over the next 12 months that would see the policy rate peak between 3.50-3.75%, up from 3.50% at the start of last week and 2.50% in late May.
U.K. CBI began releasing the results of its June surveys. Industrial trends survey today showed total order at 18 vs. 20 expected and 26 in May, while selling prices came in at 58 vs. 75 expected and actual in May. Distributive trades survey will be reported Thursday, with retailing reported sales expected at -3 vs. -1 in May. Ahead of that, June GfK consumer confidence will also be reported Thursday and is expected to remain steady at -40.
The Reserve Bank of Australia released the findings of its review of Yield Curve Control. The bank acknowledged that the exit from YCC was disorderly and caused some reputational damage, adding that it’s unlikely to deploy this program again. As part of the review, the RBA agreed to strengthen the way it considers the full range of scenarios when making policy decisions, especially involving unconventional policy measures. It found that while YCC worked for the bulk of its existence, “the exit in late 2021 was disorderly and associated with bond market volatility and some dislocation in the market. This experience caused some reputational damage to the bank.” The bank admitted that YCC’s effectiveness waned as markets reassessed the outlook for the policy rate. Is there a lesson here for the Bank of Japan? Stay tuned.
Korea reported trade data for the first 20 days of June. Exports fell -3.4% y/y while imports rose 21.1% y/y. However, when adjusted for working days, exports rose 11% y/y. Shipments to the U.S. fell -2.1% y/y while those to China fell -6.8% y/y. On Monday, Taiwan reported firm May export orders. Orders rose 6.0% y/y vs. 3.0% expected and -5.5% in April. While the recovery in orders is welcome, regional trade and activity are clearly in a slowing trend due in part to the lockdowns in China.