U.S. yields remain low as recession fears rise; the U.S. yield curve is flattening but nowhere near inverting; we get some major June PMI readings this week; regional Fed manufacturing surveys for June will wrap up; May core PCE Thursday will be closely watched
June eurozone CPI readings take center stage; final eurozone manufacturing PMI readings will be reported Friday; ECB tightening expectations have softened; BOE expectations have eased after the weak data; Riksbank meets Thursday and is expected to hike rates 50 bp to 0.75%
Japan reports some key data; Q2 Tankan survey will be reported Friday
U.S. yields remain low as recession fears rise. The 10-year yield traded as low as 3.00% Friday but ended the week near 3.13%. Similarly, the 2-year yield traded as low as 2.87% Friday but ended the week near 3.06%. Both are well below the mid-June peaks near 3.50% and 3.45%, respectively. We acknowledge that U.S. recession fears are likely to keep yields depressed near-term, but would add that we feel those fears are overblown. Yes, the U.S. economy is slowing but that is exactly what the Fed wants. We do not see any signs yet of an abrupt recession. When all is said and done, we still 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.
The U.S. yield curve is flattening but nowhere near inverting. Some portions of the curve have inverted but faithful readers will know that we favor the 3-month to 10-year curve as the best recession signal. At 150 bp, it is the flattest since early March but still far from inverting. This suggests very low odds of recession over the next 12 months.
Fed tightening expectations have eased as recession fears have picked up. WIRP suggests a 75 bp hike at the next meeting July 27 is 75% priced in vs. 85% at the start of last week, while 50 bp hikes at the subsequent meetings September 21 and November 2 are no longer fully priced in. Looking ahead, the swaps market is now pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak between 3.50-3.75%, down from nearly 4.0% at the start of last week. There only a few scheduled Fed speakers this week but all should sound hawkish. Daly speaks Tuesday. Powell, Mester, and Bullard speak Wednesday.
It’s worth noting that tightening expectations have softened for most major central banks. The slowdown is not just being felt in the U.S., but also in the eurozone and the U.K. Both ECB and BOE tightening expectations have been pared back too (see below) and so the 2-year differentials with the U.S. are moving back in the dollar’s favor. We are not yet near the recent cycle peaks but we’ll eventually get there. Why? Simply put, the U.S. economy went into this period of elevated risks in a much stronger position than the eurozone, U.K., and Japan. As such, the U.S. is likely to prove more resilient and the Fed more willing to tighten policy more aggressively.
We get some major June PMI readings this week. Chicago PMI will be reported Thursday and is expected at 58.0 vs. 60.3 in May. ISM manufacturing PMI will be reported Friday and is expected at 54.7 vs. 56.1 in May. Keep an eye on employment and prices paid, which stood at 49.6 and 82.2 in May, respectively. There are downside risks to this week’s PMI readings after S&P Global last week reported weak flash PMI readings for June. Manufacturing came in at 52.4 vs. 56.0 expected and 57.0 in May, services came in at 51.6 vs. 53.3 expected and 53.4 in May, and the composite came in at 51.2 vs. 53.0 expected and 53.6 in May. That composite was the lowest since July 2020 and has fed into U.S. recession fears.
Regional Fed manufacturing surveys for June will wrap up. Dallas Fed reports Monday and is expected at -6.5 vs. -7.3 in May. Richmond then reports Tuesday and is expected at -5 vs. -9 in May. So far, Empire survey has come in at -1.2 vs. -11.6 in May, Philly Fed has come in at -3.3 vs. 2.6 in May, and Kansas City has come in at 12 vs. 23 in May. Manufacturing still seems to be suffering from supply chain issues but now has to contend with a possible slowdown in demand. Stay tuned.
May core PCE Thursday will be closely watched. It is expected to fall a tick to 4.8% y/y. If so, it would be the third straight month of deceleration from the 5.3% peak in February and would help take some pressure off of the Fed. That said, it is nowhere near the 2% target and so the Fed is likely to continue hiking aggressively in H2. Personal income and spending will be reported at the same time and are expected to rise 0.5% m/m and 0.4% m/m, respectively.
Other important data will give a clearer picture of the U.S. economy. May durable goods orders will be reported Monday and are expected at 0.2% m/m vs. 0.5% in April. Pending home sales will also be reported Monday and are expected at -3.9% m/m vs. -3.9% in April. Advance goods trade, wholesale and retail inventories, April S&P CoreLogic house price index, and June Conference Board consumer confidence (100.0 expected) will be reported Tuesday. Final Q1 GDP revision will be reported Wednesday. Weekly jobless claims will be reported Thursday. May construction spending (0.4% m/m expected) and June auto sales (13.4 mln annualized expected) will be reported Friday.
June eurozone CPI readings take center stage. Germany and Spain report Wednesday. For both of these two, EU Harmonized inflation is expected at 8.8% y/y and would be an acceleration from May. France reports Thursday and its EU Harmonized inflation is expected at 6.5% y/y vs. 5.8% in May. Italy reports Friday and its EU Harmonized inflation is expected at 8.0% y/y vs. 7.3% in May. Eurozone also reports CPI Friday. Headline is expected at 8.5% y/y vvs.8.1% in May, while core is expected at 3.9% y/y vs. 3.8% in May. Eurozone reports May M3 data Wednesday.
Final eurozone manufacturing PMI readings will be reported Friday. Last week’s flash readings were disappointingly weak, with headline eurozone manufacturing coming in at 52.0 vs. 54.6 in May. Both German and France manufacturing PMIs fell close to three full points from May. Italy and Spain report for the first time and are expected at 50.5 and 52.1, respectively. If so, both would represent drops of around one and a half points.
ECB tightening expectations have softened. WIRP suggests a 25 bp hike July 21 is fully priced in. Then, 50 bp hikes are no longer fully priced in for the subsequent three meetings on September 8, October 27, and December 15 and so the deposit rate is seen near 1.0% at year-end vs. 1.25% at the start of last week. Looking ahead, the swaps market is now pricing in 225-250 bp of tightening over the next 24 months that would see the deposit rate peak between 1.75-2.0% vs. 2.25% at the start of last week.
Many ECB speakers are scheduled this week. Most are centered around the ECB forum in Sintra, Portugal. Villeroy and Lagarde speak Monday. Lagarde, Lane, Elderson, and Panetta speak Tuesday. Guindos, Schnabel, and Lagarde speak Wednesday.
Germany has a busy week. July GfK consumer confidence will be reported Tuesday and is expected at -27.3 vs. -26.0 in June. June unemployment will be reported Thursday and is expected to remain steady at 5.0%. It also reports May retail sales Thursday, which are expected at 1.0% m/m vs. -5.4% in April. Elsewhere, Italy reports April industrial sales Tuesday. Spain reports May retail sales Wednesday and are expected at 2.0% y/y vs. 1.5% in April. France reports May consumer spending Thursday and is expected at 0.2% m/ vs. -0.4% in April.
Bank of England expectations have eased after the weak data. WIRP suggests a 50 bp hike move at the August 4 meeting is nearly 75% priced in vs. 95% at the start of last week, and no longer fully priced in for the subsequent meetings September 15 and November 3. Looking ahead, the swaps market is now pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%, down from nearly 3.75% at the start of last week. Cunliffe speaks Tuesday, followed by Bailey Wednesday. Otherwise, the U.K. has a fairly quiet week. Final Q1 GDP data will be reported Thursday. May consumer credit and final June manufacturing PMI will be reported Friday.
The Riksbank meets Thursday and is expected to hike rates 50 bp to 0.75%. WIRP suggests nearly 50% odds of a 75 bp move. At the last meeting April 28, it delivered a surprise 25 bp rate hike. The Riksbank said then that it expects another two or three more hikes this year and also announced a slower pace of asset purchases in H2. The bank raised its inflation forecasts significantly and adjusted its expected rate path upward to imply another 25 bp hike to 0.5% in Q3 22, three more hikes to 1.25% by Q2 23, and one more hike to 1.5% by Q2 24. It sees the policy rates “somewhat below 2%” in three years’ time. Since then, the inflation outlook has worsened and this has been picked up by the swaps market, which is pricing in 300 bp of tightening over the next 12 months that would see the policy rate peak near 3.25% vs. 3.0% at the start of last week and 2.5% right after the April hike. The Riksbank’s expected rate path should move much closer to market pricing.
Japan reports some key data. May retail sales and June consumer confidence will be reported Wednesday. Sales are expected at 1.0% m/m vs. 1.0% in April, which would push the y/y up to 4.0% vs. 3.1% in April. May IP and housing starts will be reported Thursday, with IP expected at -0.3% m/m vs. -1.5% in April. June Tokyo CPI will be reported Friday. Headline is expected at 2.5% y/y vs. 2.4% in May, while core (ex-fresh food) is expected at 2.1% y/y vs. 1.9% in May. Lastly, core ex-energy is expected at 1.0% y/y vs. 0.9% in May. While price pressures are the highest in years, Japan’s inflation is still much lower than what is being seen in the rest of the world. For now, the Bank of Japan is going nowhere fast.
Q2 Tankan survey will be reported Friday. Large manufacturing index is expected to fall a point to 13, while large non-manufacturing index is expected to rise four points to 13. Large manufacturing outlook is expected to rise four points to 13, while large non-manufacturing outlook is expected to rise nine points to 16. Lastly, all-industry capex is expected at 8.3% vs. 2.2% in Q1. Overall, the economy continues to recover but we know that BOJ is wary of removing accommodation too soon. For now, it’s steady as she goes.