The Fed is expected to hike rates 50 bp to 1.5% when the 2-day FOMC meeting ends Wednesday; U.S. yields continue to rise; the rise in short-end U.S. yields reflects significantly higher Fed tightening expectations; May PPI will be reported Tuesday; May retail sales will be reported Wednesday; June regional Fed manufacturing surveys start rolling out
The BOE is expected to hike rates 25 bp to 1.25% when its meeting ends Thursday; monthly U.K. data dump begins Monday; Brexit will remain in the headlines; markets are still digesting last week’s ECB decision; ECB tightening expectations have picked up and yet the euro is weaker; the SNB is expected to keep rates steady at -0.75% Thursday; Sweden reports May CPI Tuesday
The BOJ is expected to keep all policy settings unchanged when its 2-day meeting ends Friday; Japan reports some key data as well; Australia highlight is May jobs data Thursday
The Fed is expected to hike rates 50 bp to 1.5% when 2-day FOMC meeting ends Wednesday. New macro forecasts and Dot Plots will be released. We fully expect a hawkish tilt in the Dot Plots that will be justified by significantly higher inflation forecasts. We note that some banks are raising their Fed calls for a 75 bp move, one for as early as this week. Is 75 bp possible? Sure, but we think it's unlikely as there is likely to be a very high bar after the Fed already flagged 50 bp moves for June and July. Have things really worsened that much? We say not really. A three tick miss on headline CPI? Not a great development but hardly a disaster. Plus, core inflation decelerated for the second straight month, albeit less than expected.
U.S. yields continue to rise. The 10-year yield traded near 3.18% Friday, up from last month’s low near 2.70% but just shy of the May 9 peak near 3.20%. As a result, the real 10-year yield rose to 0.37%, the highest since June 2019. Elsewhere, the 2-year yield traded at a new cycle high near 3.06% Friday, up from last month’s low near 2.44% and well above the previous peak May 4 near 2.85%. The 2-year differential with Germany has recovered to 209 bp after falling to 197 bp last week, the lowest since the end of February, while the 2-year gap with Japan has risen to a new cycle high near 314 bp, the highest since October 2007. 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 best relative to its DM peers, the dollar uptrend remains intact.
The rise in short-end U.S. yields reflects significantly higher Fed tightening expectations. WIRP suggests 50 bp hikes are now fully priced in for June, July, September, and November. There are low odds (~25-30%) of 75 bp at all of these meetings. What's even more noteworthy is that a 50 bp move in December is now nearly 85% priced in. Looking further ahead, the swaps market is now pricing in a terminal rate just above 3.75%, which is slightly higher than the peak from early May. This was the risk if inflation were to remain persistent and that's what we are seeing.
May PPI will be reported Tuesday. Headline is expected at 10.8% y/y vs. 11.0% in April, while core is expected at 8.6% y/y vs. 8.8% in April. Last week, headline CPI came in at 8.6% y/y vs. 8.3% expected and actual in April, while core came in at 6.0% y/y vs. 5.9% expected and 6.2% in April. As such there are upside risks to the PPI. The inflation data come during the Fed's media blackout period and so we are left waiting for Powell's post-decision press conference for the next clues to Fed policy. While there are some rays of hope regarding inflation, it’s way too early to get excited and the Fed still has a long road ahead in terms of tightening.
May retail sales will be reported Wednesday. Headline sales are expected at 0.1% m/m vs. 0.9% in April, sales ex-autos are expected at 0.7% m/m vs. 0.6% in April, and the so-called control group used for GDP calculations is expected at 0.3% m/m vs. 1.0% in April. Sales have surprised to the upside for several months as so far, consumption has held up in the face of rising inflation and falling real wages. Indeed, the graph below shows how retail sales have accelerated well beyond the pre-pandemic pace. Can this be sustained? Stay tuned.
June regional Fed manufacturing surveys start rolling out. Empire survey starts things off Wednesday and is expected at 3.0 vs. -11.6 in May. Philly Fed reports Thursday and is expected at 5.0 vs. 2.6 in May. May IP will be reported Friday and is expected at 0.4% m/m vs. 1.1% in April. Despite the weak Fed surveys for May, the manufacturing sector remains in solid shape.
Other minor data will be reported. May import/export prices, April business inventories, June NAHB housing market index, and April TIC data will all be reported Wednesday. May building permits, housing starts, and weekly jobless claims will be reported Thursday. May leading index will be reported Friday. There is no doubt that the housing sector is slowing but that’s exactly what the Fed hopes to accomplish.
The Bank of England is expected to hike rates 25 bp to 1.25% when its meeting ends Thursday. There won’t be updated macro forecasts until the next meeting August 4. WIRP suggests over 55% odds of a 50 bp move. In addition, odds of a 50 bp move at the August 4 and November 3 meetings have risen. The swaps market is now pricing in 250 bp of tightening over the next 12 months that would see the policy rate peak around 3.5% vs. 2.5% in late May. Yet despite the heightened expectations, sterling remains under pressure. Last week’s break below $1.2350 sets up a test of the May 13 low near $1.2155. After that is the May 2020 low near $1.2075. After that, there aren’t any major chart points until the March 2020 low near $1.1410.
Monthly U.K. data dump begins Monday. April GDP, IP, services, construction output, and trade will all be reported Monday. GDP is expected at 0.1% m/m vs. -0.1% in March, IP is expected at 0.3% vs. -0.2% in March, services is expected at 0.1% m/m vs. -0.2% in March, and construction is expected at -0.5% m/m vs. 1.7% in March. May labor market data will be reported Tuesday. Unemployment is expected to drop a tick to 3.6%, driven by an expected 108k rise in employment for the three months ending in April. May retail sales will be reported Friday. Headline sales are expected at -0.6% m/m vs. 1.4% in March, while sales ex-auto fuel are expected at -0.9% vs. 1.4% in March. Any further weakness in the data would add to sterling selling pressures.
Brexit will remain in the headlines. Last week, reports suggested the U.K. government will move ahead with planned legislation Monday that would allow it to unilaterally rewrite the Brexit agreement. This will be done with the hopes of passage in the House of Commons before Parliament adjourns at the end of July. The EU is likely to respond swiftly with retaliatory tariffs. A potential trade war with its largest trading partner is another reason we remain negative on sterling.
Markets are still digesting last week’s ECB decision. ECB tightening expectations have picked up. WIRP suggests a 25 bp hike July 21 is fully priced in. Then, 50 bp is now nearly priced in for two of the three meetings on September 8, October 27, and December 15 that would take the deposit rate to near 1.0% by year-end. Looking ahead, the swaps market is now pricing in 250 bp of tightening over the next 12 months that would see the deposit rate peak near 2.0% vs. 1.75% before the meeting. Here too, Fed expectations have offset ECB expectations and the euro remains soft. Last week’s break below $1.2350 sets up a test of the May 13 low near $1.2155. After that is the May 2020 low near $1.2075. After that, there aren’t any major chart points until the March 2020 low near $1.1410.
ECB tightening expectations have picked up and yet the euro is weaker. It’s not just the Fed. We think the rising risks of fragmentation are a major factor behind subsequent euro weakness. Markets were very disappointed by the lack of any concrete measures to address peripheral spreads, which are making new cycle highs as a result. Reports had hinted at some sort of new emergency bond-buying program but all we got was a pledge to use PEPP reinvestments to address the issue. That wasn't enough and so the euro is plumbing new depths. We may see some attempts at damage control but the ECB blew its chance last week to make a stronger statement. It's a quiet data week for the eurozone. Germany reports June ZEW survey Tuesday. April eurozone IP and trade data will be reported Wednesday.
The Swiss National Bank is expected to keep rates steady at -0.75% Thursday. One major bank has called for a 25 bp hike but most observers have penciled in September for liftoff. It’s a close call as inflation is running above target, which will likely lead to significant upward revisions to the SNB’s forecasts. However, Switzerland is not facing the type of price pressures that the U.S. and eurozone are. Indeed, it’s closer to Japan and we all know that the BOJ is in no hurry to remove accommodation. For now, we expect this to be a placeholder meeting but the September one is likely to be live. The swaps market is pricing over 200 bp of tightening over the next 12 months that would see the policy rate peak between 1.25-1.50%.
Sweden reports May CPI Tuesday. Headline inflation is expected at 7.0% y/y vs. 6.4% in April, CPIF is expected at 7.0% y/y vs. 6.4% in April, and CPIF excluding energy is expected at 5.2% y/y vs. 4.5% in April. If so, targeted CPIF would be the highest since December 1991 and further above the 2% target. The Riksbank surprised markets with a 25 bp hike at the last meeting April 28. At that meeting, the Riksbank said 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. Contrast this rather modest path with the swaps market, which is pricing in 250 bp of tightening over the next 12 months followed by another 50 bp over the subsequent 12 months that would see the policy rate peak near 3.25% vs. 2.5% right after the April meeting. Next meeting is June 30 and another 25 bp hike seems likely.
The Bank of Japan is expected to keep all policy settings unchanged when its 2-day meeting ends Friday. Updated macro forecasts won’t be released until the next meeting July 21. While the bank is unlikely to signal any shift in its monetary stance this week, officials may express some concern about renewed weakness in the yen. Yet as long as the BOJ remains ultra-dovish, the exchange rate will continue to weaken. Jawboning is all we are likely to see for now as any FX intervention would be going against the fundamentals and so likely doomed to failure.
Japan reports some key data as well. Q2 BSI business conditions survey will be released Monday. April core machine orders will be reported Wednesday and are expected at 5.2% y/y vs. 7.6% in March. These and machine tool orders have been slowing and this trend is likely to show up in the export data as well. Here, May trade data will be reported Thursday. Exports are expected at 16.3% y/y vs. 12.5% in April while imports are expected at 43.7% y/y vs. 28.3% in April.
Australia highlight is May jobs data Thursday. 25.0k jobs are expected vs. 4.0k in April, while the unemployment rate is seen falling a tick to 3.8%, a new cycle low. The RBA has expressed concerns about rising wage pressures when this rate falls below 4.0% and so it will be on high alert. WIRP suggests a 50 bp hike is nearly 80% priced in for the next meeting July 5. Looking ahead, the swaps market is pricing in 325 bp of tightening over the next 24 months that would see the policy rate peak above 4.0%. Yet AUD continues to weaken and a break below .70 would set up a test of the May 12 low near .6830. Ahead of the jobs data, May household spending and NAB business conditions survey will be reported Tuesday. June Westpac consumer confidence will be reported Wednesday.