U.S. yields are moving higher; there is a heavy slate of U.S. Treasury issuance; Canada reports April trade and May Ivey PMI; Chile is expected to hike rates from 8.25% currently
U.K. Prime Minister Johnson survived the no confidence vote; reports suggest ECB policymakers remain very concerned about peripheral spreads; Germany reported very weak data; Turkey President Erdogan is showing no inclination to let the central bank hike rates
Japan reported weak April household spending and cash earnings data; RBA delivered a hawkish surprise with a 50 bp hike to 0.85% vs. 25 bp expected; incoming Philippines central bank Governor Medalla signaled further tightening ahead

The dollar is building on its recent gains. DXY is up for the second straight day and traded at the highest level since May 23 near 102834. The euro is down for the third straight day and trading below $1.07 despite market expectations for a more hawkish ECB. The weakening trend in the yen has reasserted itself as USD/JPY is trading at a new high for this cycle near 133. We maintain our long-standing target of the January 2002 high near 135.15. Sterling is underperforming today and trading below $1.25 after Johnson narrowly survived the no confidence vote (see below). We look for continued underperformance from ongoing political and economic risks that should push the EUR/GBP cross higher. We still view this recent move lower in the dollar as a correction within the longer-term dollar rally and are heartened by the recent bounce. That said, we acknowledge that further gains will likely be slow until the market pessimism on the U.S. economic outlook improves further.

AMERICAS

U.S. yields are moving higher. The 10-year yield traded as high as 3.06% today, up from last month’s low near 2.70% but still below the May 9 peak near 3.20%. It is currently near 3.02%. Elsewhere, the 2-year yield traded as high as 2.75% today, up from last month’s low near 2.44% but still below the May 4 peak near 2.85%. It is currently near 2.72%. The 2-year differential with Germany has risen to 205 bp after briefly touching 200 bp, the lowest since the end of February, while the gap with Japan has risen back to 279 bp, just shy of the May 3 high near 283 bp. Much of this divergence hinges on the underlying relative monetary policy divergences as the ECB pivots more hawkish and the BOJ remains ultra-dovish. However, we believe the Fed will out-hawk them all and so the dollar uptrend should remain intact.

There is a heavy slate of U.S. Treasury issuance. $44 bln of 3-year notes will be sold today, followed by $33 bln of 10-year notes Wednesday and $19 bln of 30-year bonds Thursday. At the last 3-year auction, indirect bidders took 62.0% while the bid/cover ratio was 2.59. Will investors be lured in by the higher yields, or will they wait for yields to move even higher before buying? Stay tuned. In terms of U.S. data, only April trade (-$89.5 bln expected) and consumer credit ($35.0 bln expected) will be reported.

Canada reports April trade and May Ivey PMI. With the economy firm, the Bank of Canada will continue tightening. WIRP suggests 50 bp hikes are fully priced in for June, July, and October. 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 3.50%, up from 3.0% at the start of last week. High oil prices and a hawkish BOC are likely to help CAD continue outperforming. It is the only major currency up YTD vs. USD, albeit by a modest 0.4%.

Chile central bank is expected to hike rates from 8.25% currently. Analysts polled by Bloomberg are evenly split between a 75 or 100 bp move. Chile also reports May trade data Tuesday. May CPI will be reported Wednesday, with headline expected at 11.4% y/y vs. 10.5% in April. If so, it would be the highest since July 1994 and further above the 2-4% target range. As such, we see risks of a hawkish surprise. Looking ahead, the swaps market is pricing in 150 bp of tightening over the next 3 months that would see the policy rate peak near 9.75%, followed by the start of an easing cycle in the subsequent 3 months.

EUROPE/MIDDLE EAST/AFRICA

U.K. Prime Minister Johnson survived the no confidence vote. The final tally was 211-148, meaning the margin of victory (63) was even slimmer than it was for former Prime Minister Theresa May (83), who survived the no confidence vote but was forced to step down six months later. As a result, we think political risk remains high. Going forward, much will depend on whether opposition Labour will be able to capitalize on rising popular discontent with the Tories. One weekend poll suggests Labour is ahead by 20 percentage points in the upcoming special election in Wakefield June 23. Other polls suggest the Tories will lose a special election in Tiverton and Honiton to be held that same day to the Liberal Democrats.

Final U.K. May services and composite PMIs were reported. The two improved from the preliminary readings to 53.4 and 53.1, respectively. However, the slowing trend remains intact as the composite PMI still fell to the lowest since February 2021. It’s only going to get worse. Sterling remains heavy and is likely to continue underperforming on the mix of poor economic fundamentals and ongoing political risk. Cable traded as low as $1.2430 today but has since staged a modest comeback. Break below $1.2350 is needed to set up a test of the May 13 low near $1.2155.

Reports suggest ECB policymakers remain very concerned about peripheral spreads. Yesterday, the FT reported that the ECB will firm up plans for a new bond-buying program this week. This has been previously reported back in April. Today, reports are that ECB policymakers will ask President Lagarde to use stronger language this week to signal that so-called fragmentation will be resisted and that peripheral borrowing costs will be contained. This would be a far cry from one of her earliest pronouncements back in March 2020 that “We are not here to close spreads.” Still, it’s not clear if a concrete plan will be announced at this week’s meeting but the timing would be ideal since the bank is widely expected to announce an end to QE Thursday. Stay tuned.

Germany reported very weak data. German April factory orders plunged -2.7% m/m vs. 0.4% expected and a revised -4.2% (was -4.7%) in March. As a result, the y/y rate fell to -6.2% y/y vs. -4.1% expected and a revised -2.9% (was -3.1%) in March. IP will be reported tomorrow and is expected at 1.2% m/m vs. -3.9% in March. However, there are clearly downside risks here. Elsewhere, Spain April IP came in at 2.1% m/m vs. 0.5% expected and a revised -2.0% (was -1.8% in March), while the y/y rate came in at 2.4% vs. -0.1% expected and a revised 0.0% (was 0.1%) in March. Germany is the engine of the eurozone and it’s clear from the monthly data that activity was already slowing as we entered Q2 and is likely to get even worse. A hawkish ECB message this week will most likely be undermined by deteriorating economic fundamentals.

Turkey President Erdogan is showing no inclination to let the central bank hike rates. Specifically, he said “This government will not raise interest rates. We will continue cutting them.” Yet this policy stance is unsustainable. Inflation is running over ten times the upper limit of its 3-7% target band, while the so-called twin deficits are growing. Those deficits need to be financed in part by foreign money but the government’s policies won’t attract any inflows. Next policy meeting is June 23. If the central bank does not hike rate soon, the current situation is likely to morph into a full-blown balance of payments crisis that leads to a significantly weaker lira. As it is, USD/TRY is slowly but surely approaching its all-time high near 18.3635.

ASIA

Japan reported weak April household spending and cash earnings data. Nominal earnings rose 1.7% y/y vs. 1.5% expected and a revised 2.0% (was 1.2%) in March, while real earnings fell -1.2% y/y vs. -1.6% expected and a revised 0.6% (was -0.2%) in March. No wonder household spending remained weak at -1.7% y/y vs. -0.6% expected and -2.3% in March. With no wage pressures to speak of, the Bank of Japan has made it clear it will maintain its loose policy settings for the time being. The monetary policy divergences will continue to widen and that should lead to continued yen weakness. Governor Kuroda walked back his comments yesterday regarding greater tolerance on the part of consumers to accept higher prices, noting “I didn’t necessarily say it in an appropriate way.” Officials have the tricky task of explaining exactly why exiting years of deflation should be welcome. April leading and coincident indexes were also reported.

Reserve Bank of Australia delivered a hawkish surprise with a 50 bp hike to 0.85% vs. 25 bp expected. The RBA statement said “The Board expects to take further steps in the process of normalizing monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labor market.” WIRP suggests around 40% odds of a 50 bp move at the next meeting July 5, which strikes us as way too low in light of the RBA’s hawkish pivot. New macro forecasts won’t be released until the August 2 meeting, when December 2024 will be added to the forecast horizon. Looking ahead, the swaps market is pricing in 350 bp of tightening over the next 12 months that would see the policy rate peak near 4.25%, up from 3.25% at the start of last week. Yet AUD feels heavy. The currency initially jumped to .7245 after the decision but ran out of steam ahead of the 200-day moving average near .7255. A close today below yesterday’s low near .7185 would result in an outside down day that signals further losses ahead.

Incoming Philippines central bank Governor Medalla signaled further tightening ahead. Specifically, he said “It’s almost a sure thing to everyone that we will raise in June,” adding there is a “90% chance there’s another one in August. The real question is: is that the last one?” He didn’t seem concerned about peso weakness, noting that “Transmission of peso-dollar rate to inflation is quite low.” Medalla takes over from outgoing Governor Diokno July 1. Next policy meetings are June 23 and August 18. With headline inflation running at 5.4% and rising, we very much doubt that the bank stops hiking in August after it just started the cycle May 19 with a 25 bp hike to 2.25%. Indeed, the swaps market is pricing in 150-175 bp of tightening over the next 12 months that would see the policy rate peak between 3.75-4.0%.