- U.S. core PCE has taken on greater importance as the inflation debate rages; May Chicago PMI will be reported and there are upside risks to the consensus 68.0; weekly jobless claims data are worth a mention
- Eurozone data today were mixed; markets are coming around to our long-held view that the ECB’s accelerated PEPP pace will be extended at the June 10 meeting; the Turkish lira has weakened to a new record low
- Japan reported April labor market data and May Tokyo CPI; the Suga government was forced to extend virus restrictions as numbers remain high; data show nine of Japan’s largest life insurers lowered their dollar hedging ratios to a record low in March
The dollar is up modestly ahead of key U.S. data today. DXY is trading sideways just above 90. The euro feels heavy and trading below $1.22 after a brief poke above yesterday, while sterling is trading just below $1.42 after a brief poke above today. USD/JPY is trading at the highest level since April 9 just below 110 and is on track to test the March 31 high near 111. Until we see stronger U.S. data and higher U.S. rates (both real and nominal), the greenback is likely to remain vulnerable to further selling. The 10-year yield has inched up to 1.61% currently, while the breakeven inflation rate is flat at 2.44%, pushing the real yield up to -0.83%.
U.S. core PCE has taken on greater importance as the inflation debate rages. It is expected to rise 2.9% y/y vs. 1.8% in March. If so, this would be the highest since August 1992 and above the Fed’s 2% target for the first time since December 2018. Of note, core PCE has not been above 2% on a sustained basis since the 2004-2008 period, when the Fed was tightening aggressively. Is this current spike temporary? Only time will tell but an upside surprise here would certainly get the bond market’s attention. Personal income and spending will be reported at the same time and are expected at -14.2% m/m and 0.5% m/m, respectively.
May Chicago PMI will be reported and there are upside risks to the consensus 68.0. Why? Last Friday, the preliminary Markit composite PMI rose to 68.1 from 63.5 in April. This rise was driven by a huge jump in services to 70.1 from 64.7 in April. Manufacturing also rose a point to 61.5. The market puts more weight on the ISM PMIs, which will be reported next week. April advance goods trade (-$92.0 bln), wholesale and retail inventories, and final May University of Michigan consumer sentiment (83.0 expected) will also be reported.
Weekly jobless claims data are worth a mention. Initial claims fell to 406k vs. 425k expected and 444k the previous week, which was another new low for the pandemic. Elsewhere, continuing claims fell to 3.642 mln vs. 3.68 mln expected and a revised 3.738 mln (was 3.751 mln) the previous week, which pretty much matches the pandemic low. Continuing claims are reported with a 1-weeklag and so this week’s reading was for the BLS survey week containing the 12th of the month. The drop in both initial and continuing claims point to a solid NFP number for May, with consensus currently at 663k vs. 266k in April. Obviously, this is subject to change as new clues come in but has already crept higher from 620k at the start of the week. It’s clear from the April jobs report that the improvement in the U.S. labor market has entered into an uneven and unpredictable phase, but a 663k gain would go a long way in reassuring markets that the U.S. recovery continues.
Eurozone data today were mixed. France reported preliminary May CPI and April consumer spending data. EU Harmonized inflation picked up two ticks to 1.8% y/y, as expected, but spending plunged -8.3% m/m vs. -4.0% expected and a revised -0.3% (was -1.1%) in March. On the other hand, Spain also reported April retail sales and rose 41.0% y/y vs. 29.1% expected and a revised 14.3% (was 14.9%) in March. For the entire eurozone, May CPI (1.9% y/y expected) will be reported June 1 and April retail sales (-0.8% m/m expected) will be reported June 4. The ECB has made it clear that it views the current rise in inflation as temporary and requires no policy response.
Indeed, markets are coming around to our long-held view that the ECB’s accelerated PEPP pace will be extended at the June 10 meeting. Several major banks are calling for an extension now, reversing previous calls for tapering. It’s clear from the dovish chorus of ECB policymakers this past week that a consensus is building for extension. Today, ECB board member Schnabel said higher yields are a “natural development at a turning point in the recovery” but also warned that premature withdrawal of monetary or fiscal support would be a mistake. That said, we think ECB purchases will be driven largely by market conditions. Eurozone yields are mostly lower over the past week or so, with Italy 10-year at 0.93% vs. the 1.12% peak May 19. This may remove the near-term urgency but the ECB should nevertheless signal that it is planning to continue buying at an accelerated pace as needed.
The Turkish lira has weakened to a new record low. There are no real development behind the move up in USD/TRY to almost 8.60, just the usual mix of high inflation and low confidence in policymaking. Of note, the reshuffle at the central bank continues. After Deputy Governor Ozbas was replaced earlier this week, other key staff have reportedly also been shuffled. The Executive Directors of the banking, research and statistics departments were among those said to have been replaced, along with other in the budget and legal departments. We don’t have any special insight to form a view on whether this means an important shift in policy, but such wholesale changes at very senior technocratic positions does not bode well. That said, a rate cut at the next policy meeting June 17 seems unlikely with the lira still vulnerable.
Japan reported April labor market data and May Tokyo CPI. Unemployment rose two ticks to 2.8%, while the job-to-applicant ratio fell a tick to 1.09, both worse than expected. Elsewhere, headline CPI picked up two ticks to -0.4% y/y, while core (ex-fresh food) was steady at -0.2% y/y, both close to consensus. May national CPI will be reported June 18. Overall, the Japanese support the view that deflation pressures persist even as headwinds to the economy build. Indeed, the May drop in the composite PMI below 50 will heighten fears that GDP contracted again in Q2 due to the widening lockdowns. Bloomberg consensus currently sees 2.5% q/q growth in Q2 but that seems too optimistic in light of the extended restrictions.
As expected, the Suga government was forced to extend virus restrictions as numbers remain high. Economy Minister Nishimura said Friday the state of emergency due to end May 31 would be extended to June 20. States of emergency have been declared in Tokyo, Osaka, and seven other prefectures that together account for about half of the economy. Prime Minister Suga will make the official announcement later today. The BOJ is on hold for now but we still expect another fiscal package over the summer as the economy slumps and Suga’s popularity wanes ahead of October elections.
Data show nine of Japan’s largest life insurers lowered their dollar hedging ratios to a record low in March. Dollar sales via forward contracts covered 42.1% of the life insurers’ dollar-denominated assets totaling JPY40.2 trln ($365.8 bln) as of March 31, the lowest according to Bloomberg data going back to March 2010. Of note, total foreign assets of the nine firms amounted to JPY65.2 trln at the end of March. U.S. assets accounted for 61.6% of the total, while 18.4% were euro-denominated and about 10% were AUD-denominated. Since the end of March, the dollar has weakened 1% vs. the yen while three-month hedging costs have fallen around 8 bp to a record low 27 bp, according to Bloomberg. As such, we suspect the hedge ratios may have turned a bit higher in Q2.