- US inflation data will remain in focus; heavy US Treasury issuance this week concludes with a $27 bln sale of 30-year bonds; weekly jobless claims data may take on more importance after the big miss for April; Mexico, Chile, and Peru are all expected to keep rates steady
- BOE Chief Economist Haldane remains very bullish on the U.K. outlook; U.K. rates markets are still adjusting to the BOE’s tapering announcement at last week’s meeting.
- Japan March current account data were reported; Chinese officials are turning up the pressure on speculative forces behind the commodity boom’ Elon Musk triggered a Bitcoin rout after stating that Tesla will stop accepting Bitcoin over concerns about the environmental impact from mining
Yesterday’s much higher-than-expected inflation print provided yet another negative catalyst for already fragile markets. Implied volatility rose sharply in equity markets and to a lesser extent in fixed income markets. The VIX nearly doubled since late last week, spiking to 28 and well above its 1-year average. The MOVE index for U.S. fixed income is at 58.5, up from a recent low of 54 but well below the highs of 75 seen earlier in the year. FX implied vol has been best behaved, little changed over the last couple of sessions. We suspect it will pick up was well, as the inflation debate is not going away anytime soon.
The dollar continues to firm ahead of the PPI data. DXY is up for the second day after four straight down days and is trading at the highest level since May 7 near 90.90. A clean break of this area would set up a test of the May 5 high near 91.436. The euro is trading heavy below $1.21 and clean break of $1.2060 would set up a test of the May 5 low near $1.1985. Sterling is trading above $1.40 and a break below $1.3940 would set up a test of the May 3 low near $1.38. Lastly, USD/JPY has finally broken higher to trade at the highest level since April 9 near 109.80 before falling back slightly. A clean break of the 109.65 area would set up a test of the March 31 high near 111. In order for this dollar rally to have legs, we need a further rise in U.S. yields.
US inflation data will remain in focus. April PPI will be reported, with headline expected at 5.8% y/y vs. 4.2% in March and core expected at 3.8% y/y vs. 3.1% in March. Yesterday, April CPI came in much higher than expected, with headline at 4.2% y/y vs. 3.6% consensus and 2.6% in March and core at 3.0% y/y vs. 2.3% consensus and 1.6% in March. As such, there are clearly upside risks to the PPI data today. Some acceleration in all the inflation readings is to be expected due to low base effects that will boost y/y readings in March, April, and May. However, the m/m gains in headline and core CPI were an outsized 0.8% and 0.9%, respectively. If sustained, this will be a direct challenge to the Fed’s narrative that inflation will be temporary. The Fed’s position is further complicated by its stated focus on labor market, which so far seems to be lagging the recovery somewhat. Governor Brainard defended the bank’s position by arguing that pandemic-related price increases is unlikely to durably change inflation dynamics, but the situation remains tense, to say the least. Barkin, Waller, and Bullard speak today.
Bond markets reacted accordingly. The US 10-year yield of 1.70% is the highest since April 13 and on track to test the March 30 high near 1.77%. More importantly, the 10-year inflation breakeven rate is trading near 2.58% and is pushing the real yield up -0.86%, the highest since March 4. If this rise in real yields continues, the dollar should get more traction. The U.S. yield resumed its steepening trend, with the 3-month to 10-year spread near 170 bp and the 2- to 10-year spread around at 154 bp, nearing but still a bit short of the cycle highs from March.
Heavy US Treasury issuance this week concludes with a $27 bln sale of 30-year bonds. Keep an eye on the bid-to-cover ratio and indirect bidders (mostly foreign demand). At the last 30-year auction, these demand metrics came in at 2.47 and 61.0%, respectively. Yesterday’s $41 bln sale of 10-year notes went well as the yield was basically flat at 1.684% from 1.680% previously. The bid-to-cover ratio rose to 2.45 from 2.36 at the previous auction, while indirect bidders took 63.4% vs. 59.6%, respectively. In a rising rate environment, the firm demand for USTs is noteworthy.
Weekly jobless claims data may take on more importance after the big miss for April. Or they may take on less, since the claims data for the April BLS survey week suggested another blockbuster NFP number. For what it’s worth, initial claims are expected at 490k vs. 498k last week and continuing claims are expected at 3.65 mln vs. 3.69 mln last week. The weekly data continue to show ongoing improvement in the labor market, but the April jobs data serves as a reminder that it’s not all moving in a straight line.
Banco de Mexico is expected to keep rates steady at 4.0%. Inflation was 6.1% y/y in April, the highest since December 2017 and well above the 2-4% target range. After the last 25 bp cut back in February, Deputy Governor Esquivel left the door open to 1-2 more cuts this year. The bank sounded less sure after a unanimous decision for steady rates at the last meeting March 25, as Governor Diaz de Leon said “We have highlighted that we need to remain data dependent.” Until the inflation trajectory improves, the bank is likely to remain on hold and we very well may have seen the end of the easing cycle.
Chile central bank is expected to keep rates steady at 0.5%. Inflation was 3.3% y/y in April, the highest since April 2020 but still within the 2-4% target range. While the central bank has warned that higher energy costs would lead to a temporary rise in inflation, it has signaled a likely end to unconventional policies. Minutes from the last meeting March 30 showed that “The time was approaching when monetary policy would once again be implemented in the traditional way.” This suggests the emergency programs of buying bank bonds and opening credit lines for financial institutions will be pared back soon, perhaps today. However, the minutes stressed that the policy rate will remain at the record low 0.5% for several more quarters to boost growth.
Peru central bank is expected to keep rates steady at 0.25%. Inflation was 2.4% y/y in April, down from 2.6% in March and further within the 1-3% target range. At the last meeting April 8, the bank saw the recent acceleration of inflation as due to “supply factors” such as food costs. It said that it still sees inflation within its target range and then moving to the lower half of that range in 2022. As such, “The Board considers it appropriate to maintain a strong expansionary monetary stance for a lengthy period and while the negative effects of the pandemic on inflation and its determinants persist.”
Bank of England Chief Economist Haldane remains very bullish on the U.K. outlook. He said the economy is set to bounce back like a “tennis ball,” with double-digit growth likely a year from now. Haldane noted that people are returning “with gusto to shops, pubs and restaurants” and sees as many new jobs being created as were lost, leading to little or no rise in unemployment. Lastly, he said that by year-end, inflation is likely to be above its 2% target and that this could be a risk factor to the boom and so “with the economy bouncing back, and with inflation risks on the rise, now is the time to start tightening the tap to avoid the risk of a future inflationary flood.” Still, it’s worth noting that Haldane is stepping down from the BOE after the next meeting June 24and so his comments carry less weight. Recall Haldane was the lone vote to decrease the BOE’s QE by GBP50 bln at the last meeting.
U.K. rates markets are still adjusting to the BOE’s tapering announcement at last week’s meeting. With the prospects of fewer BOE purchases, the 10-year gilt yield continues to rise, trading at the highest level since March 2020 near 0.92%. BOE tightening expectations have also adjusted. the short sterling futures strip suggests significant odds of the first hike in Q1 2022 and fully priced in by Q2 2022. This is of course sterling-positive, making it the second best performer YTD at 2.5% vs. USD. Still, sterling has still gotten caught up against broad-based dollar strength this week and is back testing the $1.40 area.
Japan March current account data were reported. The adjusted surplus was JPY1.7 trln vs. JPY1.9 trln expected. Of note, Japanese investors turned net buyers of US government debt to the tune of JPY1.7 trln, more than reversing net selling of -JPY618.7 bln in February. On the other hand, Japanese investors remained net sellers of Australian bonds, -JPY246.6 bln vs. -JPY643 bln in February, which was the biggest net sale on record dating back to 2005. Japanese investors remained net sellers of Italy (-JPY85.5 bln) but went back to being net buyers of Canadian bonds (JPY29.5 bln). For the entire FY2020-21, data showed that of the 13 sovereign markets tracked by MOF, the U.S. saw the largest net buying , totaling JPY3.69 trln yen. Japanese investors bought a net JPY2.75 trln ($25.1 bln) of Australian sovereign bonds and a net JPY1.81 trln of Italian bonds in FY2020-21, while net purchases of Canadian sovereign bonds came in at JPY1.71 trln.
We don’t want to read too much into the February and March data. Any selling came ahead of the end of the fiscal year and amidst a deepening global sell-off in bonds that both culminated in late March. Reports suggest that Japanese investors will once again buy higher yielding US and Australia debt in the new fiscal year but we won’t see the April current account data for another month. However, the weekly MOF data show Japan investors started to dip their toes in foreign bonds in March and this picked up significantly in April. Outward bound investment flows into U.S. bonds should help boost USD/JPY. Keep an eye on the 109.65 area. It's the 62% retracement objective from the March-April drop. We tested it back on May 3 but resistance held then. Break above it would set up a test of the March 31 high near 111.
Chinese officials are turning up the pressure on speculative forces behind the commodity boom. Among other things, this led to a nearly 10% drop in iron ore. China already increased trading limits on iron ore. Now, Premier Li Keqiang has called on new initiatives to reduce pressure from commodity prices. Despite today’s move, iron ore is still nearly 40% higher this year.
COMMODITIES AND ALTERNATIVE INVESTMENTS
Elon Musk triggered a Bitcoin rout after stating that Tesla will stop accepting Bitcoin over concerns about the environmental impact from mining. While the ESG debate about crypto currencies has intensified, the situation is very nuanced. For example, the latest study by the University of Cambridge shows that a 76% of participants in Bitcoin operations (hashers), such as miners, use renewable energies, and the share of renewables in the total energy consumption is at 39% (full report here). Moreover, it’s important to remember that bitcoin mining is in a perpetual downtrend trend due to the halving cycles, so its energy consumption will likely decline over time. Still, Bitcoin fell to $46k before rebounding back to just under $50k, as the event will surely pose a new hindrance to the institutional adoption narrative.
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