Data so far this week have helped dispel some of the U.S. recession fears; U.S. yields are moving higher as a result; ADP private sector jobs data will be today’s data highlight; the Fed Beige Book report is worth discussing; Bank of Canada hiked rates 50 bp to 1.50%, as expected
Eurozone reported April PPI; the public ECB policy debate continues; it is widely expected to announced an end to QE next week; Switzerland reported May CPI; Hungary hiked its 1-week deposit rate 30 bp to 6.75% at its weekly tender, as expected
Australia reported April trade data; Saudi Arabia is prepared to boost its oil output to make up for any sanctions-related loss from Russia

The dollar is softer ahead of ADP data. DXY is trading lower near 102.155 after two straight up days took it as high as 102.731 yesterday. The euro saw demand emerge on the approach of $1.06 but so far has been unable to mount a challenge to the $1.07 area. The weakening trend in the yen has reasserted itself as USD/JPY traded above 130 for the first time since mid-May. We look for a test of the May cycle high near 131.35 and maintain our long-standing target of the January 2002 high near 135.15. Sterling saw some demand below $1.25 but remains heavy near $1.2550 and we look for continued underperformance ahead. We still view this recent move lower in the dollar as a correction within the longer-term dollar rally but acknowledge that further gains will be slow until the market pessimism on the U.S. economic outlook improves. That process has begun but we need to see some more strength in the data.

AMERICAS

Data so far this week have helped dispel some of the U.S. recession fears. The pendulum of market sentiment may have reached an extreme negative against the U.S. and seems to be in the process of swinging back the other way. Some strong data already reported this week (Chicago PMI, ISM manufacturing PMI, JOLTS job openings) have helped boost the outlook but more strength needs to be seen.

U.S. yields are moving higher as a result. The 10-year yield is currently trading near 2.92%, up from last week’s low near 2.70% but still well below the May 9 peak near 3.20%. The real 10-year yield has recovered to 0.26% after falling as low as 0.08% last week and is nearing the May 10 high near 0.34%. Elsewhere, the 2-year yield is trading near 2.66%, up from last week’s low near 2.44% but still well below the May 4 peak near 2.85%. The 2-year differentials with Germany, Japan, and the U.K. look to have bottomed out but whether the rise in U.S. yields can be sustained will depend in large part how the rest of this week’s U.S. data come in.

ADP private sector jobs data will be today’s data highlight. It is expected at 300k vs. 247k in April. Yesterday, April JOLTS jobs openings came in at 11.4 mln vs. A revised 11.855 mln in March, which suggests labor demand remains strong. For May jobs data tomorrow, consensus sees 325k vs. 428k in April, while the unemployment rate is expected to fall a tick to 3.5%, a new cycle low that matches the pre-pandemic low. May Challenger job cuts, weekly jobless claims, and April factory orders (0.7% m/m expected) will also be reported.

The firm May ISM manufacturing PMI helped ease concerns about the U.S. economy. Headline reading came in at 56.1 vs. 55.4 in April. Most of the details were good, with new orders rising to 55.1 vs. 53.5 in April and prices paid falling to 82.2 vs. 84.6 in April. The biggest disappointment was the drop in employment to 49.6 vs. 50.9 in April, the first sub-50 reading since November 2020. However, we are not too worried about the employment component, since by all accounts there is still demand for labor. Of note, supplier deliveries fell to 65.7 vs. 67.2 in April and backlog of orders rose to 58.7 vs. 56.0 in April. The lower these numbers are, the lower the strains in the supply chains. So the fact that prices paid fell to 82.2 vs. 84.6 in April despite the mixed readings in the supply chain is certainly a good development. ISM services PMI will be reported tomorrow morning after the jobs report.

The Fed Beige Book report is worth discussing. On growth: "Four Districts explicitly noted that the pace of growth had slowed since the prior period." On the labor market: " One District explicitly reported that the pace of job growth had slowed, but some firms in most of the coastal Districts noted hiring freezes or other signs that market tightness had begun to ease." On prices: "Two Districts noted that this rapid inflation was a continuation of trend; however, three Districts observed that price increases for their own goods or services had moderated somewhat." We acknowledge that the tone was somewhat less hawkish than what we'd expect given the Fed's signal for 50 bp hikes in both June and July. However, it’s still full speed ahead for the Fed.

Indeed, Fed officials remain hawkish. Bullard said yesterday that the 50 bp rate hike path that the Fed has laid out is good for now, adding that it’s not advisable to hike rates too quickly. Bullard noted that global QT should put upward pressure on rates. This is nothing really new. While Bullard has signaled openness to a 75 bp move, it's clearly not his base case. Nor is it ours, but never say never. Logan and Mester speak today, followed by Brainard tomorrow. As of midnight tomorrow, the media blackout goes into effect and there will be no Fed speakers until Chair Powell’s post-decision press conference June 15.

Fed tightening expectations continue to adjust. WIRP suggests 50 bp is fully priced in for June and July. A third 50 bp hike for September is now over 70% priced in vs. 35% at the start of this week. After that, two more 25 bp hikes in November and December are fully priced in and a third one next February is mostly priced in that would take the Fed Funds ceiling to near 3.0% by Q1 23. However, the saps market is now pricing in one more 25 bp hike that would see the policy rate peak near 3.25%, up from 3.0% at the start of this week. The market is still pricing in the start of a tightening cycle after mid-2023 and this would only happen if the U.S. were to fall into recession next year and while it is possible, it is not our base case.

Bank of Canada hiked rates 50 bp to 1.50%, as expected. It warned rates will need to rise further and that it could be even “more forceful” if needed. The bank added that inflation is likely to move higher before eventually falling. Obviously, the forward guidance keeps the door open to a 75 bp in the future, if needed. The hawkish forward guidance cannot be ignored. WIRP suggests 50 bp hikes are fully priced in for June and July followed by 25 bp moves in September and December. Looking ahead, the swaps market is now pricing in 225 bp of tightening over the next 12 months that would see the policy rate peak near 3.75%, up from 3.0% at the start of this week. April building permits will be reported and are expected to rise 0.8% m/m vs. -9.3% in March. Like the U.S., there are growing concerns in Canada about the housing sector Of note, April existing home sales came in at -12.6% m/m vs. -5.4% in March.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported April PPI. It came in at 37.2% y/y vs. 38.6% expected and 36.8% in April. While it is tempting to say that PPI inflation is leveling out, it really is too early to say given that commodity prices remain elevated. Indeed, the lower than expected PPI reading didn’t prevent CPI readings from recording new record highs in May.

The public ECB policy debate continues. Today, Villeroy said that “Inflation is not only too high, but also too broad. This requires a normalization of monetary policy -- I say normalization and not tightening.” In the past, he has argued for a cautious pace of tightening, which we believe mirrors President Lagarde’s view and reflects current consensus. He said that the ECB meeting next week will be “decisive” in setting out its policy response. Lastly, Villeroy warned of other headwinds as “Fiscal policy will itself be further constrained by the high level of post-Covid public debt, and by the increase in interest rates. Furthermore, in the two next years, the context will be one of slower growth, or even, according to some fears, of economic stagnation.” De Cos also speaks today. Yesterday, de Cos said that “The rate increase process must be gradual and rely on data. To be gradual, it’s crucial that inflation expectations remain anchored and significant indirect or second-round effects that could put that anchoring at risk are avoided.”

The ECB is widely expected to announced an end to QE next week. There has been some chatter about a surprise rate hike but most (including us) see this as highly unlikely. Even the hawks have coalesced around July 21 liftoff, though they continue to play up the need for a 50 bp move. We think a larger move is unlikely, at least for now. However, ECB tightening expectations have picked up I light of this week’s inflation data. WIRP suggests liftoff July 21 remains fully priced in, followed by 25 bp hikes in September, October, and December. The swaps market is pricing in 225 bp of tightening over the next 24 months that would see the deposit rate peak near 1.75% vs. 1.50% at the start of this week.

Switzerland reported May CPI. Headline came in at 2.9% y/y vs. 2.6% expected and 2.5% in April, while core came in at 1.7% y/y vs. 1.6% expected and 1.5% in April. This was the highest reading for headline inflation since September 2008 and further above the 2% target. No wonder SNB officials have turned more hawkish in recent weeks, just ahead of the next policy meeting June 16. Earlier this week, SNB Vice Chairman Zurbruegg said the bank would need to act if higher inflation persists longer term. He added that he expects inflation to come down and that a large part of inflation is due to high energy prices. We believe liftoff at this month’s meeting is likely. Looking ahead, the swaps market is pricing in nearly 150 bp of tightening over the next 12 months and another 50 bp over the subsequent 24 months that would see the policy rate peak near 1.25%, up from 1.0% at the start of this week.

National Bank of Hungary hiked its 1-week deposit rate 30 bp to 6.75% at its weekly tender, as expected. This comes after the bank hiked the base rate 50 bp to 5.90%, also as expected. CPI rose 9.5% y/y in April, the highest since June 2001 and further above the 2-4% target range and so further tightening is warranted. April PPI rose 28.8% y/y vs. 25.9% in March, suggesting further upside risks to CPI. The swaps market is now pricing in nearly 120 bp of tightening over the next 12 months that would see the base rate peak near 7.10%, up from 6.75% at the start of this week. We see upside risks here as well, especially if the forint continues to weaken.

ASIA

Australia reported April trade data. Exports rose the expected 1% m/m vs. a flat reading in March, while imports fell -1% m/m vs. 1% expected and -5% in March. The y/y rates came in at 23.7% and 26.9%, respectively. Exports remain relatively firm despite the slowdown in mainland China. Recent weakness in the PMI readings is likely China-related and bears watching. For now, the economy remains robust and RBA tightening expectations have picked up. WIRP still suggests a 25 bp hike June 7 is priced in. However, the swaps market is now pricing in over 350 bp of tightening over the next 12 months that would see the policy rate peak near 4.0%, up from 3.25% at the start of this week.

COMMODITIES

Reports suggest Saudi Arabia is prepared to boost its oil output to make up for any sanctions-related loss from Russia. The FT wrote that an immediate boost to output from Saudi Arabia and UAE could be announced as soon as today’s OPEC+ meeting ends, but added that nothing has been finalized. Until now, Saudi officials have downplayed the need to increase oil output but may finally be seeing the risks of allowing prices to move too high. Brent oil has fallen nearly 10% from its $125 peak earlier this week, while WTI oil has fallen nearly 7% from its $120 peak this week. Stay tuned.