U.S. yields are inching higher as risk-off sentiment wanes; Fed tightening expectations have steadied but remain off the recent highs; regional Fed manufacturing surveys for June continue to roll out
Most ECB speakers this week are centered around the ECB forum that begins tonight in Sintra; while the ECB has a single mandate of price stability, it has an unofficial second mandate of fighting so-called fragmentation; ECB tightening expectations have softened; Brexit remains in the headlines; BOE tightening expectations have eased as risks pile up
The summary of discussions from the June 16-17 BOJ meeting suggests there is no rush to remove accommodation

The dollar is soft at the start of the new week. DXY is down for the second straight day and trading just below 104. The euro continues to have trouble breaking above $1.06 as fragmentation risks linger (see below). The weakening trend in the yen has stalled, with USD/JPY trading near 135 despite fading risk-off impulses. With BOJ dovishness being maintained (see below), we believe the pair will eventually test the August 1998 high near 147.65. Sterling remains unable to make a clean break above $1.33 as weak data and rising Brexit risks weigh on the outlook (see below). For now, the period of dollar consolidation continues but when all is said and done, we believe the U.S. economy will prove to be more resilient than the rest of DM and so we look for continued dollar gains.

AMERICAS

U.S. yields are inching higher as risk-off sentiment wanes. The 10-year yield traded as low as 3.00% Friday but ended the week near 3.13%. It is now trading near 3.17%. Similarly, the 2-year yield traded as low as 2.87% Friday but ended the week near 3.06%. It is now trading near 3.09%. Both yields are well below the mid-June peaks near 3.50% and 3.45%, respectively. We acknowledge that ongoing U.S. recession fears are likely to keep yields depressed near-term, but would add that we feel those fears are overblown. Yes, the U.S. economy is slowing but that is exactly what the Fed wants. We do not see any signs yet of an abrupt recession. When all is said and done, we still believe monetary policy divergences remain the dominant driver for FX. As the U.S. economic outlook remains the strongest and the Fed the most hawkish relative to its DM peers, the dollar uptrend should remain intact.

Fed tightening expectations have steadied but remain off the recent highs. WIRP suggests a 75 bp hike at the next meeting July 27 is 85% priced in, about the same as the start of last week, while 50 bp hikes at the subsequent meetings September 21 and November 2 are almost fully priced in. Looking ahead, the swaps market is pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak between 3.50-3.75%, down from nearly 4.0% at the start of last week.

Regional Fed manufacturing surveys for June continue to roll out. Dallas Fed reports today and is expected at -6.5 vs. -7.3 in May. Richmond then reports tomorrow and is expected at -5 vs. -9 in May. So far, Empire survey has come in at -1.2 vs. -11.6 in May, Philly Fed has come in at -3.3 vs. 2.6 in May, and Kansas City has come in at 12 vs. 23 in May. Manufacturing still seems to be suffering from supply chain issues but now has to contend with a possible slowdown in demand. Stay tuned. May durable goods orders will be reported today and are expected at 0.2% m/m vs. 0.5% in April. Pending home sales will also be reported and are expected at -3.9% m/m vs. -3.9% in April.

EUROPE/MIDDLE EAST/AFRICA

Most ECB speakers this week are centered around the ECB forum that begins tonight in Sintra, Portugal. This is the ECB’s version of the Fed’s Jackson Hole Symposium. President Lagarde speaks today. Lagarde, Lane, Elderson, and Panetta speak Tuesday. Guindos, Schnabel, and Lagarde speak Wednesday. Of note, Lagarde, Powell, Bailey, and Carstens are on a panel Wednesday.

While the ECB has a single mandate of price stability, it now has an unofficial second mandate of fighting so-called fragmentation. Yes, the ECB really is there to close spreads. In a sense, this is akin to the Fed’s unofficial third mandate of financial stability. Can the ECB deliver the goods July 21? The stakes are high and the bank knows that the markets are watching closely, but experience suggests the ECB will once again disappoint. Peripheral spreads have come in a bit as market await action but if the bank does indeed disappoint, these spreads are likely to test recent highs quickly.

ECB tightening expectations have softened. WIRP suggests a 25 bp hike July 21 is fully priced in. Then, 50 bp hikes are no longer fully priced in for the subsequent three meetings on September 8, October 27, and December 15 and so the deposit rate is seen near 1.0% at year-end vs. 1.25% at the start of last week. Looking ahead, the swaps market is now pricing in 250 bp of tightening over the next 24 months that would see the deposit rate peak near 2.0% vs. 2.25% at the start of last week. June CPI data this week will be key. On a technical note, the ECB has moved the timing of its decision and post-decision press conference. The decision will now be announced 215 PM local time (815 AM ET) and the press conference will begin 245 PM local time (845 AM ET). ECB official noted “It’s a minor technical adjustment, the format of the press release, press conference and associated documents remain unaffected.”

Brexit remains in the headlines. The House of Commons is set to get its debate today of legislation allowing it to unilaterally rewrite parts of the Brexit deal. Prime Minister Johnson said it could be approved “fairly rapidly” if Parliament cooperates and that the measures could become law by the end of this year. He stressed that “What we are trying to do is fix something that I think is very important to our country, which is the balance of the Belfast/Good Friday Agreement.” We continue to believe that this reckless action will do more harm than good, as the EU has long threatened retaliatory tariffs in response. In any trade war, the smaller country always gets harmed more.

Bank of England expectations have eased as risks pile up. WIRP suggests a 50 bp hike move at the August 4 meeting is nearly 90% priced in vs. 95% at the start of last week, but are no longer fully priced in for the subsequent meetings September 15 and November 3. 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 3.25%, down from nearly 3.75% at the start of last week.

ASIA

The summary of discussions from the June 16-17 Bank of Japan meeting suggests there is no rush to remove accommodation. Many board members spoke of the need to see clear evidence of wage pressures before shifting its policy, a theme that has gained traction at the bank in recent months. One noted that “While assessing data in real time, particularly on underlying inflation and inflation expectations, the Bank should continue with monetary easing until it becomes certain that wages have increased as a trend and the price stability target is achieved in a sustainable and stable manner.” Several other members also cited the need for wage gains to generate sustainably higher inflation. The meeting took place just days after the markets unsuccessfully tested the BOJ’s YCC and so the lack of concern is noteworthy. Next policy meeting is July 20-21 and no change is expected then. Updated macro forecasts will be released that should justify the bank’s steady stance.