- The market still does not believe the Fed; May retail sales were solid; regional Fed manufacturing surveys started rolling out; preliminary June University of Michigan consumer sentiment will be the data highlight
- ECB hiked rates 25 bp, as expected; The European Commission is siding with the U.S. with regards to China tech restrictions; U.K. inflation expectations are easing
- The two-day BOJ meeting ended with no change to policy, as expected
The dollar is getting some modest traction ahead of the weekend. DXY is trading slightly higher near 102.196 but charts suggest it will eventually test the May low near 101.027. The euro is holding on to its post-ECB gains and trading near $1.0950 and appears on track to test the May high near $1.1090. Sterling traded at a new high for this move near $1.2820 before falling back below $1.28 but appears to be on track to test the late April 20220 high near $1.3090. the yen is underperforming after the BOJ hold and traded as high as 141.40 before falling back below 141. The FX market has been choppy this week and much of that is due to Fed (mis)communication. The weak performance of dollar post-FOMC suggests the market really doesn't believe the Dot Plots (see below) and so the greenback is likely to remain vulnerable near-term.
AMERICAS
The market still does not believe the Fed. Yes, one more rate cut is about 75% priced in for July with the odds rising to 90% in September. However, the second hike that was flagged in the Dot Plots is simply nowhere to be seen in the market pricing, at least not yet. To do so, Fed speakers will have their work cut out for them. Who better to do that than the resident hawks Bullard and Waller? Both speak today, along with Barkin. We continue to believe that the skip was unnecessary and that the market continue to underestimate the Fed's capacity to tighten as the U.S. economy remains much more resilient than anyone expected.
May retail sales were solid. Headline came in at 0.3% m/m vs. -0.2% expected and 0.4% in April while ex-autos came in as expected at 0.1% m/m vs. 0.4% in April. The so-called control group used for GDP calculations came in as expected at 0.2% m/m vs. a revised 0.6% (was 0.7%) in April. Recall that retail sales are comprised mostly of goods. Since much of the recent consumer spending has been concentrated in services, the personal spending data out June 30 will paint a fuller (and stronger) picture of overall U.S. consumption. Of note, the Atlanta Fed’s GDPNow model is currently tracking 1.8% SAAR growth in Q2, down from 2.2% previously. Next model update will come next Tuesday.
Regional Fed manufacturing surveys started rolling out. Empire and Philly Fed surveys came in mixed yesterday. Empire came in at 6.6 vs. -15.1 expected and -31.8 in May, while Philly Fed came in at -13.7 vs. -14.0 expected and -10.4 in May. May IP came in at -0.2% m/m vs. 0.1% expected and 0.5% in April. Global manufacturing remains under pressure but for now, strong services activity is offsetting that weakness.
Preliminary June University of Michigan consumer sentiment will be the data highlight. Headline is expected at 60.0 vs. 59.2 in May, with current conditions seen up two ticks to 65.1 and expectations seen down two ticks to 55.2. 1-year inflation expectations are seen down a tick to 4.1% while 5- to 10-year expectations are seen down a tick to 3.0%.
EUROPE/MIDDLE EAST/AFRICA
The ECB hiked rates 25 bp, as expected. It also confirmed that all APP reinvestments will end this month. At the last meeting, President Lagarde estimated that the halt of APP reinvestments will average EUR25 bln per month and so it’s almost double the current pace of EUR15 bln per month. The ECB said it would ensure hat rates reach sufficiently restrictive levels and will be kept there as long as necessary to get inflation back down to the 2% target. It said it would continue to follow a data-dependent approach and that future decisions will ensure that rates remain sufficiently restrictive. Updated macro forecasts were released. The growth outlook was revised down modestly but the core inflation outlook was revised up significantly.
President Lagarde stayed on message at her press conference. She acknowledged that growth was likely to remain weak in the short run but strengthen later this year. She said the decline in inflation was broad-based but that underlying price pressures remain strong. Lagarde added that wage agreement have added to upside inflation risks, which also include energy and food prices. Looking ahead, Lagarde said the ECB was very likely to continue hiking rates in July, adding that there is still ground to cover and that the ECB is not yet at its destination. It remains puzzling to us how central bankers can say future decisions are data dependent and then go ahead and pre-commit in the same breath. The Fed has done it and now the ECB has too.
Madame Lagarde said the ECB is not thinking about pausing. However, the fact that she mentioned it suggests that the ECB is probably “thinking about thinking about” pausing. She would not comment on a terminal rate but said the ECB will know it when it gets there. Of note, the hawks are stressing that rate hikes may have to extend into the fall. Looking ahead, another 25 bp hike is priced in July 27, with odds of another 25 bp hike after that topping out at 80% in October. This rate path would take the peak deposit rate up to 4.0% vs. 3.75% seen at the start of this week. Holzmann, Rehn, Muller, Centeno and Villeroy all speak today.
The European Commission is siding with the U.S. with regards to China tech restrictions. It recommended that member countries phase out use of Huawei and ZTE equipment in their advanced mobile networks and explicitly labeled these companies as high risk vendors for the first time. The European Commission also banned Huawei and ZTE from its corporate communications systems. This is likely to have material impact as reports suggest that 17 of the 27 member countries continue to use equipment from high risk vendors at levels that the European Commission finds “unacceptable” since it issued its 5G guidance three years ago. European Commissioner Breton noted “This is too slow and imposes a major security risk and exposes the union connectivity security since it creates a major dependency for the EU and serious vulnerabilities.”
U.K. inflation expectations are easing. In the latest Bank of England/Ipsos inflation attitudes survey conducted in May, respondents saw inflation twelve months ahead falling to 3.5% vs. 3.9% seen in February. With inflation remaining stubbornly high, we suspect that this improvement in expectations is a bit of a fluke. May CPI data out next Wednesday is expected to show headline inflation at 8.4% vs. 8.7% in April. While down from the 11.1% peak in October, progress has been slow and so the 3.5% outlook may be too optimistic. The survey also showed rising dissatisfaction with the BOE’s job tackling inflation, with the index measuring this falling to -13 vs. -4 in February. This is the worst since the survey began in 1999. BOE tightening expectations remain elevated ahead of next week’s meeting. WIRP suggests a 25 bp hike is fully priced in, as are hikes in August, September, November, and December that would see the policy rate peak near 5.75%.
ASIA
The two-day Bank of Japan meeting ended with no change to policy, as expected. The bank said that inflation expectations have been “more or less unchanged recently” but noted that the y/y rate for core (ex-fresh food) inflation is slowing, due mainly to the impact of government measures to lower energy prices. The BOJ said it sees inflation decelerating toward the middle of FY2023 but added that it’s necessary to “pay due attention” to developments in financial and FX markets. When asked about the July meeting, Governor Ueda said “In between one policy meeting and another, various new data come in. Based on that information, the latest policy meeting may have a different result to the one before. It’s inevitable that sometimes there’s a certain element of surprise.” However, he added that any major change in its inflation outlook could trigger a change in policy. Updated macro forecasts will be released at the July meeting and will likely see significant increases in its inflation forecasts. WIRP suggests around 15% odds of liftoff in July, rising to around 25% in September, 45% in October, and 65% in December.
