- U.S. rates have rebounded a bit ahead of today’s key data and tomorrow’s FOMC decision; May PPI and retail sales will be reported; June Fed manufacturing surveys will start to roll out
- Details of ECB asset purchases for the week ending June 11 will be reported; U.K. unemployment data was firm and reinforced the strength of the economic recovery; nothing but friendly words came out of the Biden-Erdogan meeting, leading to lira underperformance on the day
- RBA minutes show it is talking about talking about tapering; it will be a very close call but we think July may be too soon to taper; concerns of a liquidity crunch in China are rising; India report a much higher-than-expected inflation print yesterday; Indonesia is tightening mobility restrictions as Covid cases rise again
The dollar is largely flat ahead of key data today. DXY is trading near 90.5, slightly below the June 4 high around 90.627. The euro is trading heavy in the wake of the dovish ECB decision just above $1.21 and a clean break below would set up a test of the May 13 low near $1.2050. Sterling is underperforming despite strong labor market data today, trading below $1.41 and on its way to testing the May 13 low near $1.40. USD/JPY finally broke above 110 but needs to break the June high near 110.35 to set up a test of the March high near 111. We believe the fundamental story favors the dollar and that today’s U.S. data and FOMC meeting may be key for the next leg up in the greenback.
U.S. rates have rebounded a bit ahead of today’s key data and tomorrow’s FOMC decision. The 10-year yield is trading around 1.50% currently after trading as low as 1.43% late last week. There are many factors being cited with regards to the ongoing UST rally: strong foreign demand, strong domestic demand from fully-funded U.S. pension funds, heightened confidence in the Fed, and abundant liquidity as the Treasury reduces its cash balances. We suspect it is a combination of all these and then some. Yet when all is said and done, it is hard to justify U.S. yields remaining this low for much longer. There are plenty of potential triggers this week for a reversal in yields.
The two-day FOMC meeting begins today and ends with a decision tomorrow afternoon. Our preview here warns of a hawkish surprise. Is the Fed close to hiking? No. However, we see potential for a hawkish shift in the Dot Plots that moves median expectations for the first hike into 2023. We also believe that tapering may actually be mentioned in the official statement after informal discussions began at the last meeting in April. Lastly, the Fed will have to acknowledge the much higher than expected inflation numbers and reaffirm its commitment not to let inflation get out of hand. For now, the markets believe the Fed but we suspect this trust will start to fray after several more months of very high inflation.
May PPI will be reported. Headline inflation is expected to remain steady at 6.2% y/y, while core is expected to rise to 4.8% y/y from 4.1% in April. After last week’s upside miss for CPI, there are clearly upside risks to these PPI readings. The Fed continues to say this spike in inflation is transitory. However, food and energy prices are soaring and are already feeding into higher core inflation. Of note, the Fed’s preferred inflation measure core PCE came in at 3.1% y/y in April, the highest since July 1992 and above the 2% target.
May retail sales data will also be reported. Headline sales are expected to fall -0.7% m/m vs. a flat reading in April, while sales ex-autos are expected to rise 0.4% m/m vs. -0.8% in April. The so-called control group used for GDP calculations is expected to fall -0.5% m/m vs. -1.5% in April. Sales are expected to soften as the impact of the stimulus payments has largely passed through. However, the labor market is probably in better shape than what the data is saying and so we think there are some upside risks to the retail sales data as well.
June Fed manufacturing surveys will start to roll out. The Empire survey kicks things off today and is expected at 22.7 vs. 24.3 in May. Philly Fed follows up Thursday and is expected at 31.0 vs. 31.5 in May. May IP will also be reported and is expected to rise 0.7% vs. 0.5% in April. The U.S. manufacturing sector remains strong, and softer Fed surveys would simply mean it is expanding at a somewhat slower rate. April business inventories (-0.1% m/m expected) and TIC data will also be reported today. Canada reports May housing starts and existing home sales.
Details of ECB asset purchases for the week ending June 11 will be reported. Yesterday, net purchases were reported at a rather low EUR10.8 bln vs. EUR20.6 bln for the week ending June 4 and EUR20.0 bln for the week ending May 28. This is about half the weekly average during the period of accelerated purchases and so the drop off is a little puzzling since it seems a bit early for seasonal factors to kick in that will require fewer purchases in thin summer markets. Today, gross purchases and redemptions will be reported. Gross purchases were EUR21.3 bln for the week ending June 4 vs. EUR25.0 bln for the week ending May 28 and EUR23.7 bln for the week ending May 21. The euro has been soft since the dovish ECB hold last week. With accelerated purchases to continue through Q3, we suspect the euro will have trouble getting much traction.
U.K. unemployment data was firm and reinforced the strength of the economic recovery. Jobless claims fell -92.6k in May and comes after a revised -55.8k (was -15.1k) in April. Employment rose 113k for the three months through April, a tad lower than the expected 135k but up from 84k previously. Weekly earnings picked up to 5.6% y/y, while the unemployment rate fell a tick to 4.7%. The decision to postpone the latest round of reopening is disappointing but as these numbers show, the economy is already rebounding quite strongly and so that delay won’t have much of an impact on the overall economic trajectory. All eyes now turn to May CPI data tomorrow, with headline inflation expected to pick up to 1.8% y/y vs. 1.5% in April and CPIH expected to pick up to 1.9% y/y vs. 1.6% in April. BOE tightening expectations remain elevated, with the first hike fully priced in by Q3 22.
As we expected, nothing but friendly words came out of the Biden-Erdogan meeting, leading to lira underperformance on the day. Of note, Erdogan confirmed that his position on the Russian S-400 missile system remains unchanged. It’s hard to imagine that anyone was counting on a breakthrough during this event, so we suspect that most of the price action was flow related, more noise than signal. Yet the lira is down, 1.1% on the day and 2% over the last two sessions, and CDS are slightly higher.
RBA minutes show it is talking about talking about tapering. At the June 1 meeting, the bank reaffirmed that it will decide at the next meeting July 6 whether to extend Yield Curve Control. The minutes set out possible scenarios: 1) cease QE in September, 2) extend QE by another AUD100 bln for another six months; 3) scale back or spread QE over a longer period of time, and 4) review the size and pace of QE more frequently based on the data and the economic outlook. The RBA stressed that the key factors in the decision would be progress towards its goals for employment and inflation as well as the likely impact on “overall financial conditions.” To us, the money quote was that because QE was “one of the factors underpinning the accommodative conditions necessary for the economic recovery, members thought it would be premature to consider ceasing the program.” This dovish hint has led AUD to underperform today as markets reassess the likelihood of any change in QE next month.
It will be a very close call but we think July may be too soon to taper. The Australian curve gets quite steep very quickly beyond the 3-year YCC target of 0.10%, with the 4-year yield at 0.47% and the 5-year yield at 0.70%. Tapering next month would risk a sharp rise in longer-dated yields and a potential spike higher in AUD.
Concerns of a liquidity crunch in China are rising. The PBOC rolled over CNY200 bln with its one-year medium-term lending facility at an unchanged rate of 2.95% but added only CNY10 bln with seven-day reverse repos that did not fully offset CNY20 bln coming due. The net CNY10 bln shortfall is not that huge but comes at a time when liquidity is expected to tighten considerably with local governments issuing more debt and lenders hoarding funds for quarter-end regulatory reasons. We do not see any policy implications given recent signals for steady policy and expect the PBOC to manage the situation before it gets out of hand.
India report a much higher-than-expected inflation print yesterday. CPI rose 6.3% y/y in May, well above the 5.4% forecast and the 4.3% in the previous month and poking back above the RBI’s 2-6% target range. Both core and headline items (food and energy) were higher. We suspect that price pressures will only get worse as economic activity and pent-up demand return with the country’s re-opening. There’s some risk the government will reduce the fuel tax (imposed last year) to help cushion the energy and transport costs. But if not, the onus will fall on the RBI to step up into a more hawkish stance. In any case, longer dated bonds have behaved well with the 10-year yield steady around the 6% level for some time, though the rupee has underperformed over the last few weeks.
The Indonesian government is tightening mobility restrictions as Covid cases rise again. The new infection case count is now the highest since February at nearly 10,000 a day, due to the highly contagious delta variant. Officials changed the guidelines for maximum office occupancy from 50% to 25% and also closed schools in areas of high risk. The new measures will be enforced by the military police and will last until the end of June.