- U.S. rates remain low as we enter a crucial week for the bond market; first and foremost is the risk of a hawkish hold from the Fed; ahead of the FOMC decision Wednesday, the market will get some key U.S. data tomorrow
- ECB asset purchases for the week ending June 11 will be reported; the inevitable internal pushback to the ECB’s dovish hold last week has already begun; Israel central bank minutes will be released; Turkey’s current account data added to already positive sentiment ahead of the Biden-Erdogan meeting
- Australia is hoping to thaw out its relations with China; India reports May CPI
The Vix continues trending lower, now threatening the 2020 lows. The index is around 16 now, not far from the pre-pandemic range. Much of this is likely due to a reduction of the big macro risks, such as the inflation (and yield) scare we got earlier in the year, and with it a smaller risk of an imminent taper tantrum. Indeed, markets digested the recent employment and CPI reports without a problem, and this week’s Fed meeting is unlikely to rattle sentiment. The U.S. Treasury fixed income implied volatility index (MOVE) has been falling even faster, but in terms of levels, it’s nowhere near as low as VIX. The MOVE is 50 now, over 10 ppts above last year’s lows.
The dollar is holding on to its recent gains as we enter a crucial week. DXY is trading near 90.50, just below the June 4 high around 90.627. The euro is trading heavy in the wake of the dovish ECB decision but found some support at $1.21,while sterling is trading just below $1.41. USD/JPY is edging higher towards 110 after being stuck around 109.50 all last week. That the dollar is gaining despite lower U.S. yields (see below) is noteworthy. We believe the fundamental story favors the dollar and that this week’s U.S. data and FOMC meeting may be key for the next leg up in the greenback.
U.S. rates remain low as we enter a crucial week for the bond market. Despite ongoing upside surprises in inflation, the 10-year yield is trading around 1.46% 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.
First and foremost is the risk of a hawkish hold from the Fed this week. Is the Fed close to hiking? No. However, we see potential for a hawkish shift in the Dot Plots that moves the median expectations for the first hike forward 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. We will be writing a preview later today.
Ahead of the FOMC decision Wednesday, the market will get some key U.S. data tomorrow. May PPI and retail sales will be reported and we see potential for upside surprises from both sets of data. There are no U.S. data prints today, though Canada reports April manufacturing sales that are expected to fall -1.1% m/m.
ECB asset purchases for the week ending June 11 will be reported today. Net purchases were EUR20.6 bln for the week ending June 4 vs. EUR20.0 bln for the week ending May 28 and EUR21.7 bln for the week ending May 21, and so it seems that the ECB is aiming for net purchases to average around EUR20 bln per week. 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. Eurozone reported April IP up 0.8% m/m, double the consensus and up from a revised 0.4% (was 0.1%) in March.
The inevitable internal pushback to the ECB’s dovish hold last week has already begun. Austrian central bank Governor Holzmann said PEPP will end in March unless there is another severe wave of coronavirus infections, noting that the program “was established and voted for to end by March 2022, and for the time being, if nothing changes in the sense that there is no fourth or fifth confinement, it will end.” Holzmann warned that “If inflation crosses 3% -- which is where we already are in Austria and elsewhere -- that would probably mean a rethink of the strategy.” He added that “what exactly the response would be I can’t say at this moment.” Austrian central bank Governor Knotsaid “there are some upside risks slipping into this equation,” while Bundesbank Governor Weidmann warned that Germany could see inflation temporarily hit 4% toward year-end. Of course, there was pushback after the March decision to accelerate the pace of purchases and yet it was just extended for another quarter. It’s also worth pointing out that the ECB is not the only central bank debating the inflation outlook. Recent Fed comments suggest there is some growing dissent amongst policymakers over tapering.
Israel central bank minutes will be released. The bank left policy unchanged at the May 31 meeting but sounded more upbeat. May CPI data will be reported Tuesday. Headline inflation is expected to accelerate to 1.6% y/y from 0.8% in April. If so, it would be the highest since December 2013 and near the center of the 1-3% target range. The bank noted that "Inflation expectations for the coming year from all sources continued to increase, and are within the inflation target range." Next central bank policy meeting is July 5 and no change is expected then either. Turning to politics, the Netanyahu era has drawn to a close as opposition parties cobbled together a razor thin majority in parliament. The first order of business should be to pass a budget, something that hasn’t been done in several years due to ongoing political instability.
Turkey’s current account figures were a welcome surprise, adding to already positive sentiment ahead of the Biden-Erdogan meeting. The deficit for May nearly halved to -$1.7 bln vs. -$2.2 bln expected. The 12-month total fell to -$32.7 bln, the lowest since September and suggesting that the sharp depreciation of the lira is doing the rebalancing work to some extent. More importantly for near-term sentiment, we expect the Biden-Erdogan meeting to generate some positive headlines, but nothing near a game changer. Much of the grievances U.S. politicians have against Turkey have become deeply rooted, going well beyond the Biden administration. For example, there will surely be no change in the S-400 status quo or the Armenian genocide recognition, whatever positive sound bites come out of the meeting.
Australia is hoping to thaw out its relations with China. Prime Minister Morrison said he wants to restart a dialog with mainland officials, noting “We, of course, would like to see the dialog that was occurring to continue again and start again. Australia is always ready to sit around the table and talk through how our partnership can be made to work.” Tensions have led to several rounds of trade restrictions by China, including tariffs of more than 200% on Australian wine. Morrison said his government will go to the World Trade Organization to resolve the dispute. Trade Minister Tehan said he wrote a letter in January to his Chinese counterpart laying out ways that the two nations could constructively engage but added that “I’m still waiting for a response.” Markets are quiet in the region today, with several countries on national holiday, including China.
India reports May CPI. Headline CPI inflation is expected to accelerate to 5.38% y/y from 4.29% in April. If so, CPI inflation would move back near the top of the 2-6% target range even as WPI points to further upside risks. Earlier today, WPI was reported up 12.94% y/y vs. 13.40% expected and 10.49% in April. Next RBI meeting is August 6. On June 4, the bank kept rates steady but the bond purchase program that began back in April was increased by another INR 1.2 trln in Q3. It also announced additional liquidity provisions to some lockdown-impacted sectors. The bank said it would maintain its accommodative policy for as long as necessary to achieve growth on a durable basis. Consensus sees steady rates through 2021, with odds of a hike rising around mid-2022 and beyond. We are not convinced the easing cycle is over, especially with the ongoing reliance on QE. However, rising inflation risks suggests that the RBI will rely on QE for now rather than outright rate cuts.