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 will wrap up
ECB President Lagarde affirmed plans to hike rates July 20; Lagarde kept mum on details of the anti-fragmentation tool; ECB tightening expectations have picked up a bit; Brexit tensions are picking up; Hungary is expected to hike the base rate 50 bp to 6.40%
China cut the required quarantine times for international arrivals; PBOC Governor Yi pledged to maintain stimulus
The dollar is getting some limited traction. DXY is trading modestly firmer near 104 after two straight down days. The euro continues to have trouble breaking above $1.06 despite hawkish ECB comments (see below). The weakening trend in the yen has resumed, with USD/JPY trading back above 136 as risk-off impulses fade. With BOJ dovishness being maintained, we still believe the pair will eventually test the August 1998 high near 147.65. Sterling remains heavy near $1.2250 as Brexit risks rise (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 3.24%. Similarly, the 2-year yield traded as low as 2.87% Friday but ended the week near 3.06%. It is now trading near 3.13%. Both yields are well below the mid-June peaks near 3.50% and 3.45%, respectively. It’s worth noting that the 2-year interest rate differentials with Germany and the U.K. are picking up again in recent days, which should translate into some great traction for the dollar against the euro and sterling.
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 near 3.75%, down from nearly 4.0% at the start of last week. Daly speaks today. Last week, she expressed support for a 75 bp hike next month.
Regional Fed manufacturing surveys for June will wrap up. Richmond reports today and is expected at -5 vs. -9 in May. Dallas Fed came in yesterday at -17.7 vs. -6.5 expected and -7.3 in May. Before that, Empire survey came in at -1.2 vs. -11.6 in May, Philly Fed came in at -3.3 vs. 2.6 in May, and Kansas City came 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. On the other hand, May durable goods orders came in stronger than expected yesterday at 0.7% m/m, as did core orders (0.5% m/m) and core shipments (0.8% m/m). Advance goods trade, wholesale and retail inventories, April S&P CoreLogic house price index, and June Conference Board consumer confidence (100.0 expected) will also be reported today.
EUROPE/MIDDLE EAST/AFRICA
ECB President Lagarde affirmed plans to hike rates July 20. She flagged a 25 bp hike then but stressed that the ECB is willing to pick up the pace if needed, noting that “There are clearly conditions in which gradualism would not be appropriate. If, for example, we were to see higher inflation threatening to de-anchor inflation expectations, or signs of a more permanent loss of economic potential that limits resource availability, we would need to withdraw accommodation more promptly.” Elsewhere, Kazaks said the ECB should consider a more aggressive approach, noting that “If we see that the situation has worsened, that inflation is high and we see negative news in terms of inflation expectations, then in my view front-loading the increase would be a reasonable choice.”
Lagarde kept mum on details of the anti-fragmentation tool. However, she stressed that it would have to contain safeguards to preserve sound fiscal policy among its members. This is a nod to the creditor nations who fear that the ECB will engage in direct financing of the debtor nations. Lagarde added that the mechanism will allow rates to rise “as far as necessary” so as not to endanger the ECB’s efforts to bring inflation back to the 2% target. Peripheral spreads are holding in as markets await details of the crisis tool July 21. As usual, we expect the ECB to disappoint.
ECB tightening expectations have picked up a bit. WIRP suggests a 25 bp hike July 21 is still fully priced in. A 50 bp hike September 8 is fully priced in but then expectations downshift for the October 27 and December 15 meetings 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 250-275 bp of tightening over the next 24 months that would see the deposit rate peak between 2.0-2.25% vs. 1.75-2.0% at the start of this week. German July GfK consumer confidence came in weak. Headline was -27.4 vs. -27.3 expected and a revised -26.2 (was -26.0) in June.
Brexit tensions are picking up. Legislation allowing the U.K Parliament to unilaterally rewrite parts of the Brexit deal is moving along. MPs voted 295-221 to allow the Northern Ireland Protocol Bill to pass its second reading in the Commons, which means it now moves to the so-called committee stage. Here, the text will be examined line-by-line and amendments will be considered. With the Tories holding 359 seats, the vote shows that many members of the party voted against it, including former Prime Minister May. The EU so far has been measured but if one reads between the lines, officials there have little patience for Johnson’s maneuverings and will respond in kind when the time comes.
National Bank of Hungary is expected to hike the base rate 50 bp to 6.40%. However, nearly half of the analysts polled by Bloomberg looked for a larger 100 bp move. At the last meeting May 31, the bank hiked the base rate 50 bp to 5.90%. Since then, it has also hiked the 1-week deposit rate a total of 80 bp to 7.25%and is expected to hike it 30 bp to 7.55% at its weekly tender Thursday. CPI rose 10.7% y/y in May, the highest since May 2001 and further above the 2-4% target range. The swaps market is pricing in 210 bp of tightening over the next 6 months that would see the base rate peak near 8.0% vs. 7.70% at the start of this week. We see upside risks as price pressures continue to climb.
ASIA
China cut the required quarantine times for international arrivals. Travelers will now only need to spend 7 days in a quarantine facility vs. 14 previously, according to China’s National Health Commission. While the move is welcome, China is still one of the few countries to maintain a quarantine policy for travelers. Indeed, officials said the decision was not a sign of reopening but was instead based solely on the shorter incubation period of the omicron variant.
PBOC Governor Yi pledged to maintain stimulus. He said monetary policy “will continue to be accommodative to support economic recovery in aggregate sense.” However, he noted that China’s “real interest rate is pretty low,” which suggests limited room for aggressive rate cuts. Instead, the bank is likely to focus on boosting lending in a more targeted manner, something that other officials have stressed.
