Data last week confirmed our view that concerns about a U.S. recession are overdone; U.S. yields are moving higher as a result; the Fed is likely to remain on its aggressive tightening path; May CPI data Friday will be the main event; there is a heavy slate of U.S. Treasury issuance; Canada highlight will be May jobs data Friday
ECB meets Thursday and is widely expected to announce an end to QE; eurozone countries will report important real sector data this week; reports suggest U.K. Prime Minister Johnson will face a no confidence vote this week; Norway reports May CPI and PPI data Friday
Japan highlight will be April household spending and cash earnings data Tuesday; April current account data Wednesday will be of interest; RBA meets Tuesday and is expected to hike rates 25 bp to 0.60%

AMERICAS

Data last week confirmed our view that concerns about a U.S. recession are overdone. Yes, the economy is slowing, but that is exactly what the Fed wants. Job growth and PMI readings are all slowing from rather lofty levels seen throughout 2021. Consumption remains surprisingly resilient but at some point, it too will slow. The million dollar questions remains whether the Fed can engineer a soft landing. That remains to be seen, but all indications are that a recession is unlikely over the next 12 months.

U.S. yields are moving higher as a result. The 10-year yield traded as high as 2.99% Friday, up from the previous week’s low near 2.70% but still below the May 9 peak near 3.20%. Elsewhere, the 2-year yield traded as high as 2.69% Friday, up from the previous week’s low near 2.44% but still well below the May 4 peak near 2.85%. The 2-year differential with Germany has fallen to 199 bp, the lowest since the end of February, while the gap with Japan has risen back to 272 bp. How these differential evolve in the coming days will depend in large part on how this week’s U.S. data come in. However, we believe the dollar uptrend remains intact.

Fed tightening expectations continue to adjust. WIRP suggests 50 bp is fully priced in for June and July. A third 50 bp hike for September is now about 75% priced in vs. 35% at the start of last week. After that, two more 25 bp hikes in November and December are fully priced in and a third one next February is mostly priced in. The swaps market is pricing in a terminal Fed Funds rate near 3.25% by mid-2023, followed by an easing cycle over the course of the subsequent 12 months. This would only happen if the U.S. were to fall into recession next year and while it is possible, it is not our base case.

The Fed is likely to remain on its aggressive tightening path. Ahead of the weekend, Daly said that she supports 50 bp hikes in June and July and added that “I’m going to come into that September meeting and if I don’t see compelling evidence, then I could easily be a 50 bp in that meeting as well. There’s no reason we have to make that decision today, but my starting point will be do we need to do another 50 or not.” Last week, Bullard made a similar pitch. In related news, the Senate Banking Committee will vote on Michael Barr’s nomination for Vice Chair for supervision this Wednesday. Due to the media blackout, there are no Fed speakers this week.

May CPI data Friday will be the main event. Headline is expected to remain steady at 8.3% y/y, while core is expected at 5.9% vs. 6.2% in April. PPI data won’t be reported until next week. The Fed will be happy to see the deceleration in average hourly earnings reported last Friday to 5.2% y/y in May vs. 5.5% in April. Prices paid components in both ISM manufacturing and services PMI reports are encouraging, yet we can’t help but fear that we get an upside CPI surprise this Friday. After all, virtually every other country has reported accelerating inflation in May. How can the U.S. buck this trend?

There is a heavy slate of U.S. Treasury issuance. $44 bln of 3-year notes will be sold Tuesday, followed by $33 bln of 10-year notes Wednesday and $19 bln of 30-year bonds Thursday. At the last auction, indirect bidders took 62.0%, 70.3%, and 69.7%, respectively, while the bid/cover ratios were 2.59, 2.49, and 2.38, respectively. Will investors be lured in by the higher yields, or will they wait for yields to move even higher before buying? Stay tuned.

Some minor data will be reported. April trade (-$89.5 bln expected) and consumer credit ($35.0 bln expected) data will be reported Tuesday. April wholesale trade sales and inventories will be reported Wednesday. Weekly jobless claims and Q1 household net worth will be reported Thursday. Preliminary June University of Michigan consumer sentiment (58.3 expected) and May budget statement (-$170.0 bln expected)will be reported Friday.

Canada highlight will be May jobs data Friday. Consensus sees 25.0k jobs created vs. 15.3k in April, with the unemployment rate seen steady at 5.2%. Ahead of that, April trade and May Ivey PMI will be reported Tuesday. With the economy firm, the Bank of Canada will continue tightening. WIRP suggests 50 bp hikes are fully priced in for June and July. Looking ahead, the swaps market is now pricing in 175-200 bp of tightening over the next 12 months that would see the policy rate peak between 3.25-3.50%, up from 3.0% at the start of last week. High oil prices and a hawkish BOC are likely to help CAD continue outperforming. It is the only major currency up YTD vs. USD, albeit by a modest 0.4%. USD/CAD is on track to test the April low near $1.2405.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank meets Thursday and is widely expected to announce an end to QE. There has been some chatter about a surprise rate hike but most (including us) see this as highly unlikely. Even the hawks have coalesced around July 21 liftoff, though they continue to play up the need for a 50 bp move. We think a larger move is unlikely, at least for now. However, ECB tightening expectations have picked up in light of last week’s inflation data. WIRP suggests liftoff July 21 remains fully priced in, followed by a follow-up 25 bp hike September 8. Markets are now pricing in some odds of a potential 50 bp move October 27, however. The swaps market is pricing in 225-250 bp of tightening over the next 24 months that would see the deposit rate peak between 1.75-2.00% vs. 1.50% at the start of last week.

Eurozone countries will report important real sector data this week. Germany reports April factory orders Tuesday and are expected at 0.3% m/m vs. -4.7% in March. IP will be reported Wednesday and is expected at 1.2% m/m vs. -3.9% in March. If so, the two series would contract y/y by -4.1% and -2.4%, respectively. Spain reports April IP Tuesday and is expected at 0.5% m/m vs. -1.8% in March. If so, the y/y rate would come in at -0.1% vs. 0.1% in March. Italy reports April retail sales Wednesday and is expected at 0.1% m/m vs. -0.5% in March, followed by IP Friday that is expected at -1.1% m/m vs. 0.0% in March. if so, the y/y rate for IP would come in at 0.1% WDA vs. 3.0% in March. It’s clear from the monthly data that eurozone activity was already slowing as we entered Q2 and is likely to get even worse. Final Q1 eurozone GDP data will be reported Wednesday. A hawkish ECB message this week will most likely be undermined by deteriorating economic fundamentals.

Reports suggest U.K. Prime Minister Johnson will face a no confidence vote this week. A total of 54 letters from Tory MPs are needed to trigger the vote. Johnson said he has no intention of resigning and it’s not clear yet if the rebels have secured the 180 votes needed to remove him. Tory backbenchers have seen popular support for their party plunge on surging inflation as well as so-called Partygate. One weekend poll suggests Labour is ahead by 20 percentage points in the upcoming special election in Wakefield June 23. Other polls suggest the Tories will lose a special election in Tiverton and Honiton to be held that same day to the Liberal Democrats. Otherwise, the U.K. has a very quiet data week. Only major data report will be final May services and composite PMIs Tuesday. The Bank of England releases its inflation attitudes survey Friday and it’s not going to be pretty. Sterling is likely to continue underperforming on poor economic fundamentals and rising political risk. Break below $1.2350 is needed to set up a test of the May 13 low near $1.2155.

Norway reports May CPI and PPI data Friday. Headline is expected at 5.6% y/y vs. 5.4% in April, while underlying is expected at 3.1% y/y vs. 2.6% in April. If so, headline would be the highest since December 1988 and further above the 2% target. At the May 5 meeting, Norges Bank kept rates on hold at 0.75% but reaffirmed its March rate path and signaled a hike at the next meeting June 23. Looking ahead, the swaps market is pricing in 150 bp of total tightening over the next 12 months followed by another 25 bp over the subsequent 12 months that would see the policy rate peak near 2.50%. This is consistent with the bank’s March rate path, which sees the policy rate peak near 2.5% in 2024.

ASIA

Japan highlight will be April household spending and cash earnings data Tuesday. Nominal earnings are expected at 1.5% y/y vs. a revised 2.0% (was 1.2%) in March, while real earnings are expected at -1.6% y/y vs. a revised 0.6% (was -0.2%) in March. No wonder household spending is expected to remain weak at -0.6% y/y vs. -2.3% in March. With no wage pressures to speak of, the Bank of Japan will maintain its loose policy settings for the time being and that should lead to continued yen weakness. USD/JPY is likely to soon break above the May 9 high near 131.35 on the way to testing the January 2002 high near 135.15. April leading and coincident indexes will also be reported Tuesday. Final Q1 GDP data will be reported Wednesday. May machine tool orders will be reported Thursday. PPI will be reported Friday and is expected at 9.9% y/y vs. a revised 9.5% (was 10.0%) in March.

Japan April current account data Wednesday will be of interest. An adjusted surplus of JPY394 bln is expected vs. JPY1.56 trln in March. However, the investment flows will be of most interest. March data showed that Japan investors were net sellers of U.S. bonds for the fifth straight month and the -JPY2.9 trln sold nearly matched the -JPY3.1 trln sold in February, which was the most since April 2020. Japan investors were net buyers (JPY149 bln) of Australian bonds for the second straight month in March but were net sellers of Canadian bonds (-JPY188 bln) for the second straight month. They were net sellers of Italian bonds (-JPY92bln) in March after two months of net buying. Of note, April will be the first month of FY22.

Reserve Bank of Australia meets Tuesday and is expected to hike rates 25 bp to 0.60%. WIRP suggests 20% odds of a larger 50 bp move but we believe this is unlikely. New macro forecasts were just released at the May 3 meeting and won’t be updated until the August 2 meeting, when December 2024 will be added to the forecast horizon. Looking ahead, the swaps market is pricing in 300-325 bp of tightening over the next 12 months that would see the policy rate peak between 3.35-3.60%, up from 3.25% at the start of last week. AUD is trading a bit softer after failing to make a clean break above the 200-day moving average near .7260 last week. Optimism regarding China is likely to help AUD sentiment but the key level from the April-May drop comes in near .7345 and a break above that would set up a test of the April high near .7660.