Euro Enjoys Relief Rally but Upside Limited

July 01, 2024

Win Thin

Data last week did not change the Fed narrative at all; June ISM manufacturing PMI will be the highlight; Peru reports June CPI
The first round of the French legislative elections was held Sunday; Germany reports June CPI; eurozone reported firm final June manufacturing PMIs; U.K. reported soft final June manufacturing PMI; Switzerland reported mixed June PMIs
Q2 Tankan report came in mostly firmer; Japan revised Q1 GDP data again; Japan and Australia reported soft final June manufacturing PMIs; Caixin reported firm June manufacturing PMI; Korea reported June soft trade data

The dollar is under pressure with the euro leading the way. DXY is trading lower for the third straight day near 105.625. The euro is enjoying a relief rally after the weekend elections in France (see below) and is trading near $1.0750. Peripheral spreads have come in, but France continues to trade wide of Portugal in the 10-year space, suggesting that markets remain concerned and further euro upside will be limited. Sterling is trading higher near $1.2675. USD/JPY is trading higher near 161.10 despite a largely firmer Tankan survey (see below). Recent data support our view that the backdrop of persistent inflation and robust growth in the U.S. remains largely in place, and so the Fed remains in hawkish mode. At the same time, weaker data in many of the major economies underscore the widening economic and monetary policy divergences that should continue to support the dollar.

AMERICAS

Data last week did not change the Fed narrative at all. PCE readings fell as expected but remain elevated enough to warrant a continuation of the Fed’s cautious stance. Meanwhile, the real sector data remain firm and economic growth remains at or above trend. The Atlanta Fed GDPNow model is now tracking Q2 growth at 2.2% SAAR vs. 2.7% previously and will next be updated today after the data. Elsewhere, the New York Fed Nowcast model is tracking Q2 at 1.9% SAAR and Q3 at 2.2% SAAR and both were steady from last week's estimates. The market sees 70% odds of a September cut, but it will of course depend on the data.

June ISM manufacturing PMI will be the highlight. Headline is expected at 49.1 vs. 48.7 in May. The regional Fed manufacturing business surveys suggest risks are balanced. Of note, S&P Global manufacturing PMI rose to a three-month high of 51.7 in June vs. 51.3 in May. Prices paid component is expected at 55.8 vs. 57.0 in May, new orders is expected at 49.0 vs. 45.4 in May, and employment is expected at 50.0 vs. 51.1 in May. ISM services will be reported Wednesday.

Peru reports June CPI. Headline is expected at 2.3% y/y vs. 2.0% in May. If so, it would be the first acceleration since February but would remain well within the 1-3% target range. At the last meeting June 13, the central bank surprised markets by holding rates steady at 5.75% vs. an expected 25 bp cut. Even though inflation had fallen to the 2% target in May, the bank noted that “Inflation excluding food and energy is showing some persistence associated with the services industry.” Next meeting is July 11 and if inflation pressures resume falling, a 25 bp cut to 5.5% seems likely. Bloomberg consensus sees a year-end policy rate of 5.0%.

EUROPE/MIDDLE EAST/AFRICA

The first round of the French legislative elections was held Sunday. The hard-right National Rally party was the clear winner but may struggle to get an absolute majority in the second and decisive round of voting next Sunday. In line with polls, Marine Le Pen’s National Rally took 33.1% of the national vote, the hard left alliance got 28%, and President Emmanuel Macron’s centrist Ensemble group got 20%. The two most likely scenarios for France’s second round of voting July 7 are either an absolute majority for the hard-right National Rally or a hung parliament. In our view, both scenarios are bearish for EUR and French bonds. It is still not clear how much of the National Rally’s fiscal spending plans are funded while a hung parliament will generate more political instability and lead to policy gridlock. The euro is enjoying a relief rally and peripheral spreads have come in today. However, France continues to trade wide of Portugal in the 10-year space, suggesting that markets remain concerned.

Germany reports June CPI. Its EU Harmonised inflation is expected to fall three ticks to 2.5% y/y. Last week, EU harmonized CPI inflation for France and Spain slowed to 2.1% vs. 2.3% and 3.5% vs. 3.8%, respectively, while Italy’s quickened to 0.9% y/y in June from 0.8% in May. Eurozone reports June CPI tomorrow. Headline is expected to fall a tick to 2.5% y/y while core is expected to fall a tick to 2.8% y/y. Overall, Eurozone disinflationary process is well on track and supports the case for the ECB to cut rates again in September. Nagel and Lagarde speak today.

Eurozone reported firm final June manufacturing PMIs. Headline was revised up two ticks from the preliminary to 45.8. Looking at the country breakdown, Germany was revised up a tick to 43.5 while France was revised up a tick to 45.4. Italy and Spain reported for the first time and came in at 45.7 and 52.3, respectively. Services and composite PMIs will be reported Wednesday. Italy and Spain report for the first time and their composites are expected at 51.3 and 56.0, respectively. Of note, the preliminary June eurozone composite fell for the first since October and is the lowest since March.

U.K. reported final June manufacturing PMIs. Headline was revised down half a point from the preliminary to 50.9. Services and composite PMIs will be reported Wednesday. This was the second straight drop in the composite and is the lowest since November.

Switzerland reported June PMIs. Manufacturing came in at 43.9 vs. 45.5 expected and 46.4 in May, while services came in at 52.0 vs. 48.8 in May. Both were in contractionary territory in May for the first time since March and so the improvement in services is a welcome development.

ASIA

Bank of Japan Q2 Tankan report came in mostly firmer. Large manufacturing index came in at 13 vs. 11 expected and actual in Q1, while large non-manufacturing index fell a point as expected to 33. Large manufacturing outlook came in at 14 vs. 11 expected and 10 in Q1, while large non-manufacturing outlook came in a point lower than expected and was steady at 27. Lastly, all industry capex came in at 11.1% vs. 13.9% expected 4.0% in Q1. The Tankan survey also showed a small uptick in medium- to long-term inflation expectations. Businesses’ 3- and 5-year inflation expectations rose to 2.3% and 2.2%, respectively, while 1-year was unchanged at 2.4% for a third consecutive quarter. Overall, we doubt the Bank of Japan will tighten more than is currently priced in, as underlying inflation is in a firm downtrend and near the 2% target. The market sees around 60% odds of a rate hike at the next meeting July 31, and around 40 bp of tightening over the next 12 months.

Japan revised Q1 GDP data again. As widely reported, revisions to construction data saw downward revisions. The economy contracted -0.7% q/q vs. -0.5% previously. The contribution of private demand was unchanged at -0.4% ppt, while fixed investment was revised to -0.3 ppt vs. 0.0 ppt previously. Public demand contributed zero vs. 0.2 ppt previously, while the contribution of net exports was unchanged at -0.4 ppt. This raises downside risks to the BOJ’s growth forecasts, which will be updated at the July meeting.

Japan reported a soft final June manufacturing PMI. Headline was revised down a tick to 50.0. Services and composite PMIs will be reported Wednesday. This was the first drop in the composite PMI since February but is the lowest since December.

Australia reported a soft final June manufacturing PMI. Headline was revised to 47.2 vs. 47.5 preliminary. Services and composite PMIs will be reported Wednesday. The composite PMI has fallen three straight months to the lowest since January and suggests that ongoing tightness in monetary policy is having a significant impact on the economy.

Caixin reported firm June manufacturing PMI. Headline came in at 51.8 vs. 51.5 expected and 51.7 in May. Services and composite PMIs will be reported Wednesday, with services expected at 53.4 vs. 54.0 in May. Over the weekend, soft official PMIs were reported. Manufacturing remained steady at 49.5 but non-manufacturing fell to 50.5 vs. 51.1 in May. As a result, the composite PMI fell half a point to 50.5, the lowest since December and nearing the 50 boom/bust level. We believe the Caixin PMIs have been overstating growth in China and that the official readings are closer to the mark.

Korea reported June soft trade data. Exports came in at 5.1% y/y vs. 4.4% expected and 11.5% in May, while imports came in at -7.5% y/y vs. -4.7% expected and -2.0% in May. The limited recovery in regional trade and activity supports our view that China is having a limited impact due to its muddle through approach.

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