Fed Chair Powell finally acknowledged recession risks are building; Fed expectations are pretty much unchanged after Powell; yet U.S. yields are falling again as risk-off impulses build; preliminary June S&P Global PMI readings will be reported; Canada May CPI data ran hot; Mexico is expected to hike rates 75 bp to 7.75%.
Eurozone reported weak preliminary June PMI readings; ECB tightening expectations have eased; U.K. reported preliminary June PMI readings and public sector net borrowing; Norway hiked rates 50 bp to 1.25%; Turkey kept rates steady at 14.0%, as expected
Former head of FX policy at Japan’s Finance Ministry Takehiko Nakao said markets shouldn’t rule out unilateral intervention; Philippines hiked rates 25 bp to 2.5%, as expected; Indonesia kept rates steady at 3.5%, as expected

The dollar is firm as risk-off impulses return. DXY is traded near 104.7 today but has yet to mount a serious challenge to the new cycle high from last week near 105.788. The euro is testing $1.05 again after weak June PMI readings were reported (see below). The weakening trend in the yen has stalled, with USD/JPY trading near 135.50 due to rising risk-off sentiment after making a marginal new high for this cycle 136.70 yesterday. As risk-off impulses fade and BOJ dovishness is maintained, we believe the pair will eventually test the August 1998 high near 147.65. Sterling is testing support near $1.32 despite better than expected June PMI readings (see below). For now, the so-called dollar smile seems to be in play and so we look for continued dollar gains.

AMERICAS

Fed Chair Powell finally acknowledged recession risks are building. He said a soft landing will be “very challenging” and this was a very clear change in his tone. He later softened the message by saying that the likelihood of recession is not elevated now but acknowledged that growth is slowing. Powell later said “I would never take something off the table.” Yet he took 75 bp off the table last month only to be forced to put it back on this month. We've been a staunch Powell defender but we think his messaging has gotten more inconsistent the last couple of months. He appears before the House today and we hope that he has sharpened his message.

Fed expectations are pretty much unchanged after Powell. WIRP still suggests 80% odds of a 75 bp hike in July, while 50 bp hikes are largely priced in for September and November. Elsewhere, the swaps market is still pricing in a terminal Fed Funds rate between 3.50-3.75% vs. 3.75% at the start of this week.

Yet U.S. yields are falling again as risk-off impulses build. The 10-year yield traded near 3.08% today after ending last week near 3.23%. Elsewhere, the 2-year yield traded near 2.99% today after ending last week near 3.18%. We acknowledge that U.S. recession fears are likely to keep yields depressed near-term. For now, the dollar smile remains in effect as the greenback benefits from the risk-off impulses. When all is said and done, however, we believe monetary policy divergences remain the dominant driver for FX. As the U.S. economic outlook remains the strongest and the Fed the most hawkish relative to its DM peers, the dollar uptrend should remain intact.

Preliminary June S&P Global PMI readings will be reported. Headline manufacturing is expected at 56.0 vs. 57.0 in May, services is expected at 53.3 vs. 53.4 in May, and the composite PMI is expected at 52.9 vs. 53.6 in May. All of the PMI readings are slowing but at this point are falling from rather lofty pandemic recovery levels to ranges that are considered more normal. Regional Fed manufacturing surveys for June will continue rolling out. Kansas City Fed also reports today and is expected at 13 vs. 23 in May. Last week, Empire came in at -1.2 and Philly Fed came in at -3.3 and so there are downside risks to the Kansas City reading. Weekly jobless claims will be of interest. Initial claims are for the BLS survey week containing the 12th of the month and are expected at 226k vs. 229k the previous week.

Canada May CPI data ran hot. Headline came in 7.7% y/y vs. 7.3% expected and 6.8% in April, while common core came in at 3.9% y/y vs. 3.4% expected and a revised 3.5% (was 3.2%) in April. Headline was the highest since January 1983 . A 75 bp hike at the next Bank of Canada meeting July 13 is 85% priced in, while 50 bp hikes in September and October are fully priced in. Looking ahead, the swaps market is pricing in 225 bp of tightening over the next 12 months that would see the policy rate peak near 3.75%, down from 4.0% last week but up from 3.0% at the start of this month.

Banco de Mexico is expected to hike rates 75 bp to 7.75%. At the last meeting May 12, the bank hiked rates 50 bp to 7.0%, as expected. However, it hinted at larger hikes ahead as it noted “Given the growing complexity in the environment for inflation and its expectations, taking more forceful measures to attain the inflation target may be considered.” The vote was 4-1, with Deputy Governor Espinosa dissenting in favor of a 75 bp hike. Since then, Deputy Governor Heath has also signaled support for a 75 bp move. The swaps market is pricing in 275-300 bp of tightening over the next 12 months that would see the policy rate peak between 9.75-10.0% vs. 9.5% at the start of this month. Ahead of the decision, Mexico reports mid-June CPI. Headline is expected at 7.73% y/y vs. 7.58% in mid-May. If so, inflation would remain near the cycle highs and well above the 2-4% target range.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported weak preliminary June PMI readings. Headline manufacturing came in at 52.0 vs. 53.8 expected and 54.6 in May, services came in at 52.8 vs. 55.5 expected and 56.1 in May, and the composite came in at 51.9 vs. 54.0 expected and 54.8 in May. This composite reading was the lowest since February 2021. Looking at the country breakdown, the German composite came in at 51.3 vs. 53.0 expected and 53.7 in May and the French composite came in at 52.8 vs. 55.9 expected and 57.0 in May. Italy and Spain will be reported with the final readings July 1. The slowdown in Europe is gathering pace even as the ECB prepares for the start of the tightening cycle. Headwinds are building and despite U.S. recession fears, we continue to believe it will outperform the eurozone economy.

ECB tightening expectations have eased. WIRP suggests a 25 bp hike July 21 is fully priced in. Then, 50 bp hikes are no longer fully priced in for the subsequent three meetings September 8, October 27, and December 15. Conviction is wavering and a year-end rate of 1.0% is now priced in vs. 1.25% at the start of the week. Looking ahead, the swaps market is now pricing in 250 bp of tightening over the next 24 months that would see the deposit rate peak near 2.0% vs. 2.25% at the start of this week. Nagel and Villeroy speak today.

U.K. reported preliminary June PMI readings and public sector net borrowing. Manufacturing came in at 53.4 vs. 53.6 expected and 54.6 in May, services came in at 53.4 vs. 52.9 expected 53.4 in May, and the composite came in at 53.1 vs. 52.4 expected and 53.1 in May. We expect the PMI readings to get worse over the summer as headwinds build. PSNB ex-banking groups came in at GBP14.0 bln vs. GBP12.0 bln expected and a revised GBP21.9 bln (was GBP18.6 bln) in April. This was due largely to a surge in debt servicing to GBP7.6 bln, the most for any May on record. It’s only going to get worse as the BOE continues to tighten, with debt servicing forecast to rise to a whopping GBP19.7 bln in June. Lastly, U.K. CBI released the results of its June distributive trades survey. Retailing reported sales came in at -5 vs. -3 expected and -1 in May, while total reported sales came in at 1 vs. 13 in May. June GfK consumer confidence will be reported later today and is expected to remain steady at -40.

Norges Bank hiked rates 50 bp to 1.25%. Most analysts looked for 25 bp but nearly a quarter of the analysts polled by Bloomberg look for a larger 50 bp move. After all, 50 is the new 25. The bank warned that “In the Committee’s assessment, a markedly higher policy rate is needed to stabilize inflation around the target. Given a tight labor market, employment will likely remain high even with a higher policy rate ahead.” It also flagged a likely 25 bp hike to 1.5% at the next meeting August 18. New macro forecasts and an updated rate path were released. The new rate path suggests a steeper tightening cycle ahead as the bank now sees the policy rate peaking near 3.1% in 2024 vs. 2.5% previously. This is more aggressive than the market, as the swaps market is pricing in 125-150 bp of tightening over the next 24 months that would see the policy rate peak between 2.50-2.75%.

Turkey central bank kept rates steady at 14.0%, as expected. The only silver lining is that the bank didn’t ease, as President Erdogan recently suggested it would. The bank repeated earlier statements that it continues to review its policy framework and that additional measures are possible if needed. With headline inflation at 73.50% y/y in May and PPI at 132.16% y/y suggesting no turnaround in sight, it’s pretty clear that more measures are needed. Turkey remains an outlier within EM, as rising inflation has led virtually every major EM central bank to tightening aggressively. With the twin deficits becoming a greater issue, we believe a balance of payments crisis is unfolding that will eventually force policymakers into an orthodox policy response that include massive rate hikes.

ASIA

Former head of FX policy at Japan’s Finance Ministry Takehiko Nakao said markets shouldn’t rule out unilateral intervention. However, he added “Coordinated intervention is generally very difficult unless there’s a very excessive movement in the market, or a kind of crisis mode.” We have never ruled out unilateral intervention; we just don’t think it would be effective beyond an initial knee-jerk effect. Until the Bank of Japan pivots from its ultra-dovish stance, a weaker yen is the natural by-product. Nakao is also correct that multilateral intervention will be very difficult to muster, as yen weakness stems directly from Japan policy decisions. The yen is bid today but we think it’s more from growing risk-off impulses than fear of intervention. Elsewhere, Japan reported solid preliminary June PMI readings. Manufacturing came in at 52.7 vs. 53.3 in May, services came in at 54.2 vs. 52.6 in May, and the composite came in at 53.2 vs. 52.3 in May.

Philippines central bank hiked rates 25 bp to 2.5%, as expected. However, a third of the analysts polled by Bloomberg were looking for a larger 50 bp hike after the bank started the tightening cycle at its last meeting May 19. Outgoing Governor Diokno said the bank is “prepared to take all necessary policy actions” to bring inflation back to its target. Incoming Governor Felipe Medalla will take July 1 and has already flagged a likely hike at the next meeting August 18. The bank also raised its inflation forecast for 2022 to 5.0% vs. 4.6% in May and for 2023 to 4.2% vs. 3.9% in May. It added 2024 to the forecast horizon and inflation is expected at 3.3%. Headline inflation rose 5.4% y/y in May, the highest since November 2018 and further above the 2-4% target range. The swaps market sees 325 bp tightening over the next 36 months that would take the policy rates up to 5.75%.

Bank Indonesia kept rates steady at 3.5%, as expected. However, nearly a quarter of the analysts polled by Bloomberg had expected liftoff with a 25 bp hike to 3.75%. Governor Warjiyo said that the bank does not need to rush into hiking rates unless it sees fundamental inflationary pressures. He added that the bank forecasts inflation of 4.2% this year, above the 2-4% target “but still very low compared to other countries.” Inflation is seen moving back to target in 2023. Headline inflation rose 3.55% y/y in May, the highest since December 2017 and nearing the top of the 2-4% target range. At the last meeting May 24, the bank raised reserve requirements to 9% starting in September vs. 6.5% previously planned. We think this lays the groundwork for liftoff at the next meeting July 21.