Markets Tread Water Ahead of BOE Decision

June 24, 2021
  • Since the Fed’s hawkish hold last week, inflation expectations have fallen dramatically; Fed manufacturing surveys for June will continue to roll out; weekly jobless claims data will be reported; we get another revision to Q1 GDP; Mexico is expected to keep rates steady at 4.0%; Chile central bank minutes were on the hawkish side, confirming a hike is coming in the next few meetings
  • BOE decision will be out shortly; Germany reported firm June IFO business climate survey; Czech central bank delivered the expected 25 bp hike to 0.5% yesterday
  • Japan’s Cabinet Office maintained a steady economic outlook after last month’s downgrade; BOK Governor Lee finally took a committed step towards the hawkish side; in contrast, Bangko Sentral ng Pilipinas (BSP) offered no signs of a hawkish shift
The dollar continues to tread water as markets await fresh drivers. DXY is modestly lower but remains above the 200-day moving average near 91.505 currently. The euro is trading near $1.1950, while sterling is near $1.40 ahead of the BOE decision (see below). Lastly, USD/JPY continues to edge higher and is trading near the high for this move near 111.10. The March 2020 high near 111.70 is the next target, followed by the February 2020 high near 112.25 and the April 2019 high near 112.40.
Since the Fed’s hawkish hold last week, inflation expectations have fallen dramatically. With the nominal yield still stuck below 1.5%, this has led to a drop in the U.S. real 10-year yield to -0.86% currently from the June 16 peak near -0.75%. While the dollar has softened of late, we expect continued gains as U.S. yields should eventually break out to the upside. Perhaps tomorrow’s core PCE data will be a wake-up call for the bond market.
The Fed releases the results of its latest bank stress tests. This should be a non-event, as U.S. banks passed two stress tests last year with flying colors despite the pandemic. Elsewhere, Barkin, Bostic, Williams, Bullard, and Kaplan all speak. Yesterday, Kaplan was quite explicit in saying that tapering will start sooner rather than later and that rates will be hiked in 2022. Kaplan has emerged as one of the leading hawks on the FOMC, with several more policymakers moving into his corner. That said, we believe most Fed officials still embrace Powell’s more cautious outlook on rates, though even the Chair has acknowledged that taper talks have official begun.

Fed manufacturing surveys for June will continue to roll out. Kansas City Fed is expected at 24 vs. 26 in May. So far, Richmond came in at 22 vs. 18 in May, Philly Fed came in at 30.7 vs. 31.5 in May, and Empire survey came in at 17.4 vs. 24.3 in May. While there are modest downside risks to this week’s Fed surveys, the U.S. manufacturing sector remains in solid shape, growing but at a slightly slower pace. Markit preliminary June PMI readings were reported yesterday, with manufacturing coming in at 62.6 vs. 61.5 expected and 62.1 in May and services coming in at 64.8 vs. 70.0 expected and 70.4 in May.

Weekly jobless claims data will be reported. Initial claims are expected at 380k vs. 412k the previous week, while continuing claims are expected at 3.46 mln vs. 3.518 mln the previous week. Last week’s readings were disappointing as both series unexpectedly rose. The continuing claims data this week are for the BLS survey week containing the 12th of the month. Of note, consensus for June NFP is currently at 695k vs. 559k in May. Advance goods trade (-$87.5 bln), wholesale and retail inventories, and durable goods orders (2.8% m/m expected) will also be reported.

We get another revision to Q1 GDP. Growth is expected to remain steady at 6.4% SAAR but this is in the rear-view mirror already. Looking ahead, the U.S. growth outlook for Q2 remains strong. The Atlanta Fed’s GDPNow model forecasts Q2 growth at 10.3% SAAR vs. 10.5% previously, and it will be updated today. Elsewhere, the New York Fed’s Nowcast model currently shows Q2 growth at a more modest 3.7% SAAR vs. 4.2% previously and Q3 growth at 4.5% SAAR vs. 5.3% previously. Of note, Bloomberg consensus sees 10.0% growth in Q2, easing to 7.0% in Q3 and 4.9% in Q4, all in SAAR terms.

Banco de Mexico is expected to keep rates steady at 4.0%. Ahead of the decision, Mexico reports mid-June CPI. Headline inflation is expected at 5.89% y/y vs. 5.80% in mid-May. If so, it would mean that inflation is accelerating again after a brief period of deceleration. Markets are no longer looking for rate cuts, but rather rate hikes. Bloomberg consensus sees no more easing now, with the first 25 bp hike seen as likely in Q4. The economic outlook has gotten more uncertain due to the recent increase in virus numbers, which led Mexico City to move up from the lowest Covid-19 alert level green to the higher level yellow.

Chile central bank minutes were on the hawkish side, confirming a hike is coming in the next few meetings. The MPC discussed the option of a 25-75 bp hike at this month’s meeting. This means that it’s now just a matter of waiting for the updated macro outlook in June to decide on how to calibrate communication and the cycle itself. The economic data are improving and inflation will settle well above the 3% this year, but we still don’t think they will opt for a Brazil-style front-loaded cycle. The reason is that Chile faces huge political uncertainty with the start of constitutional convention drafting next month, so it might be wise to leave some dry powder and assess the changing landscape. The Chilean peso was one of the best performing currencies yesterday but it still has a long way to catch up with the recent performance of the Brazilian real. Next policy meeting is July 14.

Bank of England decision will be out shortly. No change is expected as this meeting seems too soon for another policy shift. At the last meeting May 6, rates were kept steady but the bank announced the start of tapering by reducing the weekly pace of asset to GBP3.4 bln, down GBP1 bln from the previous pace of GBP4.4 bln. Of note, by our calculations, the new pace would still see QE hit the GBP 875 bln limit in October. Given the bank’s intent to have QE run to year-end, this suggests another tapering is in the cards. However, this meeting seems too soon. Indeed, recent developments have dented some of the recent optimism on the U.K. recovery. Let’s see if the BOE acknowledges any of these growing risks. This will be the last meeting for Chief Economist Haldane, who was the lone vote to cut the size of QE to GBP825 bln in May and will likely be the only one again. The short sterling futures strip suggests some odds of the first hike in Q4 2021, rising significantly in Q1 to being fully priced in by Q2 2022.
Germany reported firm June IFO business climate survey. The headline rose to 101.8 vs. 100.7 expected and 99.2 in May. The current assessment rose to 99.6 vs. 95.7 in May, while expectations rose to 104.0 vs. 102.9 in May, both stronger than expected. GfK consumer confidence (-4.0 expected) will be reported tomorrow. Of note, ECB’s Panetta and Schnabel speak. Virtually all of the recent ECB speakers are in the dovish camp and so expect a lot of headlines downplaying the need to slow asset purchase. Despite the cyclical pickup in the eurozone economy, policymakers remain concerned about removing accommodation too early.

The Czech National Bank delivered the expected 25 bp hike to 0.5% yesterday. The CNB, along with the Hungarian central bank yesterday, became the first in Europe to hike. Poland is the odd one out, but we expect officials to soon start changing their tone. Not surprisingly, HUF is the top EMEA performer QTD vs. EUR, followed by CZK and then PLN, confirming the impact that monetary policy divergences will have on currencies in the short term. Governor Rusnok said rates will continue rising in H2 and warned that hikes are possible at “every coming meeting” even as he hoped that wouldn’t be necessary. Bloomberg consensus sees the policy rate at 0.75% by year-end, rising to 1.5% by end-2022. Next policy meeting is August 5.

Japan’s Cabinet Office maintained a steady economic outlook after last month’s downgrade. In its latest June report, the cabinet saw conditions still improving from an extremely low base. The cabinet upgraded its view of the housing sector but noted that spending on services remains weak. Although the government lifted its third state of emergency last week for most of the nation, there are still headwinds remaining as authorities continue to ask bars and restaurants to close by 8 PM in an effort to contain the virus before the Tokyo Olympics next month. Elsewhere, Japan reported May supermarket sales up 2.9% y/y vs. 6.0% in April.

BOK Governor Lee finally took a committed step towards the hawkish side, saying that policy normalization now expected to begin in 2021. While not imminent, we should expect the process of "orderly normalization” to start in Q4, pending more information on external demand and the virus outlook. As always, BOK officials are worried about financial stability risks from elevated household debt levels, so they won’t rush into tightening. It’s interesting to see how the Korean yield curve behaved very much like that in the U.S. in terms of steepening at the start of the year, followed by the recent sharp flattening. We suspect BOK officials are content with this outcome and expect this flattening to continue. Next policy meeting is July 15 and while no change is likely, we expect some further clarification of the bank’s forward guidance then.

In contrast, Bangko Sentral ng Pilipinas (BSP) offered no signs of a hawkish shift. The bank kept rates on hold at 2.0% for the fifth consecutive month and sees no prospect to change it. Despite some headline inflation items coming in higher, the economy is still facing many headwinds, including a weak credit outlook. The Philippine peso has performed in the middle of the pack over the last few weeks and this year as whole. Today’s meeting led to no reaction in the local fixed income markets. We believe policy is likely to remain on hold well into 2022.

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