- The RBA’s hawkish surprise has global implications; May ISM services PMI was softer than expected; Fed tightening expectations remain steady; Canada highlight will be May Ivey PMI
- Eurozone inflation expectations continue to fall; Germany reported weak April factory orders; Finance Minister Simsek is reportedly trying to get a market-friendly face to head up Turkey’s central bank; Poland is expected to keep rates steady at 6.75%
- Japan reported weak April cash earnings; RBA unexpectedly hiked rates 25 bp to 4.10%; Australia also reported Q1 current account data; China has asked its largest banks to cut their deposit rates
The dollar is firm as yesterday’s mild sell-off fades. AUD is outperforming after the RBA’s hawkish surprise (see below) but the weak China outlook should cap its gains. However, that surprise sends an important message to global markets (see below). DXY is trading higher near 104.178 after trading as low as 103.816 overnight. We look for a retest of last Wednesday’s cycle high near 104.699 and then the mid-March high near 105.103. The euro is trading lower near $1.0685 after trading as high as $1.0735 overnight. We look for a retest of last Wednesday’s low near $1.0635 and then the mid-March low near $1.0515. Sterling is trading lower near $1.2410 after trading as high as $1.2460 overnight. We look for a test of the late May low near $1.2310. USD/JPY is lagging and trading near 139.35. We believe the pair remains on track to test the late May high near 141. The headwinds on the dollar (banking sector weakness, debt ceiling battle) have been resolved even as the tailwinds (strong economy and robust labor market) pick up. We look for this post-NFP rally to continue.
AMERICAS
The RBA’s hawkish surprise has global implications. Markets would do well to recognize that inflation is proving to be stubbornly high and very difficult to tame. After pausing in April, the RBA has now delivered back to back hawkish surprises as the labor market remains tight and inflation pressures remain high. Sound familiar? This is exactly what is happening here in the U.S. (and many other countries) and we continue to believe that the Fed made a mistake by signaling a skip before last week’s jobs data. Ahead of the Fed, the Bank of Canada meets tomorrow and we see risks of a hawkish surprise as well after it paused in March and April. After the Fed, the Bank of England meets and tightening expectations have risen sharply after April U.K CPI data were released. The list goes on but the bottom line is that inflation is not falling fast enough in many countries and so global liquidity will tighten even more than anticipated. This will have the usual repercussions on global growth that will weigh on risk assets
May ISM services PMI was softer than expected. Headline came in at 50.3 vs. 52.4 expected and 51.9 in April, and was the weakest since December. Employment and prices paid both fell to 49.2 and 56.2, respectively. Activity also fell to 51.5 vs. 52.0 in April. The sub-50 employment reading suggests contraction but that is clearly not what's being seen in the jobs data and so we really have to downplay the ISM report. Of note, S&P Global services PMI was revised to 54.3 vs. 54.5 previously but there is still a real disconnect between this and ISM. We don't think this moves the needle much on Fed policy but it’s certainly worth keeping an eye on. There are no U.S. data reports today.
Fed tightening expectations remain steady. WIRP suggests odds of a hike this month around 30% and those odds rise to around 80% in July. More importantly, WIRP suggests around 50% odds of a rate cut by year-end. There has been quite a bit of Fed repricing in recent weeks but more needs to be done. Due to the media blackout, there are no Fed speakers until Chair Powell’s press conference June 14. It’s going to be a close call for the Fed and the final determinant for its decision will be May CPI data next Tuesday. Consensus sees headline rising 0.2% m/m and 4.1% y/y and core rising 0.4% m/m and 5.2% y/y. Of note, the Cleveland Fed’s Nowcast model shows headline rising 0.2% m/m and 4.1% y/y and core rising 0.45% m/m and 5.3% y/y.
Canada highlight will be May Ivey PMI. It stood at 56.8 in April as the economy is showing great resiliency, similar to the U.S. April building permits will also be reported and are expected at -5.0% m/m vs. 11.3% in March. Bank of Canada meets tomorrow and is expected to keep rates steady at 4.5%. However, nearly a quarter of the analysts polled by Bloomberg look for a 25 bp hike, while WIRP suggests nearly 50% odds of a hike. Looking ahead, that hike is fully priced in for July 12, followed by nearly 40% odds of a second hike September 6 that rise to nearly 60% October 25. Similar to what we’ve seen for Fed expectations, a BOC rate cut by year-end is now totally priced out. Updated macro forecasts won’t be released until the July meeting.
EUROPE/MIDDLE EAST/AFRICA
Eurozone inflation expectations continue to fall. The monthly ECB survey showed inflation expectations for the next 12 months fell to 4.1% in April vs. 5.0% in March. For three years ahead, inflation expectations fell to 2.5% vs. 2.9% in March. The ECB will be quite happy to see these drops and will allow the doves to retain control of the narrative at next week’s meeting. WIRP suggests a 25 hike is priced in June 15, followed by another 25 bp hike in either July or September that would see the deposit rate peak near 3.75%.
Germany reported weak April factory orders. Orders came in at -0.4% m/m vs. 2.8% expected and a revised -10.9% (was -10.7%) in March. German IP will be reported tomorrow and is expected at 0.6% m/m vs. -3.4% in March. Of note, Spain reported April IP today at -1.8% m/m vs. -0.5% expected and a revised 1.3% (was 1.5%) in March. Germany and France have been weakening this year even as Italy and Spain have helped drive eurozone growth. With growing signs that the weakness is spreading south, it’s clear that the eurozone cannot escape unscathed from what is shaping up to be a broad-based global slowdown this year.
Reports suggest new Finance Minister Simsek is trying to get a market-friendly face to head up Turkey’s central bank. Even though current head Kavcioglu’s term doesn’t end until 2025, Simsek has reportedly approached Hafize Gaye Erkan for the post. Erkan has a Ph.D. from Princeton University in financial engineering and applied mathematics and held the post of co-CEO at First Republic Bank before moving to become CEO of commercial property lender Greystone last year. As we noted yesterday, moving to orthodox monetary policy would require a massive hike in the nominal policy rate to something between 45-50% in order to get a sufficiently high positive real rate. Will Erdogan really allow that? In a word, no. This is why we just can’t get too excited about the purported return of orthodoxy to the economic team.
National Bank of Poland is expected to keep rates steady at 6.75%. Minutes to the May 10 meeting will be released Friday. At that meeting, the bank kept rates steady. While Governor Glapinski said that rate cuts weren’t discussed then, he wouldn’t rule out cuts in late 2023. The market is pricing in the start of an easing cycle over the next three months, which seems too soon when headline inflation is still running at 13% and core inflation is still accelerating.
ASIA
Japan reported weak April cash earnings. Nominal earnings came in at 1.80% y/y vs. 1.8% expected and 1.3% in March, while real earnings came in at -3.0% y/y vs. -2.0% expected and -2.3% in March. Despite some highly anticipated wage increases in the annual spring negotiations, nominal wages have not kept pace with higher inflation and so real wages remain deeply in the red. No wonder household came in at -4.4% y/y vs. -2.4% expected and 1.9% in March. This will likely keep the Bank of Japan on hold for now, with no change expected at the next meeting June 15-16.
Reserve Bank of Australia unexpectedly hiked rates 25 bp to 4.10%. However, last week’s announcement that the minimum wage will be boosted 5.75% in the FY beginning July 1 had impacted market expectations, as nearly a third of the analysts polled by Bloomberg looked for a 25 bp hike to 4.10%, WIRP had suggested nearly 25% odds of a hike. And so after a pause in April, the RBA has delivered back to back hawkish surprises. The bank noted that “The board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the still very low rate of unemployment.” Looking ahead, it warned that “Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe. But that will depend upon how the economy and inflation evolve.” WIRP suggests over 10% odds of a hike July 4, rising to nearly 65% August 1 and over 80% September 5. Updated macro forecasts will come at the August meeting. Governor Lowe and Deputy Governor Bullock both speak tomorrow.
Australia also reported Q1 current account data. The surplus came in at AUD12.3 bln vs. AUD15.0 bln expected and a revised AUD11.7 bln (was AUD14.1 bln) in Q4. Q1 GDP data will be reported tomorrow. Growth is expected at 0.3% q/q vs. 0.5% in Q4, while the y/y rate is expected at 2.4% vs. 2.7% in Q4. The bank hiked despite slowing seen in the economy, which tells us that it is still very concerned about the inflation outlook.
China has asked its largest banks to cut their deposit rates. Reports suggest the request was made last week and covered a range of products, including 5 bp cuts on demand deposits and at least 10 bp cuts on 3- to 5-year time deposits. While this may boost lending activity of these banks, it’s getting to the point where policymakers are simply pushing on a string in what is shaping up to be a deflationary environment in China. Aggressive, broad-based stimulus seems unlikely right now as policymakers take a more targeted, timid approach. Perhaps part of the problem is that China may feel constrained from relying on another debt-fueled recovery when debt/GDP is rapidly approaching 300%. Either way, it’s clear that the recovery is faltering and further stimulus is likely. Looser monetary conditions in China and tighter ones in the U.S. have seen its spreads to the U.S. fall again after a period of rising. These spreads should continue to fall to the lows from last fall (and below) and would weigh heavily on the yuan.
