Drivers for the Week of July 11, 2021

Here's a look at the main drivers in Developed Markets this week.
  • This is a very important week for global markets; inflation readings will be in focus; June retail sales data Friday will be a key indicator of the real economy; U.S. Treasury note and bond issuance picks up again; Fed releases its Beige Book report for the upcoming FOMC meeting Wednesday; Fed manufacturing surveys for July will start to roll out; BOC meets Wednesday.
  • ECB President Lagarde went full Draghi; perhaps she was addressing market disappointment with its rather timid strategy review; U.K. reports some key data this week
  • Two-day BOJ meeting ends Friday with a decision; new forecasts will be released and reports suggest higher inflation will be seen; RBNZ meets Wednesday; Australia reports some key data

The dollar should recover this week. The central bank divergence trade is likely to come back into play and that’s dollar positive. The euro is likely to come under pressure given the ECB’s dovish tilt (see below), while U.K. data is likely to continue weighing on sterling. USD/JPY is the wild card. Does the yen continue to gain from risk-off impulses? If so, we would likely see the pair trade back below 110. That said, we continue to believe that the dollar smile theory may be back in vogue near-term, as the greenback should benefit both from strong U.S. data and from risk off impulses.

AMERICAS

This is a very important week for global markets. Was last Friday’s risk on backdrop for real? Or does risk off make a comeback? While the U.S. outlook continues to improve, it’s hard to ignore that many parts of the globe are going back into hard lockdowns as the delta variant spreads. U.K. data came in much softer than expected, underscoring just how difficult it is to fully recover from the pandemic. This week, we see downside risks to mainland China data in light of the abrupt PBOC RRR cut last Friday. The U.S. data have also been softer of late, but still point to continued above-trend growth across most sectors. For now, we continue to believe that the U.S. economy stands to outperform in H2, which underscores are call for continued dollar gains.

Inflation readings will be in focus. CPI will be reported Tuesday. Headline inflation is expected to fall a tick to 4.9% y/y, while core inflation is expected to pick up a couple of ticks to 4.0% y/y. This will be followed by PPI data Wednesday, where headline inflation is expected to rise a tick to 6.7% y/y and core inflation is expected to pick up a couple of ticks to 5.0% y/y.

June retail sales data Friday will be a key indicator of the real economy. Headline sales are expected -0.4% m/m vs. -1.3% in May, while sales ex-autos are expected to rise 0.4% m/m vs. -0.7% in May. The so-called control group used for GDP calculations Is expected to rise 0.4% m/m vs. -0.7% in May. Let’s take a look back at the May retail sales data. While the m/m drops were larger than expected, the large upward revisions to April largely offset the downside misses. Sales fell in May from record levels well above trend and so while one could say that May sales softened a bit, the readings were by no means weak. The same may go for June, it seems. With the labor market expected to continue improving and credit growth remaining robust, consumption should be well-supported as we move into H2.

U.S. Treasury note and bond issuance picks up again. Treasury will auction coupon-bearing debt for the first time since June 24. Sales will be front-loaded with $58 ln and $38 bln of 3- and 10-year notes to be sold Monday, respectively. $24 bln of 30-year bonds will be sold Tuesday for a grand total of $120 bln. Keep an eye on the demand metrics. At the previous auctions, indirect bidders (the proxy for foreign demand) accounted for 54.2% for the 3-year, 65.0% for the 10-year, and 64.0% for the 30-year, while bid-to-cover ratios were 2.47, 2.58, and 2.29, respectively. Since June 25, the 10-year yield has fallen from 1.54% to 1.33%, while the 30-year yield has fallen from 2.18% to 1.97%.

The Fed releases its Beige Book report for the upcoming FOMC meeting Wednesday. Since the last one was released June 2, the data have come in mixed. Chair Powell testifies before the House Wednesday and the Senate Thursday. His views are widely known right now but we suspect some will try to pin him down on the tapering timeline. Powell is likely to maintain maximum flexibility in his testimony, but we continue to expect something more definitive at either the August Jackson Hole Symposium or the September 21-22 FOMC meeting. We do not expect anything concrete to emerge from the July 27-28 FOMC meeting. Kashkari speaks Monday and Wednesday, Evans speaks Thursday, and Williams speaks Friday. At midnight Friday, the media embargo goes into effect and there will be no Fed speakers until Chair Powell’s press conference the afternoon of July 28.

Fed manufacturing surveys for July will start to roll out. Empire manufacturing and Philly Fed surveys will both be reported Thursday. The former is expected at 18.0 vs. 17.4 in June, while the latter is expected at 28.0 vs. 30.7 in June. This would continue the trend that we saw for the survey readings in June. That is, most fell but remained at historically high readings nonetheless. Of note, June IP will be reported that same day and is expected to rise 0.6% m/m vs. 0.8% in May.

Other minor U.S. data will be reported. June budget statement will be released Tuesday, where a deficit of -$205 bln is expected. Import/export prices will be reported Thursday. May business inventories, TIC data, and preliminary July University of Michigan consumer sentiment will be reported Friday.

Bank of Canada meets Wednesday. There will be updated macro forecasts at this meeting. The bank opted not to change anything at the most recent meeting June 9. However, the bank said then that it will adjust the QE program based on its “ongoing assessment of the strength and durability of the recovery.” That suggests further tapering is in the cards as the recovery continues. We expect another round of tapering this week, but given the mixed June jobs report that followed two straight months of job losses, it's going to be c lose call. Ahead of the decision, May manufacturing sales will be reported that morning. June existing homes sales will be reported Thursday, followed by June housing starts and May wholesale trade sales Friday.

EUROPE/MIDDLE EAST/AFRICA

ECB President Lagarde went full Draghi. She said the upcoming July 22 ECB meeting will now have “some interesting variations and changes.” She added that “It’s going to be an important meeting. Given the persistence that we need to demonstrate to deliver on our commitment, forward guidance will certainly be revisited.” Lagarde also said that she expects the current EUR1.85 trln PEPP to run “at least” until March 2022 but that it could then be followed by a “transition into a new format” without elaborating further. Lastly, she said “We need to be very flexible and not start creating the anticipation that the exit is in the next few weeks, months.”

Perhaps Madame Lagarde was addressing market disappointment with its rather timid strategy review. She is taking a page right out of Draghi’s playbook, which was to publicly stake out a dovish position in order to keep the hawks on the defensive. It’s clear from the divergence in tones between the ECB and the Fed that the two economies are very different situations. Like Japan, Switzerland, and Sweden, the eurozone was facing deflationary risks as it went into the pandemic and policymaker realize that those risks remain in place and are acting (or not acting) accordingly. This shift in tone should keep a lid on any euro gains near-erm. Guindos speaks Monday and Schnabel speaks Tuesday and should reflect Lagarde’s new dovishness. Eurozone reports May IP Wednesday, while May trade and final June CPI data will be reported Friday.

U.K. reports some key data this week. June CPI will be reported Wednesday. Headline and CPIH inflation are both expected to rise a tick to 2.2% y/y, while core is expected to remain steady at 2.0% y/y. With the exception of recently departed Chief Economist Haldane, most MPC member see elevated inflation as transitory. At the last decision June 24, the bank delivered a dovish hold. While no one was expecting any policy changes after it announced the start of tapering at its previous meeting May 6, the dovish tone took many by surprise. The bank warned against “premature tightening” due to its view that the spike in inflation is temporary, noting that “Financial market measures of inflation expectations suggest that the near-term strength in inflation is expected to be transitory.” The bank reiterated that it does not intend to hike rates until inflation has risen above the 2% target for a sustained period. Next BOE decision is August 5 and we expect a similarly cautious tone then. Labor market data will be reported Thursday.

ASIA

The two-day Bank of Japan meeting ends Friday with a decision. At its last meeting June 17-18, the bank extended its emergency lending programs beyond September and also announced that it will follow other central banks in encouraging green policies throughout the economy. The BOJ said the new initiative will aim to boost private-sector efforts to respond to global warming by providing cheap funds for bank lending to climate-friendly businesses. With another slug of fiscal stimulus looking increasingly likely in H2, the BOJ is likely to remain on hold for the time being.

New forecasts will be released and reports suggest higher inflation will be seen. In the April forecast, the bank saw targeted core inflation at 0.1% (0.5% previously) for FY2021, 0.8% (0.7% previously) for FY2022, and 1.0% for FY23, which was added to the forecast horizon. Even with an upward tweak to the 2021 inflation forecast, it is very likely to remain below the 2% target through FY23 and so the BOJ will continue to signal that it intends to keep policy accommodative until FY24 at least. The 2021 growth forecast may be cut due to the pandemic impact that is now stretching into H2. In April, the BOJ saw growth at 4.0% (3.9% previously) for FY2021, 2.4% (1.8% previously) for FY2022, and 1.3% for FY23

Ahead of the decision, Japan reports some key data. May core machine orders (2.4% m/m expected), June machine tool orders, and June PPI (4.8% y/y expected) will be reported Monday. Final May IP and tertiary industry index will be reported Thursday. With the lockdowns persisting into Q3, the economic data are likely to remain soft near-term.

Reserve Bank of New Zealand meets Wednesday. We see risks of another hawkish hold. At the last meeting May 26, the bank caught markets off guard by projecting the first rate hike in H2 2022. The bank saw the average OCR rising to 0.67% by end-2022, implying 1-2 hikes, and then to 1.78% by mid-2024, the end of the forecast period. That is a very hawkish rate path that quite frankly seems very unlikely. Of note, the RBNZ resumed its practice of publishing its cash rate forecasts after a pause of more than a year but stressed that the projections were “conditional on the economic outlook evolving broadly as anticipated.” This was quite a U-turn from the last meeting April 14, when the RBNZ delivered a dovish hold when it said that gaining enough confidence to remove accommodation “is expected to take considerable time and patience.” June manufacturing PMI and Q2 CPI will be reported Friday. Of note, headline inflation is expected to pick up to 2.7% y/y vs. 1.5% in Q1.

Australia reports some key data. The main event is June jobs data Thursday. 20k jobs are expected to be added vs. 115.2k in May, while the unemployment rate is seen falling a tick to 5.0%. if so, this would be the lowest since December 2019. Last week, RBA Governor Lowe characterized unemployment in the “low 4s” as full employment. If the rate continues to fall in H2, the RBA will likely have to follow the RBNZ in taking a more hawkish stance. Ahead of the jobs data, June NAB business confidence will be reported Tuesday. July Westpac consumer confidence will be reported Wednesday.

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