Drivers for the Week of June 20, 2021

Here's a look at the main drivers in Developed Markets this week.
  • Markets are still digesting the Fed’s hawkish hold from last week; we believe that the central bank divergence story (driven by the underlying economic fundamentals) will be one of the major drivers for FX in H2; Fed speakers will be plentiful this week; the Fed’s preferred inflation measure core PCE for May will be reported Friday; Fed manufacturing surveys for June will continue to roll out
  • BOE meets Thursday; markets may need to reassess BOE tightening expectations in light of recent developments; there will be some minor U.K. data reported; it’s a quiet week for the eurozone; ECB asset purchases for the week ending June 18 will be reported Monday; ECB speakers are plentiful
  • Japan has a busy week; last week, the BOJ kept policy steady; Australia has a busy week; RBA Assistant Governor Ellis speaks Wednesday

The dollar remains bid in the wake of the hawkish Fed hold. Last week was the best week for DXY since April 2020, up nearly 2%. DXY traded last Friday at the highest since April 9 near 92.405, and the break above 91.946 sets up a test of the March 31 high near 93.437. Likewise, the euro broke below $1.1920 and sets up a test of the March 31 low near $1.1705. Sterling has been underperforming as U.K. virus numbers rise, and the break below $1.3890 sets up a test of the April 12 low near $1.3670. Lastly, USD/JPY is trading just above 110 after posting a new cycle high last week near 110.80. The pair is on track to test the March 31 high near 111.

Of note, AUD is leading this move lower for the foreign currencies. As is often the case, this high beta currency is the canary in a coalmine and its recent price action points to further broad-based gains ahead for the US dollar. AUD is trading at the weakest level since last December, easily breaking below the April 1 low near .7530 last Friday. Charts point to a test of the mid-November low near .7220. For comparison’s sake, EUR and GBP have both retraced about 75% of their respective Q2 rallies and are on track to test their recent lows near $1.17 and $1.3670, respectively. If AUD continues to post losses, then we believe EUR and GBP will also follow it lower.

AMERICAS

Markets are still digesting the Fed’s hawkish hold from last week. The biggest surprise for most was the curve flattening that was seen in the U.S. Markets seem to be especially fixated on the huge move in the 5- to 30-year part of the U.S. Treasury curve. This was a popular expression of the reflation trade as it captured some risks that the Fed’s credibility being challenged, and inflation would become unanchored. As a result, positioning surely has played a role in the nearly 25 bp flattening seen in June so far. Fundamentally speaking, the move seems to confirm that markets are fully embracing the narrative of short-term inflation risks that are now very likely under control thanks to a more assertive Fed. Does this mean the Fed will manage to avoid a Taper Tantrum? Stay tuned.

We believe that the central bank divergence story (driven by the underlying economic fundamentals) will be one of the major drivers for FX in H2. At the heart of the matter is that those economies that were in strong shape before the pandemic are seeing strong recoveries. These include the U.S., U.K., Canada, Australia, New Zealand, and Norway. As a result, these central banks are removing or about to remove accommodation. On the other hand, the eurozone, Japan, Switzerland, and Sweden were all struggling with deflation before the pandemic and so their recoveries are shaping up to be more vulnerable and spottier. As a result, they are nowhere near removing accommodation. The one central bank that may need a major rethink is the BOE, as this current wave of infections risks the strong recovery story that has led to heightened BOE tightening expectations. The BOE may be more cautious than markets realize but it’s still too early to say. It may give some hints at this week’s meeting (see below). This definitely bears watching, especially in light of the much weaker than expected UK retail sales reported last week.

With the media embargo over, Fed speakers will be plentiful this week. Last Friday, Bullard confirmed that Chair Powell officially opened up the tapering discussions at that FOMC meeting. Bullard, Kaplan, and Williams speak Monday. Mester and Daly speak Tuesday, while Powell testifies before Congress. Bowman, Bostic, and Rosengren speak Wednesday. Bostic, Williams, Bullard, and Kaplan speak Thursday, while the Fed releases the results of its latest bank stress tests. Mester, Rosengren, and Williams wrap things up Friday. We expect most Fed officials to embrace Powell’s tapering talk, though we know there are several officials that remain more cautious.

The Fed’s preferred inflation measure core PCE for May will be reported Friday. It is expected at 3.4% y/y vs. 3.1% in April. If so, it would be the highest since April 1992 and further above the 2% target. Of note, core PCE has not remained above the 2% target on a sustained basis since the 2004-2008 period, which is when the Fed last undertook a conventional tightening cycle. Personal income and spending will be reported at the same time and are expected at -2.7% m/m and +0.4% m/m, respectively.

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, while the New York Fed’s Nowcast model currently shows Q2 growth at a more modest 3.7% SAAR vs. 4.2% previously. The New York Fed model estimates 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. Another revision to Q1 will be reported Thursday and is expected to remain steady at 6.4% SAAR but this is in the rear-view mirror already.

Fed manufacturing surveys for June will continue to roll out. Richmond reports Tuesday and is expected to remain steady at 18. Kansas City reports Thursday and is expected at 25 vs. 26 in May. So far, 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 reports preliminary June PMI readings Wednesday, with manufacturing expected at 61.5 vs. 62.1 in May and services expected at 70.0 vs. 70.4 in May.

Weekly jobless claims data will be reported Thursday. Initial claims are expected at 380k vs. 412k the previous week, while continuing claims are expected at 3.481 mln vs. 3.518 mln the previous week. Last week’s readings were disappointing as both series unexpected 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 +685k vs. +559k in May.

Other minor data should fill out the picture of robust growth in the U.S. May Chicago Fed National Activity Index (0.70 expected) will be reported Monday. Existing home sales (-2.4% m/m expected) will be reported Tuesday. Q1 current account data (-$206.5 bln expected) and May new home sales (0.9% m/m expected) will be reported Wednesday. Advance goods trade (-$87.7 bln), wholesale and retail inventories, and durable goods orders (2.9% m/m expected) will be reported Thursday. Final June University of Michigan consumer sentiment (86.5 expected) will be reported Friday.

EUROPE/MIDDLE EAST/AFRICA

Bank of England meets Thursday. At the last meeting May 6, the bank delivered a hawkish hold. Rates were kept steady but the bank announced the start of tapering. The bank reduced the weekly pace of asset to GBP3.4 bln, down GBP1 bln from the previous pace of GBP4.4 bln. Bank officials insisted this was an “operational decision” that shouldn’t be interpreted as a shift in their policy stance. Of note, by our calculations, the old pace would see QE hit the GBP875 bln limit in September while the new pace would see QE hit the 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. 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. Of note, the short sterling futures strip suggests some odds of the first hike in Q4 2021, rising significantly in Q1 and Q2 2022 to being fully priced by Q3 2022.

Markets may need to reassess BOE tightening expectations in light of recent developments. Last week, the U.K. reported very weak May retail sales even as Covid infections continued rising. Daily new cases have risen to around 11k, the highest since mid-February despite the nation’s aggressive vaccine roll-out. With new variants spreading even as restrictions have been lifted, this would seem to justify the government’s recent decision to extend the last phase of restrictions into July. That said, the weak retail sales readings will certainly lead to some angst and second-guessing of the extension. Either way, these 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.

Ahead of the BOE decision, there will be some minor U.K. data reported. May public sector net borrowing data will be reported Tuesday. Ex-banking groups, the need is expected at GBP26.0 bln vs. GBP31.7 bln in April. Preliminary June PMI readings will be reported Wednesday. Headline manufacturing PMI is expected at 64.0 vs. 65.6 in May, while services PMI is expected at 63.0 vs. 62.9 in May, leading the composite to remain steady at 62.9. CBI reports its June industrial trends survey Tuesday, followed by its distributive trade survey Friday.

It’s a quiet week for the eurozone. Preliminary June PMI readings will be reported Wednesday. Headline manufacturing PMI is expected at 62.1 vs. 63.1 in May, while services PMI is expected at 57.9 vs. 55.2 in May, leading the composite higher to 58.5 vs. 57.1 in May. Looking at the country breakdown, the German composite is expected at 57.5 vs. 56.2 in May while the French composite is expected at 59.3 vs. 57.0 in May. Germany reports June IFO business climate (100.6 expected) Thursday, followed by GfK consumer confidence (-4.0 expected) Friday.

ECB asset purchases for the week ending June 18 will be reported Monday. Net purchases were only EUR10.8 bln for the week ending June 11 vs. EUR20.6 bln for the week ending June 4. This was about half the weekly average seen during this period of accelerated purchases and so the drop off is a little puzzling. Of note, redemptions were rather high at EUR7.3 bln and so gross purchases came in at EUR18.1 bln for the week ending June 11 vs. EUR21.3 bln for the week ending June 4. Madame Lagarde hinted at seasonal flexibility that would require fewer purchases in thin summer markets, but this seems too early. Let’s see how this week’s purchases come in before making any hasty judgments. Of note, eurozone M3 data for May will be reported Friday, with growth expected to slow to 8.5% y/y vs. 9.2% in April. If so this would be the fourth straight month of deceleration from the January peak of 12.5% y/y and is a worrisome sign for policymakers.

ECB speakers are plentiful. Lagarde speaks Monday, while Rehn, Lane, and Schnabel speak Tuesday. Guindos and Lagarde speak Wednesday, followed by Panetta and Schnabel Thursday. Hernandez de Cos speaks Friday. Virtually all of these 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.

ASIA

Japan has a busy week. May department store sales will be reported Tuesday. Preliminary June PMI readings will be reported Wednesday. May supermarket sales will be reported Thursday. June Tokyo CPI will be reported Friday. Headline inflation is expected at -0.3% y/y vs. -0.4% in May, while core (ex-fresh food) is expected at -0.1% y/y vs. -0.2% in May. Japan stands out as one of the few nations that are not experiencing significantly higher inflation.

Last week, the BOJ kept policy steady. The bank extended its emergency lending programs beyond September, as expected. It also announced that it will follow other central banks in encouraging green policies throughout the economy. The July 15-16 meeting will bring new macro forecasts but there are unlikely to be any significant changes. The latest ones from the April meeting see targeted core inflation is seen at 0.1% for FY2021, 0.8% for FY2022, and 1.0% for FY23, which was just added to the forecast horizon. Recent inflation data suggest no substantive changes in the forecasts are necessary. The bottom line is that inflation is likely to remain below the 2% target through FY23 and so the BOJ has signaled that it intends to keep policy accommodative until FY24 at least. That message won’t change at the July meeting.

Australia has a busy week. Preliminary May retail sales will be reported Monday and are expected to rise 0.4% m/m vs. 1.1% in April. Preliminary June PMI readings and May trade data will be reported Wednesday. After last week’s blockbuster jobs data for May, it’s clear that the economy is running hot right now, adding to RBA tapering expectations.

RBA Assistant Governor Ellis speaks Wednesday. RBA officials have sounded fairly upbeat recently but have not given any indications on what its plans are for QE at the July 6 meeting. We believe the RBA will extend the program at its current pace but move to a more flexible QE program subject to more frequent reviews. This would set the table for likely tapering in H2 if the labor market continues to heal. Of note, a noted RBA-watcher from Down Under is now calling for rate lift-off in early Q1 23.

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