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Market Continues to Converge With Fed’s Forward Guidance

Market Continues to Converge With Fed's Forward Guidance

Overview:  A key development in recent days has been the market's convergence with the Federal Reserve's forward guidance regarding scope for two quarter-point hikes in the second half. The US two-yield is up about six basis points today, extending yesterday's 15 bp increase. It is approaching 5%. The Fed funds futures strip implies one hike has been fully priced in and about a third of the next one. The dollar has risen against all the G10 currencies this week but the Norwegian krone. It is mixed today (+/- ~0.20%) ahead of US data, and especially the PCE deflator. The weakness in China's PMI and Japan's industrial output contrasts with the string of stronger than expected US economic data. 

Asia Pacific equities were mixed, while Europe's Stoxx 600 is advancing for the fourth consecutive session, which snapped a six-day down draft that ended on Monday. US index futures enjoy a firmer bias. Among the large bourses, the S&P 500 is up nearly 7% this quarter compared with less than 1% gain of the Stoxx 600. The Nikkei leads with a nearly 18.4% surge. China's CSI 300 is off a little more than 5%. Europe's 10-year yields are mostly 2-3 bp firmer, but the Gilt yield has jumped seven basis points bringing the Q2 increase to more than 90 bp. The 10-year US Treasury yield is up five basis points near 3.89%, a 34 bp rise this quarter. Gold recovered from the first dip below $1900 in three months but stalled near $1910 and is now below $1905. August WTI is firm and reached a new high for the week near $70.75. It is up about 1.5% this week after falling almost 4% last week. For the quarter, it is off almost 7% after falling nearly 5% in Q1.

Asia Pacific

China's June PMI was in line with expectations. The manufacturing PMI was little changed at 49.0 (48.8 in May). It spent Q4 22 below the 50 boom/bust level and the re-opening helped lift the manufacturing PMI above 50 in Q1 and it disappointingly spent Q2 back below 50. The non-manufacturing PMI slowed for the third consecutive month (53.2 from 54.5) after improving in Q1 from below 50 in Q4 22. The composite PMI also eased for the third consecutive month (52.3 vs. 52.9). Early Monday, the Caixin PMI will be reported. Investors seem to be chomping at the bit for new supportive measures for the economy, which may not be forthcoming until later next month. In the meantime, from sentiment remains poor.

There were three high-frequency data points from Japan. First, for the first time in four months, Japan's May industrial output fell. The 1.6% decline was greater than expected (median forecast in Bloomberg's survey was for a 1.0% pullback. Softer export volumes were a drag. This likely reflects weaker demand, but also sanctions as chip fabrication equipment shipments fell. Second, the labor market was little change with the unemployment rate steady at 2.6% and the job-to-applicant ration unchanged at 1.31 (from 1.32). Third, and most importantly, was Tokyo's June CPI, which does a good job anticipating the national figures. The headline pace eased to 3.1% from 3.2% and the core measure that excludes fresh food stands at 3.2% (from a revised 3.1% in May). Excluding both fresh food and energy, consumer prices eased to 3.8% from the cyclical high of 3.9% previously. Economists had expected a small increase. Bank of Japan Governor Ueda said two things of note in at the Sintra confab this week. First, he revealed that the central bank estimates that underlying inflation is lower than 2%. Second, that if it had confidence in the price outlook for 2024, it would adjust policy. At the BOJ meeting next month (July 28), the BOJ will update its forecasts. Its latest forecast was for 2% core CPI (excluding fresh food) in 2024 and 1.6% in 2025. Note that the first thing Monday, Japan's Tankan survey results will be published. Sentiment is expected to improve slightly while capex plans may show a sharp increase.

The dollar pushed to a new seven-month high against the Japanese yen. This will be the third consecutive weekly advance but around 0.80%, it is the smallest. The dollar has fallen in only four weeks here in Q2. With the BOJ still convinced that inflation is sustained, the policy divergence is significant. What made last October intervention by the successful was that it coincided with a top US 10-year rates. Japanese officials may be playing for time. Ironically, the dollar may come off and intervention would be more effective if rates were near a peak. The US 10-year Treasury yield settled at its highest level (3.85%) since the first part of March. The year's high was set in early March before the banking stress a little below 4.10%. Last year's high, coinciding with BOJ intervention on October 21 was nearly 4.35%. The trend line connecting the Oct 22 and March 23 highs comes in slightly above 3.85%. Even though Japanese officials have made it clear that they are more concerned about the pace of the move than the level, many market participants are wary as the JPY146 area is approached because it is seen as the level of the first intervention last year. 

The dollar rose to almost JPY145 yesterday and to a little above JPY145.05 today. It is making higher highs and higher lows, i.e., it is trending higher. After punching above JPY145, the dollar was sold back to about JPY144.45 where it found new bids. The five-day moving average, now near JPY144.30, may offer a metric of the momentum. It has not closed below it nearly three weeks and when it does, it will be as momentum flags. The Australian dollar found support around $0.6660 for the third consecutive session. However, the bounce has been unimpressive, having stalled near $0.6640, which is not quite the (38.2%) retracement of the sell-off from Tuesday's high around $0.6720. The five-day moving average is closer to $0.6655 and the (50%) retracement is about $0.6660. The high before the soft CPI figures was a little shy of $0.6700. The odds of a rate hike are around 33%, which is a little above where it finished last week (~29%). Chinese officials are also leaning against the tide, trying to manage the yuan's decline. Given their opacity, the signal needs to be clear and consistent. For the fourth time this week the dollar's reference rate was set lower than the market projected (CNY7.2258 vs CNY7.2485). Still with a broadly firm dollar and rising US rates, if Chinese officials want to steady the yuan, it will have to step up its game. The dollar is trading a new high for the year and reached CNY7.2685. The high from last year, set in November, was almost CNY7.3275. It is less than 1% away.


The preliminary estimate for the June eurozone CPI was in line with expectations, rising 0.3% on the month for a 5.5% year-over-year rate (from 6.1% in May). It stood at 9.2% at the end of last year and 6.9% at the end of Q1. The 0.3% month-over-month gain means that in H1 23, eurozone CPI rose at an annualized rate of about 4.8%. Meanwhile, the core rate increased to 5.4% from 5.3%. The cyclical high was set in March at 5.7%. ECB's Lagarde gave no reason not to expect a hike at the July 27 meeting. The swaps market leans toward a September hike (~56%) but seems to be pricing in the first cut around mid-2024. Separately, the May eurozone unemployment was unchanged at 6.5%. It has not been lower during monetary union. Lastly, note that early Monday, the final June manufacturing PMI is due. The euro sold offer in response to the preliminary report on June 23 (43.6 from 44.8). It has not been above 50 since last June. 

In the UK, Nationwide reported house prices eked out a 0.1% gain in June, rather than a 0.2% decline that was expected. The year-over-year decline of 3.5% (vs. -4.0% that was forecast) is the most since 2009. Houses are work less as mortgage servicing rises. Revisions to Q1 GDP details showed less government spending and more business investment but are old to impact the capital markets. Moreover, after 0.1% quarter-over-quarter growth in Q1, the median forecast in Bloomberg's survey sees the UK economy stagnating here in Q2. The UK will also see its final manufacturing PMI on early Monday. It has not been above 50 since last August. Meanwhile, the swaps market is pricing in about an 82% chance that the Bank of England lifts the base rate by another 50 bp at the next meeting on August 3, which would take it to 5.50%. The terminal rate is seen between 6.00% and 6.25%.

The jump in US rates sent the euro to new lows for the week, after closing yesterday at its lowest level since June 14 (Fed Day). The euro has been sold through the 20-day moving average (~$1.0855) for the first time June 12 and through last week's low around $1.0845 to $1.0835. Below there, the $1.0825 is the (50%) retracement of the rally from May 31 low near $1.0635. The momentum indicators have turned down, and we suspect there is potential toward $1.0780 (61.8%) retracement in the week ahead, and possibly $1.0725 (assuming a solid even if not spectacular US jobs report). Sterling nearly retraced half of its gains since the May 25 (~$1.2310) found around $1.2580. It is trading quietly in roughly a have a cent range today above $1.2600. A break of $1.2580 targets $1.2515 next and then the $1.2400-30 support area. The momentum indicators have rolled over and the five-day moving average are set to cross over next week. It is difficult to envision the market pricing in a more aggressive BOE trajectory without more data. The next employment report is July 11, and the June CPI is on July 19. 


The string of stronger than expected US economic data continues. US Q1 GDP was revised to 2% (from 1.3%) helped by a 4.2% (from 3.8%) rise in consumption. That is the largest increase since H1 21 which was bolstered by government assistance. The 26k decline in weekly initial jobless claims was the largest fall since October 2021. It is not necessarily a clean read as it covers the Juneteenth holiday, but the decline was more than expected. The US 2-year yield shot up around 18 bp at its best to nearly 4.90% and is higher today (4.93%), the highest since the banking stress hit in March. The yield of the January Fed funds futures contract rose almost 15 bp and is now about 5.40%. This means that the market has priced in one more hike in full and has about a third of a second quarter-point hike discounted.

Ahead of what for many in the US will be a long holiday weekend, the focus is on the personal income and consumption reports. We expect two takeaways. First, spending likely slowed in nominal and real terms after increasing by 0.8% and 0.5%, respectively in April. Indeed, we think this is part of a key development we expect to emerge in H2:  slower growth led by a pullback in the consumer. Second, while the headline deflator is set to fall further (below 4% from 4.4% in April) and the base effect suggests another step decline this month. However, the core rate, is likely to be steady to firmer (4.7%). Assuming the deflators are in line with expectation, it will mean that the headline rate is rising at around half of last January-May's pace (~3.6% vs. 7.0%), while the core may be rising slightly faster (~4.8% vs. 4.6%).

The Bank of Canada meets on July 12. Ahead of the meeting there are two high-frequency data points that can help shape expectations. The first is today's April's GDP. It is "old,” but the Bank of Canada was surprised by the strength of the economy in Q1, and this will give a sense of how the economy was doing at the start of Q2. The median forecast in Bloomberg's survey calls for a 0.2% increase after a flat showing in March. The second important data point is next week's employment report. Canada lost full-time positions in both April and May. It was the first back-to-back loss of full-time jobs in two years. The Bank of Canada's decision to hike rate on June 7 was made two days before the May jobs data were reported. The swaps market is pricing in about a 60% chance of a hike next month, the most this week. Last week's peak was closer to 70%. 

The greenback surged from the nine-month low on Tuesday near CAD1.3115 and stalled yesterday slightly beyond a retracement objective and the 20-day moving average near CAD1.3280. It was sold to a new session low as Europe was closing yesterday near CAD1.3240. However, the risk is that the upside correction for US dollar is not over. The next technical target is near CAD1.3300-20   Meanwhile, the dollar remains pinned near its trough against the Mexican peso. It has not traded above its 20-day moving average since June 1. It is found a little above MXN17.20. Last week's high was near MXN17.2650 and this week's high, set Monday was about MXN17.18. Separately, the US dollar closed above the 20-day moving average (~BRL4.8485) against the Brazilian real yesterday for the first time since June 1. A trough was carved over the past week-and-a-half near BRL4.75. A move above BRL4.90 could retarget BRL5.00. 

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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