by Marc Chandler
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The dollar appears at an inflection point. Its failure to draw much traction even as US rates rose may be an important tell. The US 2-year yield rose to a new multiyear high near 5.12%, while the 10-year yield set a new high for the year around 4.09% after the employment report. The dollar's broad gains in the second half of last month looks corrective. The underlying downtrend, which we argue began last September and October, looks set to resume. Moreover, the base effect warns of another large drop in the headline CPI on July 12. This coupled with the disappointing jobs report (209k and a downward revision of 110k in April and May) will reinforce market skepticism of not the hike later this month, but the one after that, which the Fed signaled in June.
Japan's verbal intervention and threats of action succeeded in arresting the dollar's rally near JPY145. The Tankan survey showed business inflation expectations remained over 2% over the next three years, and then the wage data was double expectations, and this helped spur a further short covering of the yen. Chinese officials appeared to use formal (the setting of the dollar's reference rate) and informal (getting banks to cut dollar deposit rate) channels to express its displeasure. According to Bard, the Google AI, the yen, and yuan have moved in the same direction against the dollar about 2/3 of the time recently (100 sessions) and longer-term (1000 sessions). China is expected to report lending and price data in the coming days, but the key to the yuan may be the greenback's overall direction.
The Reserve Bank of New Zealand and the Bank of Canada meet (July 12). The RBNZ is most assuredly on hold. The central bank has signaled as much, and the economy has entered a prolonged slump and the median forecast in Bloomberg's survey does not see quarterly growth returning until Q1 24. The Bank of Canada is a closer call. Until the outsized 109.6k surge in full-time employment reported before the weekend, the odds seemed to have been fading. We do not think there is a compelling case for back-to-back hikes and lean toward it standing pat. However, after being surprised last month, no one wants to be bitten by the same dog twice.
United States: The issue is not about rising prices in the US but the pace of moderation. The Federal Reserve is not satisfied with the pace and hence have signaled the likelihood of two more rate hikes. The ongoing resilience of the labor market gives them scope to act. The economic highlight in the week ahead is the US June CPI. The median forecast in Bloomberg's survey looks for a 0.3% increase. That would bring the H1 annualized pace to about 3.6%. Owing to the fact that last June's 1.2% surge drops out of the 12-month comparison, the year-over-year rate is expected to drop from 4.0% to 3.1%, which would be the lowest since March 2021. Recall it peaked in June 2022 at 9.1%. The June report in some ways marks the end of the low hanging fruit. Year-over-year comparisons will be more difficult in the second half of the year. In H2 22, US CPI rose at an annualized rate of about 2.8%. The core rate has not softened as much. The 12-month pace peaked at 6.6% last September. It had slowed to 5.3% in May and is expected to have slipped to 5.0% last month. If so, it would the slowest pace since November 2021. The median forecast calls for a 0.3% increase, which would put the annualized pace in H1 to a little more than 4.8%, unimpressively below the 5.0% annualized pace of H2 22. Disinflationary forces are most evident in producer prices. The year-over-year rates peaked in March 2022 at 11.7%. It stood at 1.1% in May. It could fall below 0.5% in June, given the base effect. Comparisons will prove more difficult. In H2 22, PPI rose at an annualized rate of 0.8%, with two negative monthly prints and one unchanged month.
The somewhat disappointing June job growth, and the 110k downward revision in the April and May series, are unlikely to change the Fed or market's economic assessments. The jobs market is slowing but remains strong enough to allow the Fed to hike later this month. The market remains skeptical of a second hike. The year-end effective Fed funds rate is now seen near 5.38%, which implies about a 1-in-4 chance of a second hike. The Dollar Index was sold to a seven-day low (~102.25) after the employment report. The inability of higher US rates to lend the greenback much support is an important development if sustained. The trendline connecting the May and June lows starts the new week near 102.20. A break signals a tested on the year's lows (100.80-101.00)
China: There are three reports from China in the week ahead that are important for different reasons. First, the June lending figures will likely improve sharply from May. Shadow lending dried up in May. It can be estimated by subtracting new yuan loans (CNY1.362 trillion) from the aggregate financing (CNY1.555 trillion). Shadow lending is likely to have recovered. Bank lending is also expected to have improved, but even if it meets the median forecast in Bloomberg's survey of CNY2 trillion), it will remain below average monthly gain in Q1 of CNY3.5 trillion. Still, the takeaway is lending is increasing. Second, and the reason China has scope to boost lending and ease financial conditions is that inflation is not a problem. To the contrary, deflationary forces clear. Producer prices have been falling on a year-over-year basis beginning last October. China's consumer price increases have slowed sharply from the 1.8% year-over-year pace last December to less than 1% in the three months through May, when it stood at 0.2%. The price of housing on a year-over-year basis has been falling since last October. Transportation and communication prices fell for three months through May. Food prices rose 1% year-over-year in May. While the conventional view is that low inflation reflects weak demand, but the story may be more complicated. Excess capacity is spurring competition in some sector, like autos. The modest rise in food prices seems more supply driven than demand. Housing costs are likely a reflection of the weak real estate market, which is also ailed by oversupply. The takeaway is that inflation does not stand in the way additional economic support. Third, China reports its politically sensitive trade numbers for June. Its trade surplus through May is more than a quarter larger for the first five months of 2022. This is happening despite weak exports. On a year-over-year basis, exports fell in three of the first five months of the year and the average pace has been 0.8%. Imports have been even weaker and have fallen on a year-over-year basis for seven of the past eight months. This may be picking up the impact of sanctions, falling prices, and import-substitution.
The yuan rose by a little more than 0.4% last week. It is only the fourth weekly increase since the end of Q1. Chinese officials have stepped up their defense of the yuan via the daily fix and through informal channels to get banks to cut their dollar deposit rates. The recovery of the yen on jawboning may have also helped the yuan's recovery. Still, the greenback needs to fall back below CNY7.1940-CNY7.2020 to signal anything important. The former is the 20-day moving average, which the dollar has not traded below since late April. The latter is a two-week dollar low. Recall that the dollar reached a multiyear high last November near CNY7.3275.
Canada: The Bank of Canada meets on July 12. The market was surprised by the quarter-point hike in June, which ended the "conditional pause" announced in January. Until the 109.6k surge in full-time jobs was reported at the end of last week, there did not appear to be a strong case for back-to-back hikes. The jump in full-time jobs more than offset the declines in April and May. April's GDP was flat, and if anything, May CPI was slightly softer than expected and the three-month averages of the underling core rates, which Governor Macklem referred to, drifted lower. Still, the employment data saw the swaps market increase the likelihood of a quarter-point hike to 67%, the most in two weeks.
The US dollar had fallen to nine-month lows in late June near CAD1.3115. Poor Canadian news and constructive US developments helped the greenback recoup about half of last month's losses (~CAD1.3385) that was seen a few hours before the diverging employment reports. The Loonie recovered quickly. The US dollar slipped below CAD1.3270. The next area of support is in the CAD1.3220-50 area. But the Canadian dollar is vulnerable if the central bank stands pat.
Eurozone: May industrial production and trade figures will be reported on July 13 and 14, respectively. Of the four largest EMU members, all but Italy reported their figures in recent days. After rising by 1.0% in April, industrial production likely stagnated in July. On the other hand, the eurozone trade balance has been improving on a trend basis. Consider that in the first four months of the year, its trade deficit has averaged about 1.42 bln euros a month. In the Jan-Apr 2022 period, the average shortfall was 21.4 bln euros a month. It seems reasonable not to expect a significant market reaction to either report. The data is unlikely to change views of the trajectory of the ECB. The swaps market has 90% of a quarter-point hike discounted and it is nearly as convinced of another 25 bp hike in Q4. These expectations do not hinge a view of the real economy, within reason, but prices and the will of the ECB.
Since peaking near $1.1010 on June 22 (last month's high), the euro trended lower and recorded a three-week low near $1.0835 on July 6. The disappointing US employment report saw the euro recover and close above the downtrend line (~$1.0895). It surpassed the (61.8%) retracement objective of the losses since late June (~$1.0945). It looks poised to retest last month's high. Indeed, a move above the June high would give more evidence that the euro's pullback from $1.1100 approached in late April and early May was corrective in nature, meaning that new euro highs should be expected in the second half of the year. To be sure, it is not so much about the euro itself as it is the largest and most liquid alternative to the dollar.
Japan: Producer price inflation in Japan has evaporated. It rose at annual pace of slightly more than 10% in Q4 22 and fell at annualized rate of almost 1.5% in the first five months of 2023. The manufacturing PMI show a drop in the input price index to a 28-month low. Consumer prices, which is the focus of policy are different story. The Tankan survey showed expectations for CPI to be above 2% in from the one-year outlook to five years. Meanwhile, Japanese officials are gradually climbing the intervention escalation ladder. After last year's intervention that was criticized by some US officials, Tokyo and the US Treasury are reportedly discussion the pros and cons of intervention. This seems like a diplomatic courtesy. What made last October's intervention successful was arguably the astute tactics that dovetailed with the peak in US 10-year yield. The yield remains below that peak (~4.33%) but are near the best level since the March bank stress (~3.85%) and could rise toward the year's high a little below 4.10%. While intervention is thought to be more effective if it signals a policy change, in Japan that was not the case last year. The move to widen that band took place last December and by then the dollar was around 10% below its late October peak (~JPY152). Much to the annoyance of Beijing, NATO will establish an office in Tokyo, and Prime Minister Kishida has been invited to this week's NATO Summit (July 11-12) in Lithuania.
Jawboning by Japanese officials, raising the specter of material intervention, began to deter the market from pushing the US dollar above JPY145, which is near where the BOJ is believed to have intervened last September. A strong rise in May wages (2.5% year-over-year vs. 1.2% expected) spurred speculation that the BOJ may adjust policy at the meeting later this month. The disappointing US employment report pushed on the open door and sent the greenback to almost JPY142.00. The dollar settled below the 20-day moving average (~JPY142.75) for the first time in nearly two months. The momentum indicators have turned down, and the risk is more yen shorts are covered. This could drive the dollar into the JPY138.75-JPY140 area. Tactically, this would be an opportunity for the BOJ to intervene, with the wind at their backs and the US 10-year near its highest yield in nearly eight months. However, a break in the yen's downtrend may make it difficult to explain an intervention decision to the US, with whom they are consulting.
United Kingdom: Sentiment toward the UK economy appears to be deteriorating. The recession that economists, including those at the Bank of England, warned of, has been revised away. However, it seems to be returning as UK rates rise and policy is set to tighten further in the coming months. Indeed, the swaps market has 125 bp of additional tightening discounted for H2 23. It is 90 bp higher than at the end of May. The UK reports its latest employment figures on July 11. The labor market and wage growth remain robust. Average weekly earnings, excluding bonus payments, rose by 7.2% in the three-months through April compared the year ago period. It has increased in all but two months since April 2022. The UK's monthly GDP estimate for May is due July 13. The economy eked out 0.1% growth in Q1. The economy grew by 0.2% in April. The median forecast in Bloomberg's survey is for the UK economy to have stagnated in Q2.
Even if falling house prices, the most in a decade, rising mortgage rates, and elevated inflation sours the outlook for the economy, sterling rose by a little more than 1% last week. It erased the losses of the previous two week. It reached a marginal new high since April 2022. Momentum indicators have curled up from mid-range, never having gotten to oversold territory. A move above $1.2880 likely clears the deck for $1.30. A convincing move above there would target the $1.3200-$1.3300 area. That said, a break of the $1.2725 area would be disappointing.
Australia: It is a light week for official Australian economic data. The RBA's decision last week to stand pat, the downward revision to the flash June PMI (composite now 50.1, a four-month low) and falling exports this year through May, have discouraged speculation of a hike at the next meeting on August 1. Still, a hike is fully discount in the futures market by the end of the quarter. have also been downgraded. A hike is now fully priced in for early Q4 and the year-end target rate is seen slightly a little above 4.65%, . Separately, note that the Reserve Bank of New Zealand meets on July 12. It has hiked rates at ever meeting beginning in October 2021. It has taken the case target rate from 0.25% to 5.50%. With the May hike, the RBNZ signaled the cycle is over. The swaps market has the first cut penciled in for Q2 24. Over the past fortnight, the Australian dollar has carved a shelf near $0.6600. It is flirted with $0.6700 but has been unable to settle above it since June 22. The momentum indicators have begun turning and a move through $0.6700 targets $0.6785-$0.6800 initially. At this point, only a break of $0.6600 weakens the constructive near-term outlook.
Mexico: The peso rose by nearly 5.3% in 2022 and is up 13.7% so far here in 2023. The dollar traded below MXN17.00 last week for the first time since December 2015. The appreciation of the peso has not seen the trade balance deteriorate. Exports in May were up 5.8% year-over-year, while imports were less than 1.5% higher. Exports are near record levels and worker remittance set their own record ($5.69 bln in May), up 10.7% year-over-year. Real sector data has surprised to the upside, while price pressures continue to ebb. Meanwhile, Mexico's inflation is trending lower, though still above the 3% (+/- 1%) target. The swaps market sees the first cut in Q4. On July 6, the peso slumped by more than 2% at its worst which is the most since the bank stress of early March. The combination of the jump in US rates and the strengthening of the yen spurred a sharp drop in the peso. Short yen/long Mexican peso positions have been a favorite money maker for several months for levered accounts.
Profit-taking on some of these positions also appear to help explain the dramatic price action that lifted the greenback to nearly MXN17.40 before the US jobs data, from a multiyear low near MXN16.98 on July 5. This met the (38.2%) retracement objective of the dollar's decline from the May 23 high near MXN18.00. The fundamental drivers of the peso's strength remain in place and the peso was snapped up on the setback. The dollar fell to MXN17.0730 ahead of the weekend but finished above the 20-day moving average The US dollar finished the week back below the 20-day moving average (~MXN17.1340). Some consolidation may be seen near-term. The yen's performance also may be important for re-establishing carry trades. Still, we suspect that an significant dollar low is not in place. It is difficult to talk about support or important chart points given that the dollar has not seen these levels in 6-7 years. That said, our guess is that the next leg down could see the MXN16.80-90 area.
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