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Sobering PMI Readings Sap Risk Appetites

Sobering PMI Readings Sap Risk Appetites

Overview: As US markets prepare to re-open from yesterday's holiday, the dollar is trading mostly higher, though the euro and yen are steady to slightly firmer. Narrow ranges are prevailing. The Canadian and Australian dollars are exceptions and are off about 0.3%. Emerging market currencies are mostly lower, including Russia, China, South Africa, and Turkey. Final service and composite PMIs were mostly revised lower in Japan, Australia, and the eurozone, while the Caixin readings were lower than expected. 

Asia Pacific equities were weaker, led by a nearly 1.6% drop in the Hang Seng and almost a 1.9% fall in mainland shares that trade in HK. Europe's Stoxx 600 is off 0.6% after rising less than 0.1% yesterday. US index futures are trading heavily. European benchmark 10-year bonds are mostly 3-4 bp lower, though UK 10-year Gilt yield is off less than one basis point. US 10-year year Treasury yield is near 3.84%, down a little less than two basis points. Gold is firm near Monday and Tuesday's high (~$1930). A break above $1935 would help lift the technical tone. August WTI is trading above $71, seemingly encouraged by Saudi Arabia extending the unilateral 1 mln bpd cut into next month and Russia saying it will cut output by 500k bpd (though many observers are skeptical of Moscow's promises). 

Asia Pacific

China's Caixin service PMI was weaker than expected. It fell to 53.9 from 57.1. Economists expected a pullback to 56.2. This dragged the composite stands at 52.5 from 55.6. The official composite PMI is at 52.3. China's largest banks cut dollar deposit rates again. Reports indicate that several large banks cut the premium offered over SOFR (5.09%). Recently they cut one-year dollar deposit rates to 5.7% from 6.0%. Retail dollar deposits were cut earlier to about 2.8% from 4.5%-5.0%. One-year yuan deposit rates are 1.65%. Beijing is not content with the recovery and promise to provide more support and the focus is on the Politburo meeting at the end of the month. 

Meanwhile, ahead of Treasury Secretary Yellen's visit to Beijing (July 6-9) tensions are escalating rather than receding. US officials and the media try to frame the visit as a bid to improve relations. Yet, actions speak louder than words. The US is preparing new sanction on Chinese access to cloud computing services, which would require pre-authorization before serving Chinese firms. The US is also reportedly moving close to sell semiconductor chips to China without a license. In turn, China has announced new export licensing program for gallium and germanium (starting August 1), which have numerous civilian and military use, including chip fabrication and radar, and electric vehicles. US, Europe, and Japanese sanctions on chips and fabrication equipment will force Beijing to develop the capacity on its own. Similarly, even drafting the new program will likely spur the redoubling of US and other G10 countries efforts build the critical materials and processing infrastructure. This is to say that sanctions will expedite the de-coupling/de-risking.

Japan's final services and composite PMI were slightly softer than the preliminary estimates. The services PMI slipped to 54.0 from the flash estimate of 54.2 after 55.9 record peak in May. It is the first decline in the services PMI since last November. The composite PMI fell to 52.1 from 54.3 in May and the flash estimate of 52.3. The focus is elsewhere. Specifically, Japanese officials have stepped up their verbal intervention and the Nikkei reported earlier this week that Tokyo is discussions with the US Treasury. Last year's intervention was criticized by some in Washington but in the Treasury's latest report on the international economy and foreign exchange market, Japan was dropped from the watch list.

As was generally expected, the Reserve Bank of Australia kept is cash target rate steady yesterday at 4.10%. Before the central bank meets again on August 1, Governor Lowe's fate at the helm is expected to be announced. His term ends in September. An announcement was expected last month, and the Treasury now says an announcement is likely this month. The standpat decision spurred the market to push out the next hike to October, while recognizing a little better than 80% chance it is delivered in September. The year-end rate is seen near 4.48%, the lowest in about three weeks. The final services and composite PMI were also softer than he preliminary estimates at 50.3 and 50.1(from 50.7 and 50.5, respectively. Tomorrow, Australia reports May trade figures. Exports fell by an average of 0.5% in the first four months of the year. In the Jan-Apr 2022 period, exports rose by an average of 4.4% a month. Remember, it is not just about quantities but prices too. Imports rose 0.1% on average this year and averaged 2.1% a month in the first four months of last year. 

The dollar briefly and barely traded above JPY145 on June 30. As more market participants draw cautious with the dollar near levels at which there was intervention last week, and Japanese officials escalate their rhetoric, the greenback is consolidating. There are nearly $1.1 bln of options that expire there at the end of the week. Initial support is seen in the JPY143.80-JPY144.00 area. Despite the RBA's hold decision, yesterday, the Australian dollar pushed above $0.6700 to a five-day high. It stopped just shy of the (38.2%) retracement of the decline since peaking at $0.6900 on June 16 found slightly above $0.6710. There are no follow-through buying today and the Aussie eased to $0.6665. Support is seen in the $0.6640-50 area. There are almost A$1.5 bln of $0.6700 options that expire on Friday. The preliminary signs Chinese officials are seeing of stabilizing the yuan is at risk. The dollar peaked on June 30 near CNY7.2690 and pulled back to almost CNY7.21 yesterday. After the weak Caixin PMI, the dollar rose to CNY7.2455. Officials needed to drive the dollar below the CNY7.1980-CNY7.2000 area. If Beijing makes it clear that it does not want a one-way market, or through the fix makes clear, it does not want a weak yuan, and banks (state-owned and otherwise) buy yuan, should that be considered intervention? It seems similar to Fed officials in September 2021 indicating that it would soon be removing monetary stimulus, and the financial institutions sold US Treasury and the two-year note rose more than 50 bp before the Fed delivered its first hike. The PBOC set the dollar's reference rate at CNY7.1968 compared with expectations of CNY7.2149. 


On Monday, it was announced that the eurozone's manufacturing PMI was revised to 43.4 from the flash reading of 43.6. Today the service PMI was shaved to 52.0 from 52.4 (flash) and 55.1 in May. It was the second consecutive decline. The composite PMI slipped below the 50 boom/bust level to 49.9. The preliminary estimate was 50.3. It was below 50 in H2 22 but had been above it in H1 23. The new news was not in Germany and France, where the preliminary PMI estimate is fairly accurate, but in Italy and Spain, for which there is no flash estimate. Italy's services PMI fell to 52.2 from 54.0, while the composite fell to 49.7 from 52.0. The composite was above 50 since the end of last year. Spain fared better. The services PMI dropped to 53.4 from 56.7 and the composite stands at 52.6, down from 55.2. Both were below expectations. Separately, France and Spain reported stronger than expected May industrial production figures. In France, spurred by a 1.4% surge in manufacturing output (median forecast in Bloomberg's survey was for a 0.3% decline), industrial production rose 1.2%. In Spain, industrial output rose by 0.6%, besting forecasting for a 0.4% rise.

The UK's flash manufacturing PMI was upgraded from 46.2 to 46.5. The service PMI did not enjoy the good fortune and unchanged at 53.7. It was 55.2 in May. The composite was unchanged from the flash estimate of 52.8 (54.0 in May). Last June it stood at 53.7. Meanwhile, at the Bank of England, Megan Greene has replaced Silvana Tenreyro as an external member on Monetary Policy Committee. Tenreyro was a dove and has dissented from the recent string of rate hikes, including last month's decision to hike by 50 bp, preferring a steady rate. Greene appears to be less dovish and wrote in a column for the Financial Times on July 3 that "It would be a mistake for central bankers to take comfort in the notion that inflation and rates will automatically go back to the low levels we saw before the pandemic."  She cited several structural reasons to expect the nominal policy rate will settle higher than the market assume. Yet, outside of Japan, is there a major central bank that "inflation and rates" will automatically return to pre-Covid levels? Still, the strawman reveals that Greene will likely be aligned with the more hawkish members, like Catherine Mann.

The euro was initially sold to a three-day low slightly below $1.0870 but recovered to almost $1.0910. For the most part, the euro has remained in last Friday's trading range this week (~$1.0835-$1.0930). The 20-day moving average is near $1.0885, and while it has been frayed on an intraday basis, the euro has not closed below it since June 9. Still, the five-day moving average (~$1.0890) looks poised to slip below the 20-day moving average (~$1.0885) from the first time since June 12. The moving averages crossed for sterling for the first time in a month yesterday. Sterling is confined to about a quarter of a cent today above $1.2695. Last Friday's high was slightly above $1.2725. Initial support is seen in the $1.2680-90 area.


The US has a fully economic diary today. First is May factory orders and a final read on durable goods orders. Often economist emphasize the orders data excluding transportation and/or defense. However, given the recovery of Boeing orders (and the supply chain) and US arms orders in the aftermath of Russia's invasion of Ukraine, the inclusive measure be preferable. Consider that in the three months through May, durable goods orders rose by an average of 2.1% a month. This is the most since September 2020. While clearly, there are some economic indicators, like the inversion of yield curve, the contraction of money supply (M2) and the pace that the index of leading economic indicators that are recessionary, there are other indicators, like job growth, housing, durable goods shipments, and the service sector that point to a growing economy. The US will sell $46 bln of a 17-week. Monday's 3- and 6-month bills auctions were well received (at 5.23% and 5.26%, respectively), with indirect bidders taking the most since mid-April. Including a 42-day cash management bill, the US sold $172 bln of bills on Monday and another $190 bln between today's sale and tomorrow's (4- and 8-week bills). Also, more US auto sales figures are due today. Lastly, the FOMC minutes from the last month's meeting will be released, where the Fed stood pat but signaled two more hikes might be appropriate.

A risk that looms, which everyone seems to be aware of, comes from commercial real estate. Last week, the Federal Reserve, the Office of the Comptroller of the Currency, the National Credit Union Administration, and the FDIC issued "guidance" that asked banks and credit unions to work with "creditworthy borrowers" during time of financial stress. The regulators said that financial institutions should provide short-term "accommodations" (e.g., deferring payments, accepting partial payments, or modifying a loan) before the loans become problematic. This is a powerful use of authority, which sometime eludes those focusing on formal mechanisms. Beijing seems particular adept at such informal uses of power much to ire of its critics. 

The US dollar tested CAD1.3200 area yesterday, slipping through last Friday's low by a few pips. However, the support held, and the greenback has bounced toward last week's highs (~CAD1.3285). The five-day moving averaging is edging above the 20-day moving average for the first time since early June. The next area of resistance is seen in the CAD1.3300-20 area. There are options for almost $1 bln at CAD1.3300 that expire Friday. The west coast port strike (now in the fifth day) is seen hurting Canadian exports and weakening the economy, compounding the headwinds from the fires. On the back of stronger survey data, the Mexican peso rose to a marginal new 7 1/2 year high yesterday but is consolidating so far today. The US dollar fell to about MXN17.0170 yesterday. Still, it takes a break of MXN17.00 to signal a breakout from the trough it has been stuck in since the middle of June. Technical support at multi-year is elusive, but a break could target the MXN16.50 area. The carry is sufficiently rich, and the currency volatility is low enough to still reward peso longs in a sideways market.


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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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