by Marc Chandler
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There seem to be three large forces shaping the investment climate. First is the resilience of the US economy, with four consecutive quarters of above trend growth. It appears that the US economy may be expanding faster than the 2.4% annualized pace seen in Q2. Many of the largest naysayers have capitulated. Second, the monetary tightening cycle is widely seen as almost over, and many are beginning to fine tune forecasts for the first cut by the major central bank. Rate cuts by the Federal Reserve and European Central Bank are priced in for the first half of next year. Third, the poor economic performance in Europe and China is in stark contrast to the US. Europe does not appear to be considering fresh measures to support the economy. China has published several long lists of actions and reforms it will consider but investors and economists are not convinced. And every new list is a reminder that the previous list was not sufficient. It appears more like flailing than playing Go.
In a generally quiet week ahead for high-frequency data, the preliminary estimate for the August PMI stands out. The broad pattern seems clear. The manufacturing sectors have been below the 50 boom/bust for some time. The service PMI has fared better, but it too has begun to soften. As inflation falls, real rates area are seen rising. Consider that last October, the US 10-year yield peaked around 4.33%. US CPI rose by 7.7% in the year through October 2022. Subtracting inflation from the 10-year yield showed a negative "real" rate of 3.37%. Now the US 10-year yield is slightly below 4.25% and inflation is 3.2% over the past 12 months. The translates to a "real yield" of about 1%. European "real" yields are still negative. Japan's real yields are also well below zero. The dollar is on a tear, supported by a sharp rise in US rates and is forcing an equity market adjustment.
Two meetings next week will be the focus. First, the long-anticipated BRICS summit will be held August 22-24. There had been some speculation, seemingly spurred by Russian sources and caught in the echo-chamber of social media, of a gold-backed new currency or trade-settlement token. This continues to seem far-fetched and would seem to weaken Chinese and Indian attempts to boost the internationalization of their currencies. There is no major external impediment of settling more bilateral trade in local currencies, and there have been countries, like China and Brazil, talking about it for a decade. The more concrete outcome will be to broaden the membership. We suspect that wider membership will restrain whatever 'radical' impulses there may be, like it did with the Asian Investment Infrastructure Bank (AIIB). The US initially opposed it, but the UK joined over the Washington's objections and subsequently several other NATO members have joined. The AIIB seems to supplement the existing multilateral lenders and is reportedly honoring the financial sanctions on Russia. The second meeting, the Fed's Jackson Hole symposium will be August 24-26. This year's topic is "Structural Shifts in the Global Economy." Fed Chair Powell speaks a little before European markets close at the end of next week. The recent pattern has been for the markets to hear the Chair as more dovish than the FOMC statement. Yet, given that the futures market sees only about a 10% chance of a hike next month and the first cut is fully discounted in Q2 24, while the US economic data for the most part has surprised to the upside, it is difficult to envision a more dovish-inclined market.
United States: Compared with its peers and rivals, the US economy is proving surprisingly resilient. June retail sales excluding autos and gasoline rose 1% in July, the most since January and nearly matches the 1.2% increase in Q2. July industrial output and housing starts recovered from declines in June. Economists are bound to boost their forecasts for Q3 GDP from 1.5% (median projection in Bloomberg's survey). The Atlanta Fed's GDP tracker sees Q3 growth stands at 5.8% and its accuracy tends to improve as the quarter progresses. Still, in the coming days, the US is expected to report the fifth monthly decline this year in existing home sales, while new home sales may stabilize after falling by 2.5% in June. A sharp drop in Boeing orders (52 in July from 304 in June) and deliveries (43 vs. 60) will likely see July durable goods orders reverse the lion's share of June's 4.6% surge. Excluding airplanes and defense, durable goods orders may be flat.
The Dollar Index moved above the 200-day moving average (~103.25) last week for the first time this year. It is flirting with the (61.8%) retracement of the decline from the year's high set in early March (~105.90) that is found near 103.50. The late May highs ~104.40-104.70) is the next target. As one would expect after a five-week rally, the longest since May 2022, the momentum indicators are stretched. Momentum traders and trend followers will likely tighten stops on longs. It may take a break of the 102.80 area to begin forcing them out.
Japan: Alongside the stronger than expected Q2 GDP, Japan reported the deflator accelerated to 3.4% from 2.0%. However, the Japan's growth was not so much a domestic demand story, but one of stronger exports, including hospitality services (tourism). This lends support to the BOJ's argument that price pressures are not demand-driven. Still, Tokyo's CPI at the end of the week will be scrutinized. The Tokyo CPI offers a good guide to the national figures. We expect Japanese inflation to begin easing. The other focus is on the BOJ. The rise in global yields and the Q2 GDP are dragging Japanese yields higher and is near levels that the BOJ stepped to buy bonds in the market earlier this month. At the same time, the dollar is trading at levels at which the BOJ intervened last year. We do not think that the BOJ is defending a particular level. The dollar rose to its best level in nine months near JPY146.55 on August 17 and found support ahead of the weekend in front of JPY145.00. An eight-day rally has been halted by a combination stepped up efforts by China to check the yuan's decline and the pullback in the US 10-year yield from around 4.33% to almost 4.20%. Momentum indicators remain stretched, but we suspect a break of the JPY144.60 area is needed to signal an end of this bull run.
Eurozone: The preliminary August PMI is the main data point in the weekend ahead. Germany also sees the IFO August survey results. The economic malaise persists but officials seem reluctant to provide more assistance in terms of fiscal or monetary policy. The swaps market is discounting a little more than a 50% chance of a rate hike next month. The euro cannot sustain even the most minor of upticks. It has not traded above the previous session's high since August 10, and it made new lows (since July 6) before the weekend (~$1.0840). Although momentum indicators are stretched from the five-week drop, the speculative positioning in the futures market warns of the risk of more liquidation. Chart support is seen in the $1.0790-$1.0800 area and then $1.0755. The diverging economic performance could spur a test on the late May low near $1.0635.
China: Officials managing the world's second largest economy appear becoming more desperate. Several multi-prong initiatives have been announced and informal power to reduce dollar purchases and encourage dollar sales, cut mortgage rates, and deter equity sales has been exercised. The policy divergence has seen Chinese 10-year bonds trade at 170 bp discount to US Treasuries, the most since 2007. Chinese stocks are performing miserably and have given back all the gains since recent Politburo meeting. Foreign direct investment flows are slowed markedly. The 15 bp cut in the one-year Medium-Term Lending Facility signals a cut in the loan prime rates as the start of next week. Surely, Chinese officials understood that in the current context, a rate cut would spur yuan sales and encourage Chinese business to hold onto their foreign currency export earnings. We do not think Beijing is defending a specific exchange rate with the dollar, but they do seem to push against a one-way market. Of the 14 sessions so far this month, the yuan has risen in three. Reports circulated that China wanted state-owned banks to sell dollars after the yuan had fallen for five consecutive sessions and was accelerating to new lows for the year. Sometimes, Beijing is believed to do this quietly but that it allowed the word to go out suggest a higher degree of concern. Still, the yuan was sold the following day, ahead of the weekend, but the yen's extended its recovery against the dollar and seemed to help pull the yuan higher too.
UK: Last week's data, which included new cyclical high in average weekly labor earnings, a slowing of headline CPI (6.8% vs. 7.9%) but an unchanged core rate (6.9%) and a decline in July retail sales twice as large as expected (-1.2%), expectations shifted in favor of a more hawkish BOE trajectory. The swaps market had grown a bit skeptical of even a 25 bp hike, but after the flurry of data, the market now prices in about a 25% chance of a 50 bp hike. This may help explain why sterling was the only G10 currency rise against the dollar. It gained about 0.25% and the yen was the second strongest, falling by about 0.33%. Still, sterling remains mired to a roughly $1.26-$1.28 trading range and finished the week near the middle of it. The MACD has stopped falling and the Slow Stochastic has turned higher. Sterling may lead the currencies higher when the dollar's rally stalls. Outside of the PMI and CBI surveys, the UK reports on its fiscal position. The market (median in Bloomberg's survey) sees the budget deficit widening in the current fiscal year to 5.2% of GDP from 4.4% last year.
Canada: Canada added nearly 110k full-time jobs in June. Relative to the size of its economy, it would be as if US nonfarm payrolls jumped by more than a million. The question in coming week is whether the jump in jobs translates to stronger retail sales. In the first five months of the year, Canada's retail sales rose by an average of 0.2%, However, the average disguises a volatile time series. Three of the five months of data swung by 1% or more. The Canadian dollar extended is downtrend for the fifth consecutive week, the longest losing streak since April-May 2022. The greenback set a new two-month high ahead of the weekend near CAD1.3575, which met the (61.8%) retracement of its losses since the year's high was set on March 10 (~$1.3860). The momentum indicators are overextended but show little sign of turning. The next important chart areas are the Q2 highs (~CAD1.3650-70). The US dollar has not closed below the five-day moving average (~CAD1.3520) this month. Doing so could be a preliminary sign that that the run-up has stalled.
Australia: The Australian economic calendar is light outside of the flash PMI. The composite PMI fell below the 50 boom/bust level in July for the first time since March and likely remained in contraction territory this month. The Australian dollar peak at $0.6900 in June and fell to about $0.6600 before rallying back to $0.6900 in mid-July. Since then, it has fallen by around 7.75% to new lows for the year. The Aussie fell to $0.6365 last week and the measuring objective of the potential double top is closer to $0.6300. Initial resistance may be seen in the $0.6450-65 area. The five-week slide has stretched the momentum indicators, but they are still falling.
Mexico: The peso is not immune to the dollar's broad rally, but its losses have been relatively modest compared with the most other Latam currencies. This is true even if Argentina, is excluded as a special case given the devaluation. The Mexican peso is off about 1.8% this month. The Brazilian real and Colombian peso had fallen more than twice as much. The Chilean peso has fallen about 3.3% and the Peruvian sol is down about 2.9%. The peso's resilience also may be impressive given the tension between the US and Mexico over genetically modified corn. A 75-day negotiating period proved for naught. The issue is that Mexico has banned importation of GMO corn for consumption, but the lion's share of the corn imported is for animal feed, which is not prohibited. The broad sideways movement of the peso does not deter carry-trade strategies, but there is no momentum to speak of. After briefly trading below MXN17.00 at the start of the last week, the greenback was mostly a MXN17.04-MXN17.20 range last week. Mexico sees CPI figures for the first half of August on the 24th. Inflation is expected to continue to trend lower. It was slightly below 4.80% in July (and ~6.65% at the core). However, the minutes from the recent Banxico meeting a several hours later may temper any reaction. The central bank has signaled a desire to keep the overnight cash target rate at 11.25% for a protracted period, which means late in the year, at the earliest, and maybe Q2 24 at the latest (before the first cut).
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