by Marc Chandler
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Slowing US jobs growth, the third consecutive rise in the unemployment rate, and the softer than expected CPI are a watershed. Although the Federal Reserve will not cut rates when it meets at the end of the month, Chair Powell will likely lay the groundwork for a cut in September. Indeed, the Fed funds future market has priced in slightly more than a 25 bp cut. The deteriorating economic conditions dragged US two-and 10-year yields to their lowest in around three months. This weighed on the dollar and reinforced the sense that an important top for the dollar is in place. The contrast with the UK's better than expected May GDP that helped lift sterling to new highs for the year near $1.30, while the decline in US rates and speculation of Japanese intervention saw the greenback tumble from around JPY161.75 to slightly below JPY157.40. The euro pushed above $1.09 at the end of last week. The US dollar frayed support near CAD1.3600 but quickly recovered though remained capped near CAD1.3650.
The week ahead features US retail sales, which is likely to reflect softer consumer demand, and manufacturing output may have fallen for the second time in three months in June. A review of the BOJ balances will shed light on whether it intervened, but the authoritative report is not due until the end of the month. Early indications appear to confirm modest intervention did in fact take place. The UK's inflation and labor market reports will help the market decide whether the Bank of England will cut rates at its August 1 meeting. The market is nearly evenly divided. Similarly, another firmer than expected Canadian CPI may dash the building speculation of a rate cut at its July 24 meeting. The swaps market has a little more than an 80% chance of a cut discounted. The ECB meets on Thursday, and ECB President Lagarde will likely open the door to a September rate cut. China will report its estimate of Q2 GDP, but market skepticism of its veracity limits the market impact. Ideas that China's Third Plenum session will unveil new bold initiative seem to be more a case of hope than realism.
United States: The famed soft-landing of the economy is the period between the peak of a business cycle and the subsequent contraction. The soft-landing phase appears to be ending and the deceleration appears to be intensifying. The past three months saw the weakest private sector jobs growth since 2021. Despite the reshoring efforts and the US import substitution strategy, America has lost half the manufacturing jobs it grew last year. Consumption is slowing and this will be highlighted with the June retail sales report. After an anemic 0.1% increase in May, retail sales may have flatlined in June, excluding autos. The risk in on the downside given some advance credit card use figures. Auto sales in June slowed to a five-month low of 15.3 mln (seasonally adjusted annual rate). The auto inventory accumulation (60% year-over-year) may cut into production and boost incentives to clear the old models. Industrial output is likely to slow from 0.7% in May to 0.3% in June and manufacturing production may have contracted in June, which was flat in the April-May period. The Federal Reserve's anecdotal Beige Book ahead of the July 30-31 FOMC meeting is bound to pick up on the moderating economic activity and weakening pricing power of businesses. The market, as it has done several times, is pricing in more aggressive cuts that the Federal Reserve median forecast last month thought would be appropriate. After last week's CPI and PPI, the derivatives market is pricing in two cuts full and almost a 50% chance of a third. Still, it is not as dramatic as it was earlier this year when the Fed's median forecast was for three cuts this year and the market was discounting more than six. After this month's meeting, there are three FOMC meetings in the remainder of the year. It would seem the pendulum of expectations is limited barring speculation of a 50 bp move, which there was some speculation of ahead of the weekend.
Important support for the Dollar Index is at 104.00. A convincing break will strengthen conviction that a cyclical high is in place. It settled poorly and penetration seems imminent. This year's high, set in April near 106.50, was below last October's high (~107.35) underscoring the formation of a large topping pattern. We suspect DXY will return to the low seen at the end of last year (~100.60) before the end of this year. Near-term, a break of 104.00 would likely target the 103.00 area. That said, the Dollar Index settled below its lower Bollinger Band (~104.45) and some other momentum indicators are getting stretched. A bounce toward 104.65-105.00 may offer a more attractive shorting opportunity.
Eurozone
Outside of the initial CPI estimate, aggregate eurozone data tends, at least recently, to have limited market impact. Even the recent dismal German factory orders and industrial production reports did not trigger sustained euro sales. The market appears to understand that eurozone growth remains weak but positive, inflation is falling, and that will allow the ECB to cut rates probably twice here in H2 24. However, at the July 18 meeting, there is practically no chance of a change in policy. We think the most likely scenario is a cut in September and December. Those quarterly meetings are accompanied by economic updates by the ECB staff (which includes national central bank input) and would be part of a narrative about being data dependent. Shortly after the ECB meeting, the European Parliament will hold a secret ballot to pick the President of the European Commission and if von der Leyen does not win a second term, pandemonium will likely ensue that is euro negative. The French 10-year premium over Germany hung around 65 bp most of last week, which is about the middle of the range since slightly before the European Parliament elections and French President Macron's call for a snap election. The perceived reduction of tail risks took a weight off the euro, but ultimately it was the broadly weaker greenback that fueled the euro's rise.
The euro rose for the third consecutive week and will begin the new week with a three-day advance in tow. It posted its highest settlement since March 20. The single currency has risen in 10 of the past 12 sessions. It has approached the June high near $1.0915. Before that, the March high was closer to $1.0980. The 2 1/3-cent gain in the three-week rally is stretching momentum indicators. Initial support is now seen near $1.0850.
China
There are two highlights from China in the coming days: the Communist Party's Third Plenum which traditionally would have been held late last year, and Q2 GDP. President Xi has reduced the power of the state by increasing power of the party. And not just any party, but his party, what had been an important faction has taken over the party. The princelings, typically sons of the revolutionaries, used to share power with the Communist Youth League, typically ambitious young men without such connections. Xi has actively diminished Youth League's influence, and securing a third term marked the coup de grace. It the power sharing arrangement had been maintained, it was someone who came out of the Communis Youth League, turn to hold the presidency. Simply, if crudely put, China was on a path since Deng Xia Ping, and Xi has taken China down another path. Given the delay of plenum, comments by Xi, and the disappointing economic performance post-Covid, expectations, or hopes, were running high for new stimulative measures. Of course, many western critics advocate fundamental pro-market reforms, while expanding the basket of goods and services provided to society (while often advocating cutting such services in their own countries). Still, it seems unreasonable to expect Xi to fundamentally alter course now, even if some new measures to support housing or tax reform is announced. The latest curbs on short-selling announced last week follows the squeezing out of levered "market-neutral" strategies earlier this year. It signals the risk that Xi doubles down on the current strategy rather than some sort of reversal. Many are skeptical of the accuracy of much of China's data, including its GDP figures. It will report Q2 GDP early Monday. As the recent US Treasury report noted the lack of transparency and internal inconsistencies make it hard to draw hard and fast conclusions. The median forecast in Bloomberg's survey sees growth slowing in Q2 to 0.9% from 1.6% in Q1, though the stronger export figures reported before the weekend may have bolstered growth on the margins. The June details are likely to show a sequential slowing, suggesting the economy has little forward momentum going into H2.
The soft US CPI, the drop in US Treasury yields, and the recovery of the yen may have done more to help lift the yuan that the PBOC's machinations. The dollar snapped a five-week rally against the yuan, falling a little more than 0.20%, its largest weekly decline in six months. The dollar fell for the second consecutive week against the offshore yuan. It is only the third time this year that the greenback fell in back-to-back weeks. A break of CNH7.2550 area could signal a test on the CNH7.23-CNH7.24. On the top side, resistance is seen in the CNH7.2925 area.
Japan: We suspect the bar to another step in normalizing Japanese monetary policy is low. Governor Ueda appears committed to this course barring all but the dramatic shocks. The weakness in household spending, the continued decline in real wages, nor first decline in the composite below the 50 boom/bust this year pose a serious obstacle. The weakness of the yen warns of imported inflation, and the fact of the matter is that core CPI has held above the 2% target for more than two years. Tokyo's CPI, released a couple of weeks ago, warns that the national figure may have ticked up. The core rate, which excludes fresh food, is likely to have risen to 2.7% from 2.5% in May. The swaps market is pricing in only about a 50% chance of a 10 bp rate hike later this month. We suspect the risk is greater. Japan also will report June trade figures. The balance nearly always (19 of the past 20 years) improves in June from May. Counterintuitively, given the weakness of the yen and US Treasury adding Japan to its currency-watch list, Japan runs a trade deficit. In the first five months 2024, it has averaged almost JPY700 bln a month, which is about half of the Jan-May 2023 period. Exports are up 13.5% year-over-year in May, while imports rose 9.5%. Lastly, we note that Prime Minister Kishida's public support has not improved, and the fall leadership challenge means that Japan could be another G7 country with a new leader this year.
The yen strengthened dramatically after the softer than expected US CPI reading and helping to spark speculation of BOJ intervention. A BOJ report at the end of the month will confirm what took place, though some preliminary estimates suggest intervention could have been for around $22 bln (~JPY3.5 trillion). In some ways, it does not matter. The US 10-year yield did not simply fall, but it fell to a four-month low, and the market as pricing in the risk of three Fed cuts this year. That seems to be the ultimate driver. If in fact, officials intervened, it would seem to be more aggressive in the sense of selling the dollar as it was falling rather than trying to cap a rise. The greenback found new bids slightly below JPY157.50 and before the weekend had recouped nearly half of its losses before returning to the lows. Given what could be more aggressive intervention, unless US Treasury yields recover, it is difficult to see the US dollar getting much traction against the yen. It may have been expensive, but ultimately what Japanese officials bought was time, slowing the yen's descent until the US Treasury market turned.
UK: The UK economy grew by 0.4% in May after a stagnant April. Here is a case where the signal is likely in the middle. In the coming days, the UK may report firmer CPI, weaker labor market conditions, and a fall in retail sales. This as the new government settles in. British consumer prices could have put in a near-term low at 2.0% in May. The base effect (0.1% month-over-month in June 2023) signals the risk that the year-over-year rate ticks up. But more; the UK's CPI rose at an annualized rate of 1.6% in Q3 23 and 0.8% in Q4 23. The slightest of increase (0.1%) last month, puts the Q2 24 annualized pace at 2.8% up from 2.4% in Q1 24. Meanwhile, the UK's labor market is deteriorating markedly. It lost jobs in April and May. In the first five months of the year, the UK has lost an average of 2.7k jobs a month. In the first five months of 2023, it gained an average of almost 48k a month. The claimant count has increased by 67k this year after falling 14k in the Jan-May 2023 period. The three-month unemployment rate stands at 4.4%, up from 3.8% at the end of last year. Labor market conditions are easing, and wage pressure is moderating. Weekly earnings growth is like to slow further from the 6.0% 3-month year-over-year pace in April. They peaked at 7.9% last July and August. Meanwhile, UK retail sales have been unusually volatile. The 1.8%, partly weather-induced slump in April was followed by a 2.9% surge in May (with and without gasoline). A modest slowing seems likely.
Stronger than expected UK May GDP, softer US CPI, and unresolved political uncertainty in Europe (and in the US) underpinned the attractiveness of sterling. The pound reached new highs for the year against the dollar ahead of the weekend near $1.2965, and its 1.1% gain led the G10 currencies. While $1.30 offers psychological resistance, last year's high (set July 14) was near $1.3140. Sterling's 3.5-cent rally this month has stretched the technical indicators, and it settled well above its upper Bollinger Band (~$1.2920). Initial support may be encountered in the $1.2875-$1.2900 area, though the risk may extend to $1.2850.
Canada: The Bank of Canada meets on July 24. It cut rates in June, and speculation of a follow-up cut this month was scaled back after the higher-than-expected headline and underlying CPI (reported on June 25). However, the disappointing jobs report on July 5 saw expectations for a cut increase again. This week's June CPI report may decide the case. Headline improvement has stalled. It stood at 2.9% in January, and it was there in March and May. Moreover, even if headline CPI is a meager 0.1% in June the Q2 annualized rate would accelerate to 4.8% from 3.6% in Q1. Recall that Canada's CPI fell in the last four months of 2023. The underlying core measures rose on a year-over-year basis in May for the first time this year. We suspect the market is exaggerating the urgency at the Bank of Canada that requires back-to-back cuts. The smallest of upticks in the core rate could sway the market in our direction. Canada reports May retail sales at the end of the week. Gasoline prices were the key to April's 0.7% increase in retail sales, and the weakness in May is likely to see April's gains mostly reversed and expect the central bank to look through it. We already know that auto sales slower marginally in May (-0.2% month-over-month, seasonally adjusted). It was the third consecutive monthly decline.
The US dollar briefly traded below CAD1.3600 in the immediate reaction to the softer US CPI. It quickly recovered back into the narrow range that has prevailed recently that is capped near CAD1.3650. It has been a little more than three months since the greenback settled below CAD1.3600. We suspect that the near-term risk is on the upside and see potential in the coming days into the CAD1.3700-CAD1.3720 area. In the six-weeks since the end of May, the US dollar has settled lower on a weekly basis in all but the first week of June. Still, it has gone virtually nowhere net net. It ended May slightly below CAD1.3630.
Australia: Australia reports its June employment data early on July 18. Even though the unemployment rate averaged 3.9% in the first five months of the year, up from a 3.6% average in the Jan-May 2023 period, job creation is little changed. It created 163k full-time jobs this year compared with 175k in the year ago period. Overall, job creation has been nearly 205k this year compared with about 230k Jan-May 2023. Economists surveyed by Bloomberg expect about 20k jobs were created last month, which is about half of the average seen so far this year. The participation rate stood at 66.8% in May up from 66.7% in May 2023. Still, below the surface, the labor market appears to be rolling over and job postings reported fell for the five consecutive month in June and are off 17.6% from a year ago. The central bank is more concerned about inflation. The monthly CPI print spiked to 4.0% in May from 3.6% in April and 3.4% at the end of last year. The June and Q2 reading are due July 31. The futures market is putting the odds at about 40% of a rate hike this year, down from almost 53% a week ago. The May CPI surprise flipped the futures market from a small chance of a cut to a modest probability of a hike. Recall that last November, amid heightened speculation of aggressive easing by Fed, ECB, and BOE, the RBA, with Bullock having taken the helm, surprised many with a 25 bp rate hike.
The Australian dollar reached almost $0.6800 after the US CPI report, its best level since early January. The high for the year was set on the first trading day of 2024 near $0.6840. It has risen in eight of the last ten sessions and will take a four--day advance into the week ahead. Since the high was set, the Aussie found support near $0.6755. The momentum indicators are getting stretched, but we suspect the market can make another run at $0.6800 before a consolidation/corrective phase is seen. The Australian dollar's 0.5% loss this year makes it the second best G10 performer after sterling, which is up about 1.8%.
Mexico: The peso rallied for the second consecutive week for the first time in a couple of months. The recovery began before Mexico reported firmer than expected headline June CPI. It was the fourth consecutive month that the year-over-year rate increased, and at nearly 5%, it is the highest in a year. On the other hand, the core rate has continued to fall. The last time the year-over-year core rate rose was in January 2023. It was at 8.45% then and last month was less than half of that, slightly below 4.15%. The minutes from the recent central bank meeting recognized the high degree of uncertainty. We suspect that strengthening speculation of a Fed cut as early as September, and probably more than one this year, buys Mexican officials time. Investors seem most concerned about what AMLO will do in September when he has a new and stronger majority in Congress before Sheinbaum is inaugurated. But for shorter-term traders that is still more than six weeks away and the carry is still attractive and makes shorts expensive without downside momentum. The US dollar is walking down the five-day moving average, which is has not traded above since July 2. It begins the new week slightly above MXN17.83. It fell to almost MXN17.60 before the weekend, its lowest level in a month. The greenback has recorded lower highs and lower lows for eight consecutive sessions through the end of last week. The next important chart area is around MXN17.50.
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FX: The dollar
traded mostly higher last week. I suspect more near-term gains, but
I am less convinced than I was a week ago. Given the FOMC minutes
and more recent commentary from Fed officials, I suspect the market is
exaggerating the chances of two cuts this year. That had been my
leaning too, but I think the recent resilience of the labor market and
sticky inflation has shifted the views at the Fed. The futures
market is pricing in a little more than a 37% chance of a second
cut. That is down from 76% on May 17. There is room for
further adjustment. The dollar traded above JPY157 for the
first time since May 1. The market is likely to turn more cautious
as JPY158 is approached. The euro peaked on May 16, slightly
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