by Marc Chandler
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Four drivers are shaping the investment climate. First, ahead of the run-off elections in France, the market feels more comfortable that Le Pen will not secure a parliamentary majority. The French premium over Germany narrowed to 65 bp, falling by about 14 bp last week, and arguable a supportive factor for the euro. Second, the British election was largely a foregone conclusion, and Labour did secure majority. It ought not be construed as a shift to the left as Labour received less than 2% more votes that in did in 2019 and the party's manifesto has shifted to the center, which itself appears to have moved to the right. The swaps market slightly raised the likelihood of an August cut (~68% vs. 65%), a September cut (98% vs. 88%) and two cuts this year (98% vs. 80%) over the course of the past week.
Third, the US political situation is in flux after the debate and subsequent miscues as President Biden tried to reassure voters. Many are trying to game out sectors or investments that would benefit from a Trump victory in November. The US 2–10-year yield curve has become about 10 bp less inverted from prior to the debate. There is also a risk that businesses push out investment decision until next year and defer income, which could add to the headwinds the US economy faces. That is the fourth force shaping the investment climate. Although US nonfarm payrolls were in line with expectations, a three-month average of private sector job gains slightly above 145k, a new cyclical low (January 2021). The four-week moving average of weekly jobless claims is the highest since last August. The Atlanta Fed's GDP tracker estimates Q2 GDP at 1.5%. The much anticipated but elusive turn of the US economy appears at hand, and the market is feeling more comfortable with a September rate cut and another in Q4. The dollar was pushed lower against most major currencies and still looks vulnerable. The greenback is still resilient against the yen, yuan, and Canadian dollar.
United States: With the June employment data out of the way, the focus this week shifts back to prices, with the CPI and PPI on tap. After no change in May, US headline CPI is expected to have risen by 0.1% in June. If true, the year-over-year rate can slip to 3.1%-3.2% from 3.3%. A 0.2% rise in the core rate would leave the year-over-year rate at 3.4%. Still, the three-month annualized rates are moderating, and this will bolster the Fed's confidence. The three-month annualized headline rate would ease to 1.6% in Q2 after a 4.4% pace in Q1 and 2.0% pace in Q4 23. A 0.2% rise in the core rate translates into a 2.8% annualized rate, down from 4.8% in Q1 and 3.2% in Q4 23. The markets typically are not sensitive to producer prices. However, it is of greater interest in this cycle as a few components feed into the PCE deflator. Producer prices themselves are not worrisome at less than a 2.5% year-over-year rate. We suspect the combination of evidence of a further slowing in the US labor market, including the four-week moving average of jobless claims being near their highest level since last August, and moderating price pressures, will boost the Fed's confidence and allow for a rate cut in September, barring contrary incoming information. Given monetary policy's lag effect, adjusting policy is about the conditions that likely will exist in several months, appreciating that the economy and prices do not evolve smoothly. In addition to the labor market and inflation, fiscal policy is the third big talking point. The Federal government's June budget deficit will be reported a few hours after the CPI on July 11. In the first five months of the calendar year, the US recorded a deficit of $692 bln. That is down from $743.5 bln in the Jan-May 2023 period.
The Dollar Index was turned down from the 106.00 area early last week after losing some momentum into the quarter-end. It will begin the new week with a four-day decline in tow. With the losses after the US jobs report, the Dollar Index met the (61.8%) retracement of the rally from last month's low near 104.00. The momentum indicators have turned lower. The next technical target may be near 104.50 before retesting 104.00, which it has not traded below in around three months.
Japan: Labor earnings will be reported early Monday. April's 2.1% gain has been revised to a disappointing 1.6%. Growth impulses are weak: The composite June PMI fell below the 50 boom/bust level for the first time this year. Real earnings are negative, the population is shrinking, and the older demographics are associated with less consumption. Household spending unexpectedly fell by a sharp 1.8% in the year through May. Economists had projected a small increase. Japan reports its May current account. Its surplus is running nearly twice last year's pace. This, more than the intervention, is why the US Treasury placed Japan on its currency-watch list. Yet, Japan continues to record a trade deficit. The trade deficit on the balance of payments basis was nearly JPY1.9 trillion (~$12.7 bln) in the first four months of the year. The depreciation of the yen bolsters the value of foreign earnings from past investments, like interest income, profits, royalties, licensing fees and the like. At the end of the week, Japan will finalize its estimate for May industrial output. The preliminary estimate was a 1.8% gain, following a 0.9% decline in April.
The greenback approached JPY162 in the middle of last week before pulling back to JPY160.35 before the US jobs report. The kneed-jerk bounce after the data carried it to around JPY161.15. Arguably, it was the pullback in US rates more than constructive developments in Japan that was the main consideration. The 10-year JGB yield rose for the third consecutive week and has risen 11 of the past 14 sessions. Changes in the exchange rate have a higher correlation to changes in the US 10-year yield than in changes in the US premium over Japan or Japan's 10-year yield itself over the past 30 and 60 sessions. The dollar must break below JPY160 to signify anything of importance technically. A decline in US yields, perhaps in response to soft inflation readings, could see a test on the JPY159 area.
Eurozone: Given the tactical adjustment of both the left and moderates in France, the number of three-way run-offs fell to slightly more than 100. The bottom line is investors went into the weekend vote somewhat more confident that the National Rally will not secure a majority. Speculation that President Macron will resign seem highly dubious, but a stable government may prove difficult. Yet overcoming this challenge could make it more difficult to address the other one; namely, the clash with the EC over fiscal policy. France's budget deficit last year was 5.5% of GDP the second highest after Italy within the EU. The EC's projects a 5.3% shortfall next year and 5.0% in 2025. Excessive debt proceedings have begun. The IMF issued its warning. S&P downgraded France earlier this year. Investors will likely demand a higher premium for holding French bonds than previously. Still, the use of French bonds by long-term investors, such central banks as a reserve asset and by Japanese institutional investors, could help provide some breathing space.
The euro rose for the second consecutive week for the first time since mid-May. Despite the eurozone's lowest composite PMI since last October (50.9) and shockingly poor German industrial data (factory orders -1.6% in May median forecast in Bloomberg's survey was +0.5%, and a whopping 2.5% drop in May industrial output defying expectations for a small gain), the euro saw its best level (slightly above $1.0840) since June 12. The momentum indicators are trending higher, and the five-day moving average crossed above the 20-day for the first time in nearly a month. Initial resistance is in the $1.0850-60 area. Support is seen around $1.0775.
UK: The UK reports May's monthly GDP on July 11 and details. The economy stagnated in April following 0.4% growth in March. April's steep decline in manufacturing (-1.4%) and construction output (-1.4%) are unlikely to be repeated. The economy may have grown by around 0.2%. The formation of the new government will likely dominate the talking points, though. Still, the combination of moderating inflation and slowing growth after the 0.7% Q1 surge that more than offset the contraction in Q3 23 (-0.1%) and Q4 23 (-0.3%) seems to boost the chances of a rate cut at the August 1 BOE meeting. The swaps market has about a 68% chance discounted, rising slightly above 95% at the following meeting (September 19). With weak governments several EU countries, including Germany and France, and a US drama looming on the horizon, the UK may offer relative stability. That said we note that Labour garnered about 1.6% more of the popular vote than in the last election in 2019. The Tories lost almost 20% of their 2019 vote, with Farage's Reform UK the biggest beneficiary. Its share of votes rose to 14.3% from less than 2% in 2019. It edged ahead of the Liberal Democrats for third place.
Sterling posted its first weekly rise since the end of May. It gained 1.35%, making it the third best weekly performance this year. Sterling reached nearly $1.2820 ahead of the weekend; its best level since June 12. The momentum indicators have turned higher, and the five-day moving average rose through the 20-day moving average in the second half of last week. Initial support now may be in the $1.2760 area. On the topside, June's high was near $1.2860 and the year's high, set in March, was slightly shy of $1.29. These can be successfully challenged.
China: Although many observers are skeptical of the veracity of Chinese macroeconomic data, this week's price data, lending, and trade figures will be closely scrutinized. The media and many observers see the weakness of consumer prices as a sign of weak demand. We argue that to the contrary, the key is supply. Food prices, for example, are an important drag on CPI, and this is not a function of demand. We also argue that the ferocious domestic competition, such as in autos, which generates the excess capacity that has is the source of international friction, also drives prices down and sometimes below the cost of production. Some have suggested China is exporting deflation to the US, but it is more complicated than simply looking at the prices of Chinese goods exports to the US (~-4% from early 2022 levels). For example, the lower import costs might not be passed on to the consumer but could translate to wider profit-margins. In addition, those goods may have a low weight in the US CPI and PCE baskets.
The Chinese yuan fell for the fifth consecutive week. The dollar's high for the year was set in the middle of last week near CNY7.2735. The greenback's low for the week was seen ahead of the weekend slightly below CNY7.2655. A convincing break of CNY7.2600 could signal a top is in place, but it would likely be part of the broader dollar pullback, and probably a break of JPY160. Against the offshore yuan, the greenback reached almost CNH7.3115 in the middle of last week before falling a little below CNH7.28 before the weekend, to trade below the 20-day moving average for the first time since June 12. However, as the dollar pared the losses spurred by the employment data, it resurfaced above CNH7.29.
Canada: Canada has a light economic calendar in the week ahead, with only existing home sales (June) and permits (May) are due. It is probably for the better, as the recent string of real sector data has disappointed. Canada reported a goods trade deficit in May, its third consecutive shortfall. Exports fell by 2.6% to the lowest level since July 2023. In volume terms, exports were off 1.7% (imports fell 1.3%). The June composite PMI fell to 47.5 from 50.6, its lowest reading in Q2. Before the weekend, Canada reported a 1.4k decline in overall employment, and a 3.4k loss of full-time positions. It is the first back-to-back loss of full-time jobs in three years. The unemployment rate rose to 6.4% from 6.2%. It was at 5.8% at the end of last year. It was particularly disheartening as the participation rate dipped to 65.3% from 65.4%. The central bank will not like that the hourly wage rate of permanent employees rose to 5.6% from 5.2% (5.3% expected). It is back to the cyclical high set at the end of last year (5.65%). The swaps market is pricing in almost a 62% chance of a Bank of Canada rate cut when it meets on July 24. The odds stood near 45% at the end of June.
The Canadian dollar was the only G10 currency to fall ahead of the weekend. The price action reinforces the significance of the CAD1.3600-CAD1.3800 range. The US dollar began last week testing the CAD1.3750 area and ahead of the weekend matched its lowest level since May 20, slightly above CAD1.3600. After the employment data, the greenback recovered to approach the CAD1.3660 area. A move above there could see CAD1.3680-CAD1.3700, and then CAD1.3750.
Australia: Australia has a light calendar in the coming days. The risks of a rate cut have risen following the higher-than-expected monthly May CPI print (4.0% vs. 3.6% in April) and the May retail sales (0.6% vs. median forecast in Bloomberg's survey for a 0.3% increase). The futures market is pricing in slightly more than a 20% chance of an August hike. As recently as mid-June, the market had a small bias toward a cut. The odds of a cut at the September RBA meeting doubled in the past two weeks to 50%. The Reserve Bank of New Zealand meets on July 10. It has previously indicated that as the long as the economy evolves as it expects, there will be no need to cut rates this year. The market is more dovish, and the swaps market is discounting about a 60% chance of a cut in October, and it is fully discounted in November, the last meeting of the year.
The Australian dollar has quietly strung together a four-week advance, its longest since last 2022/early 2023. It broke out of the $0.6600-$0.6700 trading range and reached $0.6750 ahead of the weekend, its best level since January. The $0.6700 area should now offer support, and near-term potential may extend above $0.6800. The momentum indicators are trending higher, and the five-day moving average has been above the 20-day moving average since mid-June. However, the move has been so sharp that the Aussie has closed above its upper Bollinger Band for three straight sessions. Over the past month, the Australian dollar appreciated by about 3.6% against the New Zealand dollar and poked above NZD1.10 before the weekend, and it reversed low. It held above NZD1.0980. Still, position adjustment ahead the RBNZ meeting could see NZD1.0930-50.
Mexico: Investors and businesses are still trying to figure out the policy outlook in Mexico, knowing are the gap between the sitting of the new legislature and the new president, and trying to decipher intent of the new administration. The market remains on edge. The non-commercials (speculators) in the futures market have roughly halved their net long peso position from before the election, but they are still long around 60k contracts (~$1.6 bln). Mexico reports June CPI on July 9. The bi-weekly estimates tend to mute the response to the monthly data. Moreover, Banxico will see the July CPI print a few hours before the next meeting on August 8. The pace of improvement has slowed, and the central bank recognized it explicitly and with its updated forecasts. Nevertheless, central bank Governor Rodriquez kept the door open to lower rates later this year and the swaps market has around 45 bp of cuts discounted before the end of the year. President-elect Sheinbaum's cabinet announcements have not antagonized investors, and a technically experienced and competent.
Last week, the dollar gave back the 1.1% gain it scored against the Mexican peso in the last week of June. However, the greenback found support at MXN18.00. Latam currencies, which underperformed emerging market currencies in June, outperformed last week. Four of the top six EM currencies last week, were from the region and the Brazilian real's 2.4% rally led the way. On the other hand, the Argentine peso was the worst performer (~-0.5%) after the Russian ruble that saw an outsized 2.5% decline. One-month implied peso volatility eased below 14% last week. The low since the election is about 13%. It was around 10% before the election. Initial resistance may now be near MXN18.20. Support is seen near the late June lows (MXN17.8750-MXN17.8900).
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July is about the Olympics and reaping what was sown in June. The UK and France will have new governments. There will be a new European Commission. China will hold its Third Plenum session, out of which many expect new measures to support the economy.The Bank of Japan may announce a plan to reduce its bond purchases, which are approximately the same as the amount maturing every month and hike rates at the end of July. Reducing its JGB holdings is another step in the normalization of Japanese monetary policy. Despite the weirdly early US presidential debate at the end of last month, before either candidate was formally confirmed, the market’s focus may not turn to US politics until September. In further evidence of a closely divided Federal Reserve, last month’s Summary of Economic
June 2024 Monthly
2024-06-01
There
are two forces that shape the investment climate: politics and economics, and
they are both at the fore in the coming weeks.Among the highlights will be the European
Central Bank meeting that will mostly likely begin its easing cycle. The Bank of
Canada is a close call. If it does not cut rates in June, it will probably do
so in July. The Swiss National Bank may deliver its second hike in the cycle,
while the Bank of England will likely continue to prepare the ground for a cut
in the second half.Four months ago, the market was still
pricing in two rate cuts by the Federal Reserve by the end of the first half.
While giving up on the notion, the derivatives market has one cut fully
discounted late this year and almost a 50% chance of a second
cut. In the March Summary of Economic
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