No, Chicken Little, the Sky is Not Falling

by
Marc Chandler
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Overview: The most recent data showed that Japanese investors took advantage of the yen's strength last week to buy foreign bonds and stocks. The US weekly jobs claims to their lowest level in four weeks, suggesting that the slowdown in the labor market remains gradual. The sky is not falling. There is no emergency. With a 28% drop in Japanese bank shares in the first three sessions of the month, stress in Japan was acute, but Japanese official actions seemed to have been limited to a deputy governor of the central bank, talking in the first person. Moreover, the market continues to lean toward a hike before the end of the year. Calls for a 50 bp cut by the Fed next month seem exaggerated. The elevated volatility is already calming, the VIX has been nearly halved since Monday's high, and the concession that US notes and bonds did not offer before the refunding is coming back. That said, geopolitical risks remain elevated, where the immediate focus remains in the Middle East. The Iranian strike that looked so imminent at the start of the week has still not materialized. 

The dollar is consolidating today in narrow ranges against the G10 currencies. It is not much more than +/- 0.10% changed today. Emerging market currencies are mostly firmer. Asia Pacific equities rallied with China's markets being the notable exception. The Stoxx 600 is up about 0.8% near midday in Europe, putting it up on the week (~0.5%). US index futures are trading with a firmer bias, though remain off 2-3% on the week. European benchmark 10-year yields are 2-5 bp lower, while the 10-year US Treasury yield is off three basis points to about 3.96%. Gold is trading in a relatively narrow range (~$6-range in either side of $2423) near yesterday's high. September WTI is also in a tight range (~$75.85-$76.40) near yesterday's high and slightly below the 200-day moving average (~$76.55). 

Asia Pacific

China reported an inconsequential change in the disinflation/deflation picture. The July PPI was unchanged at -0.8% year-over-year. The July CPI was 0.5%, up from 0.2%. While the conventional narrative focuses on lackluster demand, which is surely part of the problem, it seems over-emphasized and fails to acknowledge the role of food prices (more about supply than demand), and competitive pressures, such as in autos, electronics, and household appliances, that drives prices down. Food prices were flat in July after falling 2.1% in the 12-months through June. Core prices, which exclude food and energy rose 0.4%, matching this year's low set in January. Next week, China reports July high-frequency data (e.g., lending, retail sales, industrial production, property investment, and new and existing home prices). But in the closely managed currency regime, the data should not be expected to drive the exchange rate. For that, the yen may offer better guidance. Next week, Japan is expected to report that its economy expanded by 0.6% in Q2 after contracting by 0.7% in Q1. Consumption and business investment contributed after contracting in Q1, and net exports looks to have been a smaller drag. It is likely to have little impact on expectations for the Bank of Japan. If it had previously been concerned about the inflationary implications of the depreciation of the yen, it should be less so now. Australia reports July employment data. Job growth is expected to slow by half after rising 50k in June, but the participation rate (66.9%) and the unemployment rate (4.1%) may be unchanged. The swaps market is discounting a little more than a 70% chance that the Reserve Bank of New Zealand becomes the latest G10 central bank to begin an easing cycle. 

The dollar settled firmly against the yen yesterday, even if within Wednesday's range. So far today, it is in the narrowest range for the week: ~JPY146.70-JPY147.80. The week's high was set Wednesday near JPY147.90. There is scope for additional near-term gains. The JPY148.45 area is the halfway market of the dollar's drop since July 30 high (~JPY155.20) and the next retracement (61.8%) is around JPY150. The daily momentum indicators are poised to move higher, suggest the panic is likely behind us. The Australian dollar posted a bullish outside up day and settled at its best level in two weeks yesterday on session highs near $0.6595. It edged slightly higher today and traded briefly above $0.6600 but is struggling to maintain the upside momentum. It has retraced half of its losses from the multi-month high (July 11, ~$0.6800) at $0.6575. The 200-day moving average is found at the lower end of the previous range near $0.6600. The (61.8%) retracement is slightly above $0.6625. The daily momentum indicators have turned up. It looks as if it has more room to run. With the yen pulling back after its recent surge, the Chinese yuan also moved lower. Similar to its performance against the yen, the dollar held below Wednesday's high against the offshore yuan near CNH7.1945. The offshore yuan is arguably a better funding currency than the yen. It is less volatile and there is still scope for the PBOC to ease monetary policy, while the market is continues discounting the likelihood the BOJ hikes again. The dollar can rise into the CNH7.20-CNH7.22 in the near-term. The PBOC set the dollar's reference rate at CNY7.1449, down from yesterday's CNY7.1465 fix, a new high since last November. Last Friday's reference rate was CNY7.1376. 

Europe

The eurozone and UK end the week with light economic diaries. The highlight was the decline in Q2 French unemployment to 7.3% from 7.5% and a decline in wage growth to 0.6% from 1.3%. There was little market reaction. While the light calendar will continue next week in the eurozone, the UK reports several market-sensitive data points, including an update on the labor market, and Q2 GDP, with the details for June. The market remains confident that the ECB will cut rates next month, it continues to shave the chances that the BOE moves. At the end of last week, the swaps market had almost half of a quarter-point cut discounted, and now it is closer to 40%. 

The euro posted a big outside day yesterday, but the close was well within Wednesday's range, keeping the consolidative tone intact. It is trading in an extremely narrow range of a about a fifth of a cent above $1.0910. The euro held support near $1.0880 yesterday, a new low for the week, and recovered back to the $1.0920 area. The euro settled near $1.0910 last week. Sterling looks more constructive with what could be a key reversal higher. The pound was sold through Wednesday's low, falling to its lowest level since July 2 (~$1.2680) but held above the 200-day moving average (~$1.2660). It came back sterling, settling above Wednesday's high (~$1.2735). It also closed above the five-day moving average for the first time since the end of July (~$1.2740). It has edged up slightly through $1.2770 today. Near-term potential may extend into the $1.2810-50 area, and then $1.29.

America

The US sees the results of the NY Fed's consumer inflation survey and the monthly federal budget balance. Neither tends move markets. Many talk about the US budget deficit, which remains large despite the economy growing above trend and the unemployment rate low historically, even if it has risen in recent months, but there seems to be a bipartisan disregard. Through June, the ninth month of the fiscal year, the US federal government has accumulated a $1.27 trillion deficit, down from $1.39 trillion in the Oct-June 2023. Next week is expected to see the year-over-year headline and core CPI slip slightly, a further pullback in consumption (retail sales) once the recovery in auto sales (from the June computer glitch) is taken into account, and flat industrial output. Canada's July employment report is out today. In terms of overall jobs created this year, almost 200k is running a bit below roughly 265k jobs created H1 23. However, the slowdown in the labor market is more striking looking at full-time job growth, which has slowed to about 55k this year a little more than 200k in H1 23. The unemployment rate that was at 5.4% in June 2023 stood at 6.4% in June 2024. Moreover, the participation rate has slipped to 65.3% from 65.7%. On the other hand, wage growth for permanent employees has risen to 5.5% year-over-year from 3.9% in the middle of last year. The central bank meets in early September and the market has the third cut in the cycle fully discounted. Economists and the traders were split on the outlook for the yesterday's Bank of Mexico meeting, and defying our expectation, in a 3-2 decision, it cut its target rate to by a quarter-point to 10.75%. The cut was delivered shortly after the government reported a 1.05% rise in headline CPI, the biggest jump since late 2022. The central bank revised up its forecast for headline inflation but shaved it for core inflation. The swaps market is pricing in nearly 75 bp of cuts over the next six months. 

The US dollar consolidated yesterday in the lower end of Wednesday's range against the Canadian dollar, mostly between CAD1.3730 and CAD1.3765. It slipped a little below CAD1.3720 today ahead of the employment report. The move does not seem complete. The momentum indicators are falling, and the five-day moving average is likely to cross below the 20-day moving average early next week. It is as if the market is catching its breath after nearing the (61.8%) retracement objective of the rally from the July 11 false break of CAD1.36 support, which is found near CAD1.3725. The US dollar was probing new session lows near MXN18.92 before the Banxico announced the rate cut. It popped to around MXN19.10 before being sold to new session lows near MXN18.86. The dollar's losses were expected to MN18.7750 today. The MXN18.91 is the (50%) retracement of the dollar's leg up from lows near MXN17.60 in mid-July. The next retracement (61.8%) is near MXN18.60. 

About 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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