by Marc Chandler
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Bank shares rose in Japan and Europe for the second consecutive week, but the KBW US bank index fell nearly 2% after increasing 4.6% in the last week of March. Emergency borrowing from the Fed remains elevated ($149 bln vs. $153 bln). Bank lending has fallen sharply (~$105 bln) in the two weeks through March 29. This appears to be a record two-week decline. Commercial and industrial loans had fallen a little in the first two months of the year (before the bank stress become apparent). At the same time, the Fed's balance sheet continues to shrink. Over the past two weeks, it has fallen by a little more than $100 bln.
The US two-year yield was above 5% before the flare-up of banking stress and dropped to 3.55%. It bounced to peak near 4.17% at the end of March but tumbled back to around 3.65% last week on disappointing US data and the banking pressure. The Fed funds futures imply a year-end rate of about 4.18%, up from the 3.37% low reached in mid-March but still sharply below the 5.55% peak seen on March 9. The dollar found less traction than we had expected, given the recovery in short-term rates. Still, we expect the dollar to correct higher in the coming days.
The week ahead highlights include US March CPI. The headline may slip below 5.5% from 6% in February as last March's 1.0% monthly gain drops out of the 12-month comparison. However, the core rate looks poised to rise year-over-year for the first time since last September. China reports its inflation gauges and the politically sensitive trade balance. Consumer price pressures may tick up a little but remain modest, around 1.2%, while deflationary forces likely strengthened producer prices. China's exports have been falling year-over-year since the start of Q4 22, and the March surplus may be 10% smaller than reported for March 2022. The Bank of Canada meets on April 12, and there is little reason to expect a change from its standpat stance articulated in late January. Lastly, Australia's labor market report is unlikely to repeat the strength seen in February when it created almost 75k full-time positions after averaging nearly 43k a month in 2022.
United States: A 0.3% increase in March CPI would mean that US consumer prices rose at an annualized rate of about 4.8% in Q1 23 after a 3.2% pace in Q4 22 and 2.4% in Q3 22. Fed officials will be unhappy with the lack of improvement in the core measure. A 0.4% increase in March translates into a 5.2% annualized rate in Q1, accelerating from 4.0% in Q4 22. The year-over-year rate would edged back to 5.6% from 5.5%. Retail sales are expected to have fallen in March for the fourth time in the past five months. While the PMI and ISM surveys warn of a contracting manufacturing sector, industrial output is expected to have edged up in March, but even with a 0.1-0.2% increase, the gain in Q1 23 is not sufficient to offset the decline in Q4 23 (~1.6% vs. -2.5%). The US also reports producer prices and import/export prices, which typically are less impactful than the CPI. Still, unchanged producer prices in March (which translates into about a 0.8% annualized pace in Q1) could see the year-over-year rate fall to around 3.5%, the lowest since February 2021. The University of Michigan publishes its preliminary April results. The long-term (5-10 year) inflation expectation (median) has been stable at 2.9% since mid-2022, including the last four months. It seems anchored, though it averaged 2.5% in 2018 through 2020. Meanwhile, the US banking stress continues to appear contained. Still, the knock-on effect from reduced lending is a crucial transmission channel to other parts of the economy. The March employment report showed slower job growth and a downward trend in average hourly earnings.
The Dollar Index has been trending lower since reaching 105.90 on March 8. It recorded a low last week near 101.40. It has fallen for four consecutive weeks and five of the previous six. And the week that it rose (the week ending March 10), it posted a gain of less than 0.1%. So it is "due" for a bounce. The momentum indicators are beginning to turn higher. A move above 102.50 targets 103.00-25.
China: Data from the world's second-largest economy is notable, but not because of its market impact. Indeed, the currency is managed in a way that seems immune to the vagaries of high-frequency economic data. China may have been spared most of the volatility stemming from the banking stress in the US and Europe, but it is not because it does not have its own banking/debt challenges, as the property market illustrates. Lending appears to have soared in Q1 23 to a record of CNY13.8 trillion (~$2 trillion) and may have exceeded Q1 22 by as much as 15%. It has also deviated from the other large countries by not experiencing a sustained rise in inflation. Indeed, it was temporary. CPI peaked at 2.8% last September and fell to 1.0% in February. Food prices are the key driver. Prices are expected to have a 1.2% year-over-year gain in March, which means inflation does not stand in the way of monetary easing should the recovery falter. Meanwhile, producer price deflation is expected to have deepened in March. Producer prices on a year-over-year basis turned negative in Q4 22, and the March print is expected to be -2.4%, matching the biggest decline since June 2020. No longer are people trying to link China's PPI to US CPI. Falling producer prices, though, warn of a squeeze on income for an important part of the economy.
Chinese exports have lost momentum and have fallen on a year-over-year basis, likely declining for a sixth consecutive month in March. Still, think about the performance. In March 2021, exports rose nearly a third from the previous March. It was a recovery in foreign demand after the Covid shock and supply chain disruption. In March 2022, exports were another 14% higher year-over-year. Last month, exports were expected to have declined by nearly 7.5% year-over-year. In yuan terms, exports have still softened but less dramatically. In fact, they were up 5.2% from a year ago in February. China's trade balance tends to be noisy in the first part of the year but often improves. Still, the weakness seen in the manufacturing PMI, especially the Caixin iteration, suggests the softness of exports continued. The median forecast in Bloomberg's survey calls for a $40 bln March surplus, broadly in line with the March 2022 surplus of almost $44.4 bln.
The Chinese yuan was virtually flat last week, and the dollar was confined to a narrow trading range (~CNY6.8660-CNY6.8945). In fact, over the past two weeks, the greenback has been remarkably steady. The dollar has fallen for six consecutive weeks against the euro and five of the past six weeks against the Japanese yen. Moreover, it has fallen in four of the past six weeks against the yuan. Still, the rolling 30-day correlations between the yuan, euro, and yen changes remain notable at 0.63 and 0.54, respectively. This is off their best levels but still suggests the PBOC is allowing the yuan to mostly shadow the broad dollar movement.
Canada: The Bank of Canada meets on April 12. It acknowledges that the economy has begun the new year more resilient than expected but, apparently, not sufficiently to prompt it to change interest rates. The March employment data were mostly better than expected. The 34.7k increase in employment was nearly five-fold higher than the median forecast in the Bloomberg survey, and it was almost evenly split between full- and part-time positions. Although the participation rate unexpectedly slipped (65.6% vs. 65.7%), the unemployment rate held steady at 5.0%. The hourly wage for permanent employees slowed to 5.2% year-over-year from 5.4%. The stimulative fiscal efforts by the government (central and provincial) are seen hampering the central bank's efforts to rein in inflation. Still, the swaps market thinks that the Bank of Canada is done raising rates and has the first cut fully priced in by early Q4.
The US dollar snapped a six-day decline on Tuesday and will take a four-day advance into the start of next week. It reached CAD1.3530 after the US employment report. The momentum indicators are curling up. A move above the CAD1.3550-60 area could spur gains toward CAD1.3600-20.
Eurozone: Aggregate February retail sales and industrial output figures are due for release, but they are not market movers. In volume terms, retail sales look soft after a 0.3% gain in January. On the other hand, industrial output could surprise on the upside after stronger readings from Germany (2.0%) and France (1.2%). That said, the reports lend credence to our view that the market is too pessimistic about activity here in Q1. The Bloomberg survey from mid-March found a median forecast of a 0.1% quarter-over-quarter contraction in the eurozone in Q1. This is an improvement from -0.2% in the previous survey, but so far, most data points to expansion. As a result, the swaps market sees another 50 bp of hikes by the end of Q3.
The euro recovered from last Monday's low, slightly below $1.0790, to approach $1.0975 before stalling. That was its best level since the Q1 high was recorded on February 2, near $1.1035. The rally from the March 15 low (~$1.0515) has stretched the momentum indicators, which are turning lower. The initial target is near $1.08, where the 20-day moving average is found and the (38.2%) retracement of the advance from mid-March. A convincing break of $1.07 weakens the technical outlook.
Japan: The Tankan survey and the PMI show Japan's manufacturing sector is struggling. However, the service sector is improving, and capex is improving. The 60-day rolling correlation between changes in the exchange rate and the 2-year US yield remains firm, around the middle of a 0.45-0.55 range that has largely been in place since last August. The correlation with the US 10-year yield has risen to about 0.47, this year's high, from almost 0.35 in late January, the lowest since early Q2 21. The week's data highlights include March machine tool orders and bank lending figures. Japanese bank shares continued to recover. Recall that after the multiyear high was set on March 9, the Topix bank index tumbled nearly 19% the following week. It has recouped more than a third of those losses. Japan will report its February current account to start the new week. It has not failed to improve from January since at least 1996. Japan's trade balance (on the balance of payments basis) posted a record deficit in January (~JPY3.18 trillion or ~$24 bln). A new era will begin on April 8 as BOJ Kuroda's 10-year (two terms) ends. The new leadership, led by Ueda, is expected to adjust policy with many seeing the first moves in June-July. The swaps market is pricing in a year-end overnight rate of almost 10 bp compared with the current target of -10 bp and an effective rate about half of a basis point.
The dollar peaked at the start of last week near JPY133.80, the (50%) retracement of its decline from the March 8 high (almost JPY138). Although it pulled back (~JPY130.65 at midweek), the upside correction does not appear over. A push above last week's high could signal a test on the upper end of the recent range (~JPY134.75-JPY135.00).
United Kingdom: Economists were most pessimistic about the outlook for the UK economy among the G10 countries. Yet, it has been surprisingly resilient, and after spending six months through January below the 50 boom/bust level, the composite PMI rose to 52.2 in March, its best level since last June. January's monthly GDP surprised on the upside (0.3% vs. the median forecast in Bloomberg's survey for 0.1%). The UK reports February GDP figures and details on April 13. Recall that in February 2022, the British economy contracted by 0.1% and stagnated for the following two months. The market is pricing about a 70% chance of another hike by the Bank of England when it meets next on May 11. Sterling rose last week to its best since June 2022, pushing up to $1.2525 after stalling near $1.2450 for the past few months. Sterling drifted lower in the second half of last week and slipped to $1.2390 in thin pre-weekend activity. It nevertheless closed higher for the fourth consecutive week. It has come a long way since setting the low in Q1 on March 8, near $1.18. The momentum indicators are stretched and rolling over. The $1.2300-30 area may offer initial support and then $1.2250-70.
Australia: The Reserve Bank of Australia did not hike rates last week, and the market thinks it is done, even if the central bank preserved some wiggle room. The most important high-frequency report in the week ahead will be the jobs data on April 13. Full-time job growth averaged 43k a month last year. It is expected to slow this year. The RBA sees inflation falling from 6.6% last year to 4.8% at the end of this year. It stood at 6.8% in February after peaking at 8.4% in December 2022. The Australian dollar was turned back last week slightly below $0.6800, which met the (38.2%) retracement objective of its drop since the February 2 high (~$0.7160), its best level since last June. It recorded a new low for the week in thin pre-weekend activity near $0.6640 after the US employment. We suspect the risk is on the downside and anticipate a test on the four-month lows set in March (~$0.6565). A convincing break of the $0.6550 could initially target the $0.6400 area.
Mexico: Minutes from last month's Banxico meeting will be scrutinized for the shift to a more neutral setting that some saw accompanying the 25 bp hike to 11.25%. The minutes will be released on April 13. Last week, March's CPI slowed to 6.85% (from 7.62%), and the core eased to 8.09% (from 8.29%). The governor of the central bank had suggested that the core rate peaked. The central bank meets on May 18. The swaps market has about a 1-in-4 chance of a hike discounted, which is less than the odds of another Fed hike. Still, given the high rates, carry-trade strategies may remain attractive, especially if implied volatility falls further. Three-month implied volatility jumped to almost 15.4% in the mid-March frenzy but pulled back to 12% last week and finished near 12.4% before the weekend. It averaged slightly below 11% in February. Volatility and the dollar are tending to move in the same direction. The greenback found support at the start of last week, slightly below MXN18.00. What appears to have been a short squeeze lifted it to MXN18.40 in the middle of the week. It fell back to almost MXN18.10 before the weekend, a slightly deeper retracement than we expected. Still, the momentum indicators warn that the corrective pressures have yet to be exhausted. The next upside target is in the MXN18.45-55 area.
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