Over to the ECB

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Marc Chandler
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Overview: Equity markets in Asia Pacific and Europe are weaker.  The main exception in Asia Pacific was India, where the market rose by about 0.75%.  Europe's Stoxx 600 is lower for the third consecutive session and is now down on the week.  US futures are up around 0.3%-0.4%.  The 10-year Treasury yield is hovering a little above 3%.  European peripheral yields are softer ahead of the ECB meeting.  New Zealand’s 10-year yield jumped eight basis points in response to the central bank’s announcement that it would begin selling bonds that it bought during the pandemic.  The dollar is mixed, and in an unusual turn of events, the beleaguered yen is the strongest of the majors, recovering about 0.5%.  The euro is flat near $1.0715 ahead of the ECB meeting outcome.  Among emerging market currencies, leaving aside the Russian rouble, the Chinese yuan’s nearly 0.25% gain leads the advancer.  The Turkish lira’s leg lower continues.  Gold is trading quietly, a few dollars on either side of $1850.  July WTI is trading quietly in a narrow range (~$121.35-$122.70) near yesterday’s highs.  US natgas is off 4.5% after falling 6.3% yesterday.  The explosion at the Freeport LNG export facility in Texas, source of around 70% of US natgas exports will be closed for three weeks according to estimates. Europe’s benchmark had been off four sessions coming into today and jumped by more than 8%.  Iron ore snapped an eight-day advance and fell 2.2% in Singapore today.  July copper is almost 1.5% lower to give back the gains recorded in the past two days plus some. July wheat is off about 1% and continues to pare a 5% gain registered on Monday.

Asia Pacific

There are two developments from China to note. First, a 2.7 mln district in Shanghai is coming under new Covid restrictions.  The fact that the zero Covid policy has not be abandoned means that that there may still be rolling lockdowns, and this argues against a "V" recovery.  Second, and more optimistically, China reported stronger than expected trade figures.  Exports surged by nearly 17% year-over-year in May, more than twice the median forecast (Bloomberg survey) and follows an almost 4% gain in April.  Imports rose 4.1% year-over-year in May after a flat report in April.  The result was a $78.8 bln monthly trade surplus, up from $51.1 bln previously.  The average monthly trade surplus this year is $58.3 bln.  It averaged $38.6 bln a month in the Jan-May 2021 period.  

A new threat to supply chains especially to petrochemicals, steel, and autos is coming from South Korea.  According to the union, the majority of the 25k members of the Cargo Truckers Solidarity, affiliated with the Korean Confederation of Trade Unions, and many un-unionized truck drivers are supporting the strike.  The government has played down the impact and estimates that only 8k drivers are struck initially.  The recently elected, President Yoon Suk Yeol has issued emergency transport measures that allows government truck fleet to operate at the logistic hubs. The industrial action is over jobs and wages.  An extension of the Safe Trucking Freight Rates System is being sought.  The 3-year program that sought to prevent dangerous driving and minimum care rates for truck drivers is set to expire at the end of this year. The union want to extend the program to all the cargo truckers. The expiring agreement covered only around 60% of the drivers. Reports suggest activity at several ports, including Busan, the world's seventh largest port, have been disrupted.  It handles nearly two million containers a month.  Separately, the Korean won is off 3.3% so far here in Q2 after depreciated by 1.9% in Q2. Some attribute the weight on the won coming from foreign investors who have sold around $5.9 bln of Korean equities after divesting $6.5 bln worth in Q1.  However, this is more than offset by foreign purchases of Korean bonds.  They bought about $16.3 bln in Q1 and have bought another $9.1 bln so far in Q2.  

The dollar made a new marginal high against the yen earlier today near JPY134.55 before moving modestly lower.  The greenback was up seven of the past eight sessions. The high set in 2002 was around JPY135.15.  Above there, the previous high from 1998 was around JPY147.65.  Given the divergence of monetary policy, interest rate differentials, and the terms-of-trade shock, a persuasive argument can be made that the yen's decline is fundamentally driven.  Initial support is seen by JPY133.00 and then JPY132.50.   The Australian dollar tested the week's low near $0.7160 and it held.  There are options for about A$530 mln at $0.7165 that expire today and another at $0.7135 for A$475 mln that also roll off.  There may be some resistance around $0.7200, but a move above $0.7250 is needed to lift the technical tone.  The greenback initially pushed above CNY6.70 for the first time this week and found offers lurking.  Options for almost $2.4 bln struck there expire today.  It pushed slightly below CNY6.67 before stabilizing. The dollar's reference rate was set at CNY6.6811, a little lower than median projections (Bloomberg survey) of CNY6.6832.  

Europe

The market recognizes the hawkish pivot by the ECB.  Consider that at the end of last year, the swaps market priced in a 10 bp policy rate at the end 2022.  It rose to about 50 bp mid-February but retreated below 10 bp on the initial Russian invasion of Ukraine.  It recovered was near 60 bp in mid-April.  It surpassed 100 bp by mid-May and yesterday reached almost 1.34%.  Between the July and October meetings the market has a little more than 100 bp of tightening discounted.  That would imply at least one 50 bp move.  ECB President Lagarde has endorsed 25 bp hikes starting next month, but she is unlikely to push back hard against a 50 bp sometime in the futures.  If she were, one effect would be to weaken the euro.  The staff forecasts, as we have argued (here), the staff is likely to revise up inflation forecasts and shave growth forecasts.  These forecasts are part of the forward guidance that will underscore the likelihood of a hike at next month's meeting, even though there will be no new economic projections.  At the same time, it is hard not to argue that the risks to growth are still on the downside.  There is also a technical issue of the targeted long-term refinance operations (TLTRO), the three-year loans, which if specific lending targets are met, were secured at the incredible rate of minus 100 bp.  Although there is some talk of a new discretionary mechanism to combat fragmentation (strong divergence of interest rates), we have argued it is unlikely because, a facility currently exists and an attempt to have such a new facility faltered last year over conditionality, and the compromise struck gave the ECB added flexibility when reinvesting maturing proceeds.  

This is the ECB's fourth meeting of the year.  Consider the price action around the previous three meetings.  The euro rallied in the four days before the February 3 meeting and surged 1.2% on the day. It lost about 1% the following week, which began a five-week decline.  The euro rallied 1.6% the day before the March 10 ECB meeting and gave nearly all of it back on the day of the meeting and the following day.  The following week it rose by about 1.25%.  The euro fell on April 14 by slightly more than 0.5%, to give back the gain it scored the previous day.  It lost roughly another 0.5% in the following two sessions.  

The euro has traded roughly in a $1.0650-$1.0750 trading range this week.  It is hovering around the middle of the range ahead of the ECB meeting outcome.  There are options for 1.1 bln euros at $1.0755 that expire today.  After tomorrow's US CPI, 1.4 bln euros in options at $1.08 expire.  The euro's recovery from $1.0350 in the middle of last month stretched momentum indicators and we continue to look for the more impulsive move to the downside.  The MACD looks about to turn lower, and the Slow Stochastics have been gently trending lower this month.  Sterling posted a large outside up day on Tuesday.  There has been no follow through buying and sterling has remained within Tuesday's range (~$1.2430-$1.2600).  An option for GBP340 mln at the top of that range expires today.  A breakout seems unlikely today.  

America

The US reports weekly jobless claims and Q1 household net worth figures today ahead of tomorrow's May CPI.  Jobless claims are not going to change the view that the labor market remains robust and stronger than the Federal Reserve thinks is healthy.  Consider that through last month, nonfarm payrolls have risen by 2.44 mln this year.  In the same period last year, the US created 2.65 mln jobs.  Not only has the moderation been slight, but consider that in first five months of 2019, the US grew 890k jobs.  US household net worth rose by $5.3 trillion in Q4 21 and average $4.7 trillion a quarter last year.  It rose by an average of $3.6 trillion in 2020 and $3.1 trillion in 2019.  The markets do not seem to react much to this time series, which does not say anything about the critical distribution issue.  

US oil inventories rose by about 2 mln barrels last week even though supplies at Cushing fell to a three-month low.  The more pressing issue is gasoline.  Inventories fell for the 10th consecutive week amid rising consumption (reached 9 mln barrels a day) and slipped below 220 mln barrels. The US high driving season is just beginning, warning of the risk of higher prices.  Separately, yesterday's $33 bln 10-year note sale saw a 1.2 tail and a little softer coverage.  Of note, direct bidders took down 19.4% of the issue, the most in three years.  Today, the government sells $19 bln of the 30-year bond.  The last auction generated a 3% yield and is currently yielding almost 3.15%.  

Tomorrow Canada reports May jobs data.  Of the 27.5k increase expected, the median forecast in Bloomberg's survey sees full time positions accounting for the bulk of the new jobs.  Canada's economy appears to be continuing to outperform the US.  The swaps market is almost halfway toward pricing in a 75 bp hike next month rather than a 50 bp move.  The terminal rate expected in the swaps market dipped in late May below 3% and is now a little above 3.6%.  

The US dollar recovered against the Canadian dollar yesterday after initially slipping through CAD1.2520.  It settled near its highs (~CAD1.2565) and reached CAD1.2580 in early European activity.  Nearby support is pegged around CAD1.2540.  There are options for around $750 mln at CAD1.25 that roll off today.  While a quiet session seems likely today, tomorrow may be a different story with US CPI and Canadian jobs.  The greenback has been consolidating in recent days against the Mexican peso.  This week's range so far has been roughly MXN19.47-MXN19.68.  There appears to be more speculation that Banxico may hike by 75 bp when it meets on June 23.  Today's CPI figures could sway the market one way or the other.  Brazil also report May CPI figures today.  It may slow for the first time this year. The central bank is expected to hike by 50 bp next week.  Peru is seen lifting its rate target by 50 bp today to 5.50%. 

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