Fed Minutes were Not as Dovish as Initially Read

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Marc Chandler
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Overview: The sell-off in European bonds continues today. The 10-year German Bund yield is around four basis points higher to bring the three-day increase to about 22 bp. The Italian premium over Germany has risen by almost 18 bp over these three sessions. Its two-year premium is widening for the fifth consecutive session and is above 90 bp for the first time in almost three weeks. The 10-year US Treasury yield is a little softer near 2.88%. Most of the large Asia Pacific equity markets fell, with India a notable exception. Europe’s Stoxx 600 snapped a five-day rally yesterday with a 0.9% loss. It is slightly firmer today, while US futures are hovering around yesterday’s closing levels. The greenback is firm against most of the major currencies. The Australian and Canadian dollars and Norwegian krone and sterling are the most resilient today. The Philippines, like Norway hiked 50 bp but unlike Norway, the currency has not been bought. Most emerging market currencies are softer today. Gold is trying to break a three-day slide after approaching $1760. It settled last week at $1802. October WTI found a base a little below $85.50 and is around $88.50 near midday in Europe. The week’s high was set Monday by $91.50. US natgas is up 1.1% to recoup yesterday’s loss in full. Europe’s benchmark is extended this week’s run. It finished last week near 205.85 and now is around 232.00, a 12.7% gain after 6% last week. Iron ore ended a four-day 8% slide. September copper is recovering from the early drop to near two-week lows ($354.20) and is now near 362.00. A move above yesterday’s high (~$365) would be constructive. The sell-ff in September wheat has accelerated. It is off for the fifth consecutive session and is at its lowest level since January. After falling around 3% in three days from last Friday, it is off more than 5% between yesterday and today.

Asia Pacific

For good reasons, Beijing and Washington suspect the other of trying to change that status quo over Taiwan. The visits by US legislators may be only the initial efforts by Congress to force a more aggressive US position. It could come to a head in the fall when a bill that wants to recognize Taiwan as a major non-NATO ally and to foster Taiwan's membership in international forums will draw more attention. Meanwhile, US-Taiwan trade talks will begin later this year that was first aired a couple of months ago. At the same time, the Biden administration has been considering lifting some of the tariffs levied by the previous administration, but China's militaristic response to the visits makes it more difficult. Biden wants to lift the tariffs not to reward Beijing but to ease the costs to Americans. The Consumer Technology Association, an industry group, estimated that the tariffs have boosted the bill for American consumer technology companies by around $32 bln. The tariffs are paid to the US government. It seems that in lieu of lifting the tariffs, a broad exclusion process is possible.

Related but separately, the Nikkei Asia reported that Apple is in talks to produce its watches and computers in Vietnam for the first time. Two suppliers have been producing Apple Watches in northern Vietnam. A couple of months ago, reports indicated that Apple would more some production of its tablets to Vietnam. Apple's ecosystem is establishing a presence in Vietnam, with nearly two dozen suppliers have factories now, almost doubling since 2018. As a result of these forces and the movement of capacity outside of China, Vietnam's trade surplus with the US is exploding. The $33 bln surplus in 2016 ballooned to $91 bln last year and was nearly $58 bln in the first half. For the past five years, the dollar has traded in a roughly 2% band around VND23000. The greenback is near the upper end of the range.

Australia's July jobs report was disappointing. It lost almost 87k full-time positions after gaining nearly 53k in June. Part-time positions increased (46k), leading to a 40.9k loss of overall jobs. The median forecast (Bloomberg survey) was for a gain of 25k jobs. The unemployment rate slipped to a new record low of 3.4% (from 3.5%) but this was due to a sharp drop in the participation rate (66.4% from 66.8%). Ostensibly, this could give the central bank space to be more flexible at its September 6 meeting. However, the futures market as taken it in stride that has left the odds of a 50 bp hike next month essentially unchanged around 57%. This is essentially where it was at the end of last week and the week before.

Many are now familiar with China's rolling lockdowns to combat Covid and the implosion of property market, a key engine of growth and accumulation. A new threat has emerged. The extreme weather has seen water levels in Sichuan's hydropower reserves as much as 50% this month, according to report, prompting the shuttering of factories (hub for solar panels, cement, and urea). Dazhou, a city of nearly 3.5 mln people, imposed a 2 1/2-hour power cuts this week that were expanded to three hours yesterday. Office buildings in Chengdu, the provincial capital, were barred from using air conditioning. Many areas in central and northern China imposed emergency measures to ensure the availability of drinking water. The heat and drought threaten summer crops and risk greater food-driven inflation. At the same time, Shanxi, which provides about a quarter of China's coal is worried about floods, it has suspended the operation of more than 100 mines since June. The government-imposed measures to boost output and Shanxi coal output rose by around 16% in H1. 

The dollar is confined to a narrow range, straddling the JPY135 area. It has held `below last week's high around JPY135.60 and above the JPY134.55, where options for $700 mln expire today. The Australian dollar has been sold aggressively this week. It began near $0.7115 and tested $0.6900 today, meeting the (50%) retracement objective of the rally from the mid-July low (~$0.6880). It was only able to make a marginal new low today, suggesting that the selling pressure has abated. The next retracement (61.8%) is closer to $0.6855. Initial resistance is seen around $0.6950. After slipping a little yesterday, the greenback returned to its recent highs against the Chinese yuan around CNY6.7960. This year's high was set in May near CNY6.8125. Between Covid lockdowns, the weather disruptions, and the continued unwinding of the property bubble, a weaker yuan may the path of least resistance. The PBOC set the dollar's reference rate at CNY6.7802 compared with expectations from Bloomberg's survey of CNY6.7806. The yuan is falling for the sixth consecutive month against the dollar.

Europe

The eurozone may not have completed its banking and monetary union, but the ECB said that it would harmonize how banks offer crypto assets and have sufficient capital and expertise. Crypto companies have negotiated with national authorities in several EMU member countries, but common EU licensing rules are unlikely any time soon. There is a patchwork of differing national rules, and in some countries, some types of crypto activity may require a banking license, for example.

Norway's central bank hiked its deposit rate by 50 bp and indicated it would "most likely" lift rates again next month. What makes today's move somewhat more aggressive that it may appear is that the hike took place at a meeting that did not include an economic update and projections for the future path of policy. Norges Bank acknowledged that the policy rate trajectory would be faster than projected in June and the inflation risks being higher for longer. The deposit rate now sits at 1.75%. Another 50 bp hike next month (September 22) seems likely followed by a 25 bp move in November, the last meeting of the year.

The euro briefly popped a little above $1.02 on what was initially seen as dovish FOMC minutes in the North American afternoon yesterday. However, it returned to yesterday's lows low near $1.0145 before finding a bid. The week's low was set Tuesday slightly below $1.0125, which is ahead of the retracement objective we identified near $1.0110. The euro is consolidating as the US two-year premium over Germany falls to its lowest level in a nearly a month (2.54%), and almost 25 bp below the peak seen after the US jobs data on August 5. Labor disputes are crippling UK trains, buses, subways, and a key container port today. Sterling slipped to $1.1995, its lowest level since July 26. The nicking of the neckline of a possible double top was not a convincing violation and sterling has recovered to the $1.2060 area in the London morning. If this is not the peak in sterling, it seems close. Tomorrow, the UK is expected to report a decline in July retail sales, excluding gasoline. This measure of retail sales rose by 0.4% in June, the first increase since last October. The median forecast (Bloomberg survey) is for a 0.3% fall. The swaps market is pricing in a 50 bp hike at the mid-September BOE meeting and about a 1-in-5 chance of a 75 bp move.

America

US interest rates softened and dragged the dollar lower following the release of the FOMC minutes. The market seems to have focused on the concern of "many" members that it could over-tighten but there was no sign that this was going to prevent them for raising rates further. Indeed, it suggest that the risk of inflation expectations becoming embedded was greater. More hikes were appropriate, the minutes said, and a restrictive stance may be required for "some time". The minutes also played the recent pullback in commodity prices as an indicator of lower inflation, which it still says the evidence is lacking. When everything was said and done the September Fed funds futures were unchanged for the fourth consecutive session.

Autos and gasoline held by retail sales in July, but excluding them, retail sales rose by 0.7%, matching the June increase. The core measure, which also excludes building materials and food services rose a solid 0.8%. Retail sales account for around 40% of personal consumption expenditures. The July PCE is due next week (August 26) and picks up service consumption too. The early call is for it to rise by 0.5%. However, it too is a nominal report, and in real terms, a 0.3%-0.4% gain would be a strong showing. The retail sales report lent credence to anecdotal stories about department stores discounting prices to move inventory. Amazon's Prime Day (July 12-13) was claimed to be the biggest so far. Online sales overall surged 2.7%.

Today's data includes weekly jobless claims, the Philadelphia Fed survey, existing home sale, and the index of Leading Economic Indicators. Th four-week average of weekly jobless claims rose to 252k in the week ending August 5. Recall the four-week moving average, used to smooth out some of the noise bottomed in the week ending April 1 at 170.5k. They averaged around 238k in December 2019, which was the highest since the first half of January 2018. Continuing claims have edged higher in recent weeks, but at 1.428 mln, they are roughly 20% below the peak at the start of this year. The Philadelphia Fed survey is particularly interesting today because of the disastrous Empire State survey. The median forecast in Bloomberg's survey is for a -5 reading after -12.3 in July. Meanwhile, existing home sales have fallen for five months through June. In fact, new home sales have been fallen every quarter since the end of 2020, with the exception of Q3 21. They fell by an average of 1.7% in Q1 22 and 3.8% in Q2 22. The median forecast is for a nearly 5% decline in July. The market tends not to get excited about the leading economic index series. Economists expected the fifth consecutive decline. The only month it rose this year was February.

The US dollar extended its recovery against the Canadian dollar to reach almost CAD1.2950, its highest level since August 8 today. It was pressed lower by new offers in the European morning that drove it back to almost CAD1.2900. The market may take its cues from the S&P 500 and the general risk appetites in the North American session. With the intraday momentum indicators stretched, yesterday's post-FOMC minutes low near CAD1.2880 may offer sufficient support. The greenback rose to a five-day high against the Mexican peso yesterday around MXN20.09. It is consolidating and straddling the MXN20.00 area. Our reading of the technical condition favors the dollar's upside, and the first important target is near MXN20.20. The US dollar gapped higher against the Brazilian real yesterday and approached the BRL5.22 area, where the 20-day and 200-day moving averages converge. The opening gap was closed late on the pullback spurred by the reading of FOMC minute headlines. The price action is similar to the peso, where the dollar has traded heavily since last month but appears to have found a bottom. A break above BRL5.22 would target the month's high near BRL5.3150.