Risk Appetites are Fickle

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Marc Chandler
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Overview: Yesterday’s strong US equity gains failed to carry over into today’s session. Japanese and Australian shares fared the best among the large Asia Pacific market, with the Nikkei off less than 0.4% and the ASX off less than 0.25%. However, China’s markets were off more than 1%, while Taiwan and South Korea indices slumped more than 2%. India is off nearly 1.5%. Europe’s Stoxx 600 is down 1.5% and is giving back all of its gains in the past three sessions. US futures are approaching a 2% fall. The US 10-year yield is down about seven basis points to 3.20%. European yields are mostly 8-12 bp lower, but the peripheral premium is widening over the core. The UK's somewhat firmer than expected inflation report did not prevent the 10-year Gilt yield from tumbling more than 12 bp today. The yen and Swiss franc are the most resilient against the dollar today, but the other major currencies, led by the Antipodean and Norwegian krone are 1%+ lower. Leaving aside the Russian rouble, most emerging market currencies are lower, including the Czech koruna, where the central bank is expected to lift the repo rate by over 100 bp today. Gold is on the defensive as it trades near a four-day low below $1825. Last week’s low was around $20 lower. August WTI is taking another leg down after consolidating yesterday. It has traded at a one-month low around $103.20 before steadying. US natgas is lower for the third consecutive session and is also hovering around one-month lows. The surge in Europe’s benchmark continued with the eighth day of gains. Iron ore bounced yesterday to snap an eight-day slide but is giving it all back plus some today with a 5.85% drop. Copper is off nearly 3.5% to new 15-month lows. July wheat is jumping back almost 3% after falling almost 10% over the past two sessions.

Asia Pacific

After a quiet local session yesterday, the dollar went bid against the yen in the European morning and accelerated to JPY136.70 into the North American close. The greenback's gains came as the US 10-year yield firmed to retest the 3.30% level. The dollar is consolidating those gains today, holding above JPY136, as the US 10-year yield surrendered yesterday's five basis point rise. Still, ideas that Japanese officials will not strengthen their "protests" until the JPY140 area is approached may be emboldening the dollar bulls. Yet, there may be a misconception as Japanese officials have been clear of their concern about the pace of the move not the level. Earlier this month, the greenback was fraying the upper Bollinger Band, which is set at two standard deviations above the 20-day moving average. It comes in now around JPY138.40. On the weekly charts, the upper Bollinger Band is slightly above JPY138.80. The takeaway is that while the dollar is climbing against the yen, the move is more orderly than previously. One-month implied volatility was around 14.4% on June 15. Today it is closer to 14.0%. Note that the median forecast in Bloomberg's survey sees the dollar at JPY130 at the end of September and JPY128 at the end of the year. In the futures market, the net short yen position reached a four-year high of 112k contracts in mid-April but has fallen for the past five weeks, through June 14. At 69.75k contracts, it is the smallest in three months. Gross long positions have increased for four of the five weeks and has nearly tripled to 32.5k contracts over the span.

The US is said to be considering reducing some of the tariffs on Chinese goods that the Biden administration inherited from its predecessor. This has been a talking point for a couple of months. The tariffs need to be kept in the realm of foreign economic policy not US price pressures. They are a distraction. A study by Kathryn Russ of the Peterson Institute for International Economics found that only 2% of extra tariffed Chinese goods are included in the CPI basket and 2.7% of the PCE deflator. She calculates that the direct impact of unwinding the Trump tariffs would be worth a one-off 0.25% percent off the CPI and 0.35% off the PCE deflator. Consider that since the start of last year, CPI has risen by an average about 0.6% a month (vs. 0.2% average in the two years before Covid) and the PCE deflator has risen by 0.5% on average (vs. 0.1% previously). Meanwhile, the US import ban on goods from Xinjiang came into effect yesterday. Under the new rules, the goods made there are assumed to use forced labor and businesses that want to import must demonstrate that it is not the case. Cotton and tomato imports were previously banned. Neither Europe nor Japan have enacted similar laws yet but may face increased pressure to do so.

The push lower in US 10-year yields appears to have removed the immediate pressure on the dollar that lifted it to JPY136.70. There is a $330 mln option at JPY136.95 that expires today. The minutes from the April BOJ meeting give no sign that the extraordinarily easy monetary policy was about to be jettisoned. The JPY138.00-JPY138.60 area is seen as the next important technical area. A break of JPY136.00 may see JPY135.50. The Australian dollar was capped in front of $0.7000 on Monday and Tuesday, and it is come back offered today, falling to a five-day low near $0.6880. Last week's low was by $0.6850 and last month's low was closer to $0.6830. The intraday momentum studies are getting stretched. A move back above the $0.6900-$0.6920 area would help stabilize the tone. The broadly stronger greenback helped it gain against the Chinese yuan for the first time this week and only the second time in the past seven sessions. In fact, the dollar gapped slightly higher (today's open was the low around CNY6.7028, and yesterday's high was slightly above CNY6.7005. The dollar briefly poked above CNY6.7260. A move above CNY6.7280 could be a constructive technical sign and warn of a move back to the recent high a little above CNY6.76. The PBOC set the dollar's reference rate at CNY6.7109, a bit stronger than the CNY6.7082 median projection (Bloomberg survey). It was the first fix in four sessions that was for a firmer than expected dollar.

Europe

The ECB appears to have gotten as much from its verbal intervention--talking about a new mechanism to curb widening interest rate spreads, including an "emergency" ECB meeting which confirmed a tool was in the works-- as it likely will. The Italian 10-year bond yield jumped above 4% last early last week, which some claimed prompted ECB meeting. By the end of the week, it approached 3.50%. Kudos. Recall that the yield had moved above 3% in the first half of May and consolidated in the second half. Italy's premium over Germany peaked above 240 bp on June 14. Yesterday, it reached 185 bp, the lowest since last April. The momentum seemed to wane yesterday. Given Italy's size and debt, it is understandable why it was the focus, but do not lose sight that the fragmentation threat is not limited to Italy. Consider Spain. Its 10-year premium over Germany has been trending up since early January (~67 bp) and consolidated around 90-100 bp from mid-February through April. The widening resumed and spiked to 136 bp on June 13. The ECB's guidance drove it back toward 100 bp where it stabilized yesterday above 105. Spain's 10-year yield began the year near 0.5%. By the end of the first quarter, it had risen 100 bp and rose another 100 bp mid-June. It then jumped another 50 bp in a few days, lifting the yield to 3.12% on June 14. It fell back to almost 2.65% by the end of last week. It has been consolidating higher this week. Today, the Italian and Spanish premium has widened 4-5 bp.

UK May CPI rose 0.7% for a 9.1% year-over-year pace. This was in line with expectations. CPIH, which includes owner-related costs ticked up to 7.9% from 7.8%. While this is a touch higher than expected the core rate eased more than expected. Excluding food and energy, prices rose 5.9% above year ago levels, down from 6.2% in April. The slowing was a little more than expected and the first slippage since last September. With the energy price cap to be raised in October, the BOE has warned of an 11% peak in inflation. Producer prices were also a little firmer than expected. Note that the implies year-end rate rose to 3.08% on Monday. It slipped a couple of basis points yesterday, but is off 12 bp today to around 2.93%, the lowest in a week.

Norway was the first G10 central bank to hike rates in this cycle. Beginning last September, the Norges Bank has hiked 25 bp once a quarter (alternating meetings) and is widely expected to hike by another 25 bp tomorrow. It would bring the deposit rate to 1.0%. Policymakers have guided market expectations for quarter point hikes through the end of next year. However, with CPI accelerating, the swaps market is pricing in an acceleration of hikes. In May, headline CPI was up 5.7% above year ago levels, rising. Norges Bank's most recent forecasts are that CPI will fall back to 3.4% by the end of the year and 1.6% next. The market is less optimistic with the median forecast in Bloomberg's survey for 4.0% CPI this year and 2.3% next. The swaps market has begun discounting the strong chance of two 50 bp moves this year. The krone was little changed against the dollar in Q1, but it has been pummeled in Q2. It is the worst performing G10 currency this quarter. It is off almost 11.7% since the end of March, eclipsing the Japanese yen, (~-10.7%), as other major central banks outflank Norway.

The euro stalled in front of last week's $1.06 high yesterday, unable to make much headway above $1.0580. There are options for about 600 mln euro struck there that expire today. Another set at $1.05 (~600 mln euros) may have already been neutralized. Still, for the fourth consecutive session, the euro is consolidating within last Thursday's broad range (~$1.0380-$1.0600). The euro trended lower through yesterday's North American session and the retreat carried through the Asian session today. The euro turned a bit better bid in late dealings and recovered further in the European morning. The $1.0540 looks like a reasonable cap today. Sterling also was sold to a four-day low (~$1.2160) and it also is recovering in the European morning to recover toward $1.2240. The $1.2260-$1.2280 area may provide nearby resistance. Tomorrow is the anniversary of the UK Brexit referendum in 2016. 

America

Fed presidents Barkin, Evans, and Harker speak today, but the focus is on Chair Powell's semi-annual testimony before Congress. Today he appears before the Senate Banking Committee and tomorrow he does it again for the House Financial Services Committee. At the recent post-FOMC press conference, Powell pushed back vigorously against ideas that the economy was rolling over. However, in his prepared remarks, he recognizes some preliminary signs that the labor market may be cooling. Because the Fed is tightening financial conditions, lower equity prices, slower housing activity, and higher rates are expected. That alone won't get the Fed to change course. Outside of a material decline in inflation, which may prove difficult, as the changing composition points to resilient shelter costs, a sharp deterioration in the labor market would likely get the Fed's notice. The December Fed funds contract shows a year-end rate of a little more than 3.5%. It has reached 3.64% last week.

Canada reported stronger than expected April retail sales (1.3% excluding autos, twice what the median projection in Bloomberg's survey anticipated, and the March series was revised to 2.6% from 2.4%). On tap today is May CPI and it is expected to have accelerated. The year-over-year pace is projected to have increased to 7.3% from 6.8%. The average of the different core measures is seen rising to 4.5% from about 4.25%. The swaps market is pricing in more than a 90% chance of a 75 bp hike at the July 13 Bank of Canada meeting. It has the year-end rate slightly north of 3.50%. It had reached almost 3.70% at the start of last week, following stronger than expected employment data. 

The surge in US equities helped lift the Canadian dollar to three-day highs yesterday, and the pullback today is taking a toll. The US dollar approached CAD1.29 yesterday but is back near CAD1.30 today. A move above CAD1.3020 would signal a retest on last week's high near CAD1.3080. Still, the directional cues from the broader risk environment (S&P 500 is a reasonable proxy) remains robust. Today's risk-off mood is weighing on the Mexican peso ahead of tomorrow's biweekly CPI report and the central bank meeting, which is widely expected to result in a 75 bp hike. The greenback fell to a six-day low yesterday in front of MXN20.12. It bounced to almost MXN20.25 before steadying, just shy of the five-day moving average (~MXN20.2580) that has not closed above since last Thursday. Yesterday's high was slightly above MXN20.31. Lastly, investors reacted to the Colombian weekend election results yesterday after Monday's holiday. The stock market got tagged for almost a 4% loss and peso fell 3%., the most since March 2020.

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