Upside Surprise in UK’s Flash PMI and Better-than-Expected January Public Finances Lift Sterling

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Marc Chandler
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Overview: Rising interest rates are weighing on risk appetites and the dollar is broadly stronger. Sterling is a notable exception after a stronger than expected flash PMI and better than expected public finances. The correlation between higher US rates and a weaker yen is increasing and the greenback looks poised to rechallenge the JPY135 area. A slightly better than expected preliminary PMI and hawkish minutes from the recent RBA meeting has done little to support the Australian dollar, which is among the weakest of the G10 currencies today. Nearly all the emerging market currencies are softer today.

While mainland Chinese equities and Korea and Taiwan eked out small gains, the other larger Asia Pacific bourses fell. Hong Kong and mainland shares that trade there posted the steepest declines (1.7%-1.9%, respectively). Europe's Stoxx 600 is giving back yesterday's gains plus some. It is the second losing session in the past three, something not seen this month. US equity futures are off 0.6%-0.8%. The US 10-year yield is six basis points higher to almost 3.88%. European yields are mostly 2-3 bp higher, though the 10-year UK Gilts yield has jumped 8 bp (to 3.55%) and the Italy's10-year yield is up 6 bp (to 4.39%). Gold was turned back yesterday from its attempt at $1850 and is testing the $1830 area. April WTI had peaked above $80 last week and approached $75 before the weekend. It is in the middle of that range now. Natural gas prices (US futures and Europe's benchmark are making marginal new lows.

Asia Pacific

Japan's flash composite PMI was unchanged at 50.7 to hold above the 50 boom/bust level for the second consecutive month in February. It is being kept in expansionary territory by the strength of its service sector (53.6 vs.52.3), while manufacturing continues to struggle (47.4 vs. 48.9). That is the lowest in 2.5 years as output and new orders slid. It was last above 50 in October 2022. Still to come this week is the January CPI, for which the Tokyo figures warn of a push above 4% to new cyclical highs, and the weekly portfolio flow data. Last week's report, through February 10 showed that after last year's divestment, Japanese investors have returned to the buy side (JPY2.6 trillion, or $19.5 bln), the most for a six-week period since November 2021.

The last time Australia's composite PMI was above 50 was last September. It stands at 49.2, up from 48.5 in January. Unlike in Japan, where the service sector PMI is above the manufacturing PMI, in Australia, the manufacturing PMI has been stronger than the services component. The manufacturing PMI is at 50.1, up from 50.0. The service PMI has been in contracting territory for five months through this month. It stands at 49.2, up from 48.6. The minutes from this month's central bank meeting were more hawkish than anticipated, with the RBA making references to the need for additional hikes (plural) and choosing between a quarter-point more and a half-point move. It cited the swap curve, which implied a terminal rate of 3.75%. However, now the swaps curve sees the rate peaking closer to 4.50%. That said, the but the futures market is not convinced of another 25 bp hike at the March 7 policy making meeting. Many suspect a 15 bp hike that would bring the overnight target rate to 3.50%. Separately, the Reserve Bank of New Zealand meets tomorrow. The devastating cyclone had prompted some speculation that it would deliver a 25 bp hike instead of 50 bp, with the risk that it postpones the hike altogether. Still, the swaps market has about 90% chance of a half point hike discounted.

Rising US rates are helping lift the dollar back toward JPY135.00. It reached JPY134.85 in late Asia Pacific turnover after bottoming slightly below JPY134 in Europe yesterday. The greenback did poke above JPY135 before the weekend for the first time since last December's BOJ surprise but failed to confirm by settling there. Initial support is now seen around JPY134.40. There continue to be press reports about Japanese selling foreign bonds, but that is last year's story. In the first six weeks of 2023, Japanese investors have bought the most foreign bonds since August 2021. The hawkishness of the RBA did not translate into a stronger Australian dollar. It is trading inside yesterday's range, unable to rising above $0.6820. Last week, it briefly traded above $0.7000. Yesterday's low was slightly below $0.6860. A break of there today targets the pre-weekend low near $0.6810, and the 200-day moving average is a little lower (~$0.6805). The greenback remains firm against the Chinese yuan. It approached the one-month high set before the weekend near CNY6.8850. The 200-day moving average is closer to CNY6.8865. The dollar has not traded above there since early January. The PBOC set the dollar's reference rate at CNY6.8557. The median forecast in Bloomberg's survey was for CNY6.8569.

Europe

The eurozone composite PMI improved for the fourth consecutive month and remained above 50 for the second month. It rose to 52.3 from 50.3.  Last February, it was at 55.5. The manufacturing PMI softened to 48.5 from 48.8. It has held below 50 since the start of H2 22. However, the contraction has been slowing since bottoming last October, until now. The service PMI held above 50 for the second consecutive month and sits at 53.0 (from 50.8). The German data fit the aggregate pattern. Strength in the service PMI (51.3 vs. 50.7) lifted the composite above 50, while manufacturing remained below 50 (46.5 vs.47.3). In France, the manufacturing PMI fell back below 50 (57.9 vs. 50.5) while the service PMI jumped up to 52.8 from 49.4.  It was the first reading above 50 since last October. That helped lift the composite stood to 51.6 (from 49.1). Separately, the German ZEW investor survey continued to show improvement. The expectations component stands at 28.1, its best level since last February. The current assessment improved to -45.1. It has not been this high since last August. Note that the DAX is up about 10.7% this year after falling almost 12.4% last year.

The UK flash PMI surprised on the upside. The manufacturing PMI held below 50 but improved to 49.2 from 47.0. The services PMI jumped to 53.3 (from 48.7) to lift the composite above 50 (53.0) for the first time since last July. Last February it stood at 59.9.  Meanwhile, the UK reported a January budget surplus of GBP5.4 bln compared to a year ago surplus of GBP12.5 bln. The Office for Budget Responsibility had projected a surplus of GBP400 mln. Still, a battle is shaping up for next month's budget. Truss may have lost the battle, but a Tory rebellion is brewing to scrap the corporate tax increase slated for April. Chancellor of the Exchequer Hunt delivers the budget next month. Borrowing in the fiscal year that began last April is running about GBP22 bln below forecast last November. 

The euro is struggling. It bounced smartly at the end of last week from a brief dip below $1.0615 to edged slightly above $1.07 yesterday. However, was sold back toward to almost $1.0640. A break of the $1.06 area would sour the technical tone and warn of a deeper correction, possibly to the $1.0460-$1.0500 area. Sterling is benefitting from the stronger than expected PMI and better public finances. It is the strongest of the G10 currencies, up almost 0.50%. Buying was strong in the European morning and sterling reached nearly $1.2115; a four-day high. A band of resistance seen between $1.2135 and $1.2170, which seems too far in the present environment, where the US dollar's underlying strength is evident.

America

"No-landing" to the US economy appears to be gaining adherents but the preliminary PMI will give no succor. The composite was last above 50 in June 2022. Last February, it stood at 55.9.  It is expected to tick up to 47.5 from 46.8 in January. Both the service and manufacturing PMI are expected to rise to slightly above 47.0 from slightly below in January. Separately, and more optimistically, existing home sales are expected to have risen last month for the first time since February 2022. They ae seen at a 4.10 mln unit seasonally adjusted annual pace. In February 2022, new home sales stood at a 5.93 mln pace. 

Canada reports December retail sales and a January CPI. Retail sales are too dated to have much impact, and, in any event, the focus in on inflation. After falling by 0.6% in December, Canada's consumer prices are expected to have risen by 0.7% last month. This will see the year-over-year rate moderate to 6.1% from 6.3%. However, as we have suggested with the US, so too with Canada:  the base effect will likely see the annual rate fall sharply in the coming month. Last February, Canada's CPI rose by 1.0%, and in March it rose by 1.4%. Even if Feb and March CPI were to rise by 0.7% the year-over-year pace would fall to almost 5%. The underlying core measures will prove to be stickier and after the incredibly strong January employment report, any upside surprise will encourage more market participants to question if the pause is really the end of the cycle.

Last week, the US dollar recovered from CAD1.3275 to a little more than CAD1.3535. It pulled back to nearly CAD1.3440 yesterday and is consolidating today below CAD1.3500. There are options for about $425 mln at CAD1.3550 that expire tomorrow. The strongest directional cue may come from the general risk environment, with the US S&P 500 a reasonable proxy. The immediate risk is on the upside for the greenback. Meanwhile, the Mexican peso, which traded at five-year highs Friday-Monday, is consolidating and a tight range mostly below MXN18.50. It reached nearly MXN18.33 before the weekend. Portfolio and foreign direct investment inflows have underpinned the peso. A move above MXN18.50 could target MXN18.60 and possibly MXN18.6750. Mexico reports December retail sales today, which is not typically a market mover.