Consolidation Featured

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Marc Chandler
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Overview:  Yesterday's poor 10-year note US Treasury auction helped turn the equity market lower and this carried over into Asia Pacific and European activity today. Today, Treasury completes its quarterly refunding with the sale of $25 bln 30-year bonds. The general tone in the foreign exchange market is one of consolidation. Japanese investors were buyers of foreign stocks on bonds last week, according to the latest portfolio flow report, which is not what one would expect if Japanese investors were repatriating assets and unwinding their natural carry trade. Foreign investors were sellers of Japanese bonds and stocks. India's central bank stood pat as expected. Several hours after Mexico's CPI is reported, the central bank meets, and the market seems split over the outlook. We expect Banxico to wait for next month to cut, given the uncertain outlook, rising headline inflation, and the weakness of the peso. 

In Asia Pacific, only the Hang Seng rose among the large equity markets. Europe's Stoxx 600 is giving back a little more than half of yesterday's 1.5% gain, and US index futures are narrowly mixed. Bonds have rallied. Japan's 10-year yield fell almost five basis points to below 84 bp. European benchmark yields are 1-4 bp lower, and the 10-year US Treasury yield is about three basis points softer near 3.91%. Gold is trading quietly in about a $2380-$2400 range. September WTI approached $76 a barrel yesterday and is softer today straddling the $75 area. 

Asia Pacific

There are two highlights from the local session today. First, Japan's weekly portfolio flow data for the week ending August 2 showed Japanese investors were buyers of foreign assets (~JPY1.2 trillion bonds and JPY670 bln of foreign bonds, or about $13 bln) Foreign investors were sellers of Japanese stocks (~JPY642 bln) and bonds (JPY1.16 trillion). Separately, true to form (past 11 years), Japan's June current account balance deteriorated, but the goods and services trade surplus improved (JPY556 bln vs. -JPY1.11 trillion). It is the first trade surplus in three months on a balance of payments basis. Second, the Reserve Bank of India kept its repo rate unchanged at 6.50% by a 4-2 vote at the last meeting before the Monetary Policy Committee's four-year term ends in October. With the government set to adjust the CPI basket, which will reduce weighting for food, and, in turn, lower measured inflation, a rate cut later this year is likely.

The dollar traded between roughly JPY146.55 and JPY147.65 in the North American session yesterday. Today's range is about JPY145.45-JPY146.85. Despite what appeared as a consensus of the dovishness of BOJ Deputy Governor Uchida's comments and the setback in the Japanese yen, the swaps market was not persuaded. At yesterday's settlement the market was pricing in a little more than 7.5 bp basis point rate before year-end (75% of a 10 bp move, or a 50% chance of a 15 bp move), which was slightly higher odds than before Uchida spoke. It is little changed today. The next technical target for the dollar may be near JPY148.40, which is the halfway mark of the last leg down that began the day before the BOJ and Fed's decision on July 31. Meanwhile, one-month implied vol peaked on Monday around 16.2% and pulled back below 14% yesterday but settled firmly near 14.5%. Given the change in the put/call skew, it suggests demand for dollar calls/yen puts. The Australian dollar stalled yesterday in early North American turnover near resistance at $0.6575. It gave up most of the gains before finding support near $0.6525. It slipped slightly below $0.6510 today but recovered to about $0.6565. The price action is what one might expect in a period of weak confidence. The dollar reached almost CNH7.1950 yesterday as it continues to appear to track the broad movement of the yen. It found support today near CNH7.1550 and is holding below CNH7.1845. The PBOC set the dollar's reference rate at CNY7.1460, a new high since last November (yesterday's fix was CNY7.1386).

Europe

The eurozone and UK have light economic diaries today and tomorrow. Still, may be useful/helpful to note what the market is pricing for European central banks. A quarter-point cut from the ECB next month is fully discounted and 71 bp of cuts are discounted for this year. The market leans a little against a September cut by the Bank of England (46%) but has 32 bp of cuts priced in for following meeting in November, which is almost a 30% chance of a 50 bp move. The swaps market has another quarter point cut fully discounted for the Swiss National Bank next month. Sweden's Riksbank meets on August 20 and the market is discounted a 40% chance of a 50 bp cut. The swaps market has 105 bp of cuts priced before year-end. Norway is seen as the least dovish of the major European central banks. The swaps market sees practically no chance of a cut when it meets next week but has a cut fully discounted before the end of the year. 

The euro continued to consolidate in the lower end of the Monday-Tuesday range above $1.09 and below $1.0940. The US two-year premium over Germany is also consolidating (below 160 bp, down from around 180 bp in late July). Such a narrow range is unlikely to persist much longer, and it could be extended by 20 ticks in either/both directions without changing the technical tone. Sterling also continues to consolidate. Most of the North American activity took place between $1.2690 and $1.2730. Today's range is mostly $!.2680-$1.2715. It needs to reclaim the $1.2740 area to be of note, which could signal a further recovery toward $1.28. A break of $1.2660 could signal a move toward $1.2580-$1.2600.

America

There is much consternation about US labor market developments, and Sahm says her rule was triggered by the latest report, but that it might be different this time because the rise in the unemployment rate was a function of an increase in the labor force. We think Fed Chair Powell has been as clear as possible. When it comes to inflation, there is one measure that the Fed can use to gauge price stability, the PCE deflator. Frequently journalists and analysts talked about the core PCE deflator being the "preferred measure", but what does that really mean when the Fed targets the headline rate? Powell says, when it comes to the labor market, there is not one measure. This is why the talk that nonfarm payrolls would have been higher if it were not for the storms that kept people away for work may be nice to know but does not change assessments. Most indicators, like quits, hiring, the average length of unemployment, the Employment Cost Index, unit labor costs, elements are various surveys, all point to a slowing of the labor market. That brings us to today's weekly jobless claims. The four-week moving average, used to smooth some of the volatility (noise), will likely make a new high since last August. Through July 19, continuing claims have risen for 11 of the past 13 weeks. There may be a reasonable debate over whether the Fed should cut 25 bp or 50 bp next month, but US labor market slowing is a fact. Mexico reports its July CPI a few hours ahead of the central bank meeting today. The headline CPI is expected to rise by 1% to 5.5%, which would be the fifth consecutive monthly increase. It bottomed in February at 4.4%. The core rate, however, continues to edge lower. It has not risen since January 2023. It is approaching 4% but appears to be losing some downside momentum. The market appears split over the outlook for today's Banxico meeting. Given the uncertainty expressed at the last meeting, the peso's weakness, and the continuing firming of headline CPI, we expect the central bank to standpat and cut rates next month, after the FOMC. 

The US dollar fell to a 2 1/2-week low yesterday near CAD1.3720. It recovered to the three-day downtrend line near CAD1.3750 as risk-appetites faded in the North American afternoon. Also, the greenback settled below the 20-day moving average (~CAD1.3770) for the first time since July 12. The daily momentum indicators have turned down, but the US dollar has fallen 1.6% from Monday's high and some near-term consolidation looks likely. So far today, the US dollar traded between CAD1.3725 and CAD1.3760. The Mexican peso recovered yesterday, arguably signaled by the continued pullback in the yen. Still, the US dollar held above Monday's low (~MXN19.11). Between the threat that the war in the Middle East may escalate shortly, the risk of Banxico cutting rates today, and general fragile risk appetites, the elevated peso volatility serve to limit the peso's upside even with the apparent slowing of the unwind of carry trades. Recall that the dollar settled near MXN19.18 last week. It has traded between about MXN19.21 and MXN19.38 through the European morning today.