Week Ahead: Politics, Economics, and the Yen

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Marc Chandler
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The relationship between interest rate expectations and the foreign exchange levels is more complicated than many textbooks or conventional wisdom allows. Australia's and Norway's central banks pushed against rate cuts this year, and their currencies were rewarded. The Reserve Bank of New Zealand said more or less the same thing, but investors are less sanguine and took the New Zealand dollar down as much as it took the Australian dollar higher. The Bank of Canada is perceived to be one of the most dovish G10 central banks. The market expects at least two more cuts to be delivered this year. Yet, the Canadian dollar was the third strongest G10 currency last week, appreciating by about 0.2% for the second consecutive week. That the Swiss franc was weak, losing 0.4%, is understandable after the SNB surprised many with its second rate cut. 

The yen is the outlier. It will take a seven-day losing streak into next week, during which it has fallen by almost 1.8%. This run lifted the greenback to almost JPY159.65, its highest level since the intervention at the end of April, when it briefly traded above JPY160. The US 10-year yield has risen by a couple of basis points during the currency streak. Governor Ueda has explicitly not ruled out a rate hike next month alongside decision on reducing bond purchases (the start of QT), but the market has become less convinced of a rate hike, and the problems at Norinchukin Bank (saying it would have to sell $63 bln of low-yielding US and European government bonds) pushes them in the same direction. The losses the firm projects for this fiscal year more than tripled (to ~$9.5 bln) from an estimate made less than a bond ago. The US Treasury put Japan on its "watch list” for the rise in its exports (though it still runs a trade deficit) and the growing current account surplus (which is driven by capital flows that are flattered in yen terms given its depreciation). Some think this makes intervention less likely. 

The markets remain politically charged. The US will see its first presidential debate, but European politics overshadow it. In the next fortnight, the European Union will have a new executive arm, though it has not stopped the outgoing one to announce tariffs on Chinese-produced EVs and from initiating "excessive deficit procedures" against several members. The two big parties in the EU, the center-left and center-right will likely reach out to the Greens, who have not held an EC post before, rather than turn to Meloni's faction. In France, the middle has been eroded but neither the left nor right alliance looks to win outright. In the UK, recent polls warn Prime Minister Sunak may lose his seat, and Labour could see the largest majority in a couple generations. 

United States: As the first half winds down, the market remains sensitive to price data and is trying to firm up estimates for Q2 GDP. After softer than expected May CPI, PPI, and import prices, attention turns to the PCE deflators. Rounding could see a 0.1% gain in the headline deflator, which could translate into a 2.6%-2.7% year-over-year (2.7% in April). A 0.1% increase would see the three-month annualized rate slip to 2.8% from 3.6%. The core deflator may also rise by 0.1%, but the base effect could see the year-over-year rate slow to 2.6% from 2.8%. The three-month annualized core rate would slow to around 2.8% from 3.4%. While these are positive steps, even the doves at the Federal Reserve need to see at least a couple more months of improvement to raise their confidence. May personal income may have accelerated slightly after the 0.3% gain in April, but after the disappointing May retail sales, the risk is that consumption improved less than the 0.3% median forecast in Bloomberg's survey. The US goods trade balance has deteriorated every month this year, but may have improved slightly in May, though on a year-over-year basis, it looks about 6% wider. Durable goods orders could be an exception to the pattern of improvement sequentially. Boeing reported only four plane orders last month, down from seven in April and 69 in May 2023. For the second consecutive month, no orders were from US companies. Indeed, in the six months through May, only in March were there orders from US airlines. Deliveries held up better; unchanged at 24. Several June Fed surveys are due throughout the week, but typically do not spur much of a market reaction. Similarly, April house prices will draw passing attention. The University of Michigan's preliminary June survey saw a deterioration of consumer confidence (seven-month low). The Conference Board's measure fell in April to its lowest since July 2022 before rebounding in May. It is expected to be softening again this month. Lastly, European politics has eclipsed market interest in the US election. And the first presidential debate (yes, before the formal nominating conventions) will take place in the US evening on June 27, during the Asia Pacific session on June 28. 

Before the weekend, the Dollar Index reached its best level since May 1 (FOMC meeting) near 105.90. A move above 106.00 targets the year's high set in mid-April around 106.50. The Dollar Index found support earlier this month near 104.00, though a shelf has been created in recent days in the 105.10-20 area. The rally is extending the momentum indicators but do not appear poised to turn lower. 

Eurozone: The most important thing in the eurozone this week is not the money supply report or the ECB's May inflation survey (in April the one-year CPI expectation was at 2.9% and the three-year expectation was at 2.4%). Rather the run-up to the June 30 first round of the hastily called French legislative election following the dreadful showing the Macron's party and allies. Macron's Renaissance party could come in third place, overall and be eliminated from most run-offs that will be held on July 7. The French 10-year premium to Germany exploded from around 47 bp before the EU Parliament vote to 77 bp by June 14 and to more than 80 bp last week. It is the largest premium (on a settlement basis) since 2012 and triggered a widening in peripheral premiums as well. The European Council (heads of state) meet on June 27-28 and the main issue is assigning roles post-EU Parliament election. 

The euro traded higher in the first three sessions last week. It rose from a little below $1.0670 at the end of the previous week and peaked near $1.0760. The euro returned to $1.0670 ahead of the weekend. It has fallen for the past three weeks. Nearby support is seen around $1.0650, and a break of it, leave little to deter a test on the year's low set in mid-April close to $1.06. The euro meet the double top (set ~$1.0900-15 in mid-May and early June). A move above $1.0760 would help the tone, but the $1.0785 -$1.0800 may be a formidable hurdle and overcoming it would boost confidence a low is in place. 

Japan: There is little doubt that the Japanese economy, which contracted by 1.8% at an annualized rate in Q1 24, has returned to growth this quarter. The median forecast in Bloomberg's monthly survey is for 2.2% Q2 GDP. Forecasts may be tweaked after the May retail sales and industrial production figures due in the coming days. The most important report, though, is Tokyo's June CPI. For the market, it serves a similar function as the eurozone's preliminary CPI forecast and the US CPI. It is reasonably close approximation of the measures that matter, like the national CPI for Japan, the final CPI for the eurozone, and the US PCE deflator, which the Fed targets. From the Bank of Japan's perspective, it might not matter than much in the sense that next month's meeting, it will unveil a plan to reduce JGB purchases. Although many observers think it reduces the chance of a hike, BOJ Governor Ueda explicitly denied it. Still, what might not be generally appreciated is that the BOJ is buying around JPY6 trillion JGBs a month, which is roughly the same as the average amount maturing. Reducing bond purchases than would signal what has been dubbed as quantitative tightening--where the maturing issues are more than the new purchases.

The dollar will begin the week after having risen against the yen for the past seven consecutive sessions and ten of the past 11 sessions. The greenback traded to JPY159.85 before the weekend, its best level since the BOJ's intervention in late April. It is notable that the dollar's gains have come even as US 10-year yield is near two-month lows. Still, one-month implied volatility is subdued near 8.3%. It reached a two-month low on June 20 near 7.4%. Recall that it had spiked to around 12.4% in late April when the dollar traded above JPY160, and the BOJ intervened. The market seems somewhat less worried about intervention now, and thus far, Japanese officials have been fairly quiet. The US Treasury, using its formulaic approach, put Japan on its "watch-list" due to its increasing exports and current account surplus but it will not deter Japan from intervening again. The current account surplus is driven by earnings from foreign investment, royalties, licensing fees, and profits. The weakness of the yen boosts the value of those foreign earnings. 

China: It is a light week for Chinese macroeconomic data. Two data points are due. The first is May industrial profits. Chinese profits rose 4% year-over-year in April. In April 2023, industrial products had fallen 18.2% year-over-year, after falling 8.5% in April 2022. China's extensive subsidies do not necessarily translate into strong profits but often fierce competition instead, which in turn, creates the excess capacity. This was also the US experience and competition was often referred to as "ruinous" because it drove down prices below the cost of production and squeezed profits. In addition to finding foreign markets, the other solution was industry-rationalization through mergers and acquisitions that reduced capacity to maximize profits.

Chinese officials continue to slow the dollar's appreciation against the yuan. It has not drawn a hard line and the dollar rose to above CNY7.26 last week after previously holding below CNY7.25. This is the highest level since last November. Last year's high was set in September near CNY7.35. While dollar strength persists, and especially against the yen, Chinese officials have little practical choice but to allow the yuan to decline gradually. We have been anticipating that the dollar would move back into the CNY7.25-CNY7.30 range. The yuan has fallen by about 2.8% so far this year. It fell around 7.9% in 2023. The dollar rose to new highs since last November against the offshore yuan, reaching CNH7.2925 ahead of the weekend. Last year's high was near CNH7.3680 and the 2022 high was closer to CNH7.3750. While the market had often respected the onshore band in the offshore market this has ceased to be the case. The offshore yuan makes for an attractive funding currency for some market participants. 

UK:  After the UK's employment report, CPI, and the Bank of England meeting, the economic agenda turns quieter. Revisions to Q1 GDP (initially 0.6% quarter-over-quarter) are unlikely to capture the market's attention for long. More recent data suggests the UK economy has slowed as Q2 unfolded. After it expanded by 0.4% in March to end Q1 on a strong note (best monthly reading since June 2023), the economy stagnated in April. May's GDP print is due July 11. The economy may have eked out a 0.1%-0.2% Q2 expansion. Meanwhile, the latest polls suggest Labour will secure an outright majority in the House of Commons. The issue is over the size of that majority. The Tories may secure around 20% of the 365 seats if won previously. Although some opinion polls suggest Farage's Reform UK can eclipse the Tories in popular vote (but it is within the margin of error), in terms of seats, it may be lucky to pick up more than a half dozen or so. Some polls suggest Mordaunt could be the next Tory leader, but she needs to win her seat on the July 4 election, which she carried by almost 16k votes in 2019. Separately, Sweden's Riksbank meets on June 27. It cut its policy rate by 25 bp in May to 3.75%. It is too soon to expect another cut, but the swaps market has it fully discounted at the next meeting on August 20 and another one at the only meeting in Q4 (November 7). 

Sterling had found support near $1.2655, which was just ahead of the (38.2%) retracement of the rally from the April low near $1.2300. It fell through there ahead of the weekend, in the context of a stronger US dollar, aided by gains in the flash June PMI. Sterling also appears to have been weighed down by market perceptions that the risk of a rate cut has increased. Specifically, the swaps market now sees about a 2/3 chance of a hike at the August 1 BOE meeting. That is the most in a month. There is slightly more than a 90% chance of a cut by the end of Q3. At the end of May, the swaps market thought it was less than a 60% chance. The momentum indicators are falling, and the five-day moving average is below the 20-day, and both are headed south. There is potential toward $1.2550-80. A move above $1.2735-30 would negative this bearish view. 

Canada:  Two data points in the coming days may shape the already aggressive expectations seeing the Bank of Canada cutting rates two or three more time this year after initiating the easing cycle earlier this month. The swaps market is pricing in almost a 65% chance of a follow-up cut at next month's meeting (July 24), but this seems a bit much. The market has  55bp of cuts discounted by the end of the year. That is two cuts fully discounted about a 20% chance of a third cut. May CPI will be reported Tuesday. The slow trend of moderation will be extended. The 0.3% monthly increase the median in Bloomberg's survey projects will allow the year-over-year rate to ease to 2.6% from 2.7%. That would be the lowest since March 2021. The underlying measures (weighted median and trimmed mean) are also expected to slow. The weighted median measure has not risen since last August and it stood at 2.6% in April. The trimmed mean fell below 3% in April (2.9%) for the first time since June 2021. It has not risen this year. Still, with a 0.3% increase on the month, the three-month annualized pace would rise to 4.2% from 3.6% in Q1 24 and 1.6% in H12 23. Canada reports April monthly GDP at the end of the week. The economy stagnated in March, but the still managed to grow 1.7% at an annualized pace in Q1 24. A stronger employment report, a smaller merchandise trade deficit, and a recovery in retail sales (0.7% vs -0.2% in March) suggest a better overall performance in April. The median forecast in Bloomberg's survey is for 1% annualized Q2 GDP. 

The Canadian dollar slipped ahead of the weekend to end a five-day advance. In those five days, the Canadian dollar posted a cumulative gain of less than 0.5%. The recent price action reaffirmed support near CAD1.3660 and resistance near CAD1.38. The wider range that has contained the price action for more than two months is CAD1.3600-CAD1.3850. A move back above the CAD1.3720 will refocus traders to the greenback's upside. 

Australia: The central bank meeting takes much of the potential thunder away from May's monthly inflation report due on June 26. With income tax cuts being implemented next month, and concern that demand is running in excess of capacity already, the monthly CPI is unlikely to provide much hope for a rate cut in the coming months. Moreover, the monetary officials still put more weight on the quarterly inflation figure. The monthly CPI fell to 3.4% at the end of last year, falling consistently every month in Q4 23. It remained there in January and February but rose in March and again in April to 3.6%. The quarterly print for Q1 24 was at 3.6% year-over-year (1% quarter-over-quarter) and the trimmed mean and weighted median averaged 4.2%, down from 4.3% in Q4 23. 

The Reserve Bank of Australia is seen as one of the more hawkish central banks among the G10. The market does not expect a hike until next year. The Reserve Bank of New Zealand has signaled the same, but the swaps market is more skeptical. Still, the Australia dollar continues to mostly trade in a $0.6600-$0.6700 range, as has been the since the mid-May. The ranges may fray on an intraday basis but there has been only once close outside of it. The Aussie was slightly higher on the month going into the pre-weekend session where is fell by about 0.25%. 

Mexico: The moderation of Mexico's inflation is slowing and there was not much of a chance that the central bank would cut rates on June 27 even before the election. The peso is off nearly 6.6% since the election, and that is after its 1.4% recovery last week. The swaps market has a cut discounted before the end of the year. The central bank is likely concerned about the passthrough of the weaker peso feeding into imported inflation. The US halt of avocado (and mangos) inspections, which means their imports, as retaliation for serious mistreatment of inspectors began on June 15 and, if the past (February 2022) is any guide, it could last a week or two. The US imported $2.7 bln of avocados from Mexico last year. Mexico will report May trade figures a few hours before the outcome of Banxico. Through April, Mexico's trade balance is virtually unchanged from the first four months in 2023 (~$6.5 bln). However, in peso terms, the deficit has fallen by almost 8%. 

President-elect Sheinbaum has begun appointing her cabinet. The picks have largely come from the moderate wing of her party and have assuaged some concerns among investors. In particular, naming her rival for the party's nomination (Ebrard) to the economics ministry and keeping de la O as finance minister appeared to help lift the Mexican peso. At the end of last week, it strung together back-to-back gains for the first time since the election. Because of the carry, once the downside momentum on the peso eased, many bears were quick to cover. One-month implied volatility peaked near 20% on June 10 and has fallen back to almost 13% at the end of last week. It is still elevated, but as it approaches the 100-day moving average (~10.2%), carry-trades may be more attractive on paper. Investors are still wary of what AMLO can do in his last days in office with the overwhelming majority in congress in September before Sheinbaum's inauguration in October. The dollar was sold through support in the MXN18.20-2 area ahead of the weekend to approach MXN18.10. The next technical area is in the MXN17.95-MXN18.05 band.