by There is no need to debate whether it was tightening by the Bank of Japan or the fourth consecutive rise in the US unemployment rate that spurred the dramatic market reaction at the start of last week. It seems reasonable that both played a role. And the dramatic unwinding of short yen positions, which appeared to help fuel a recovery of the Swiss franc, Chinese yuan began before the Bank of Japan meeting and the US employment report. Moreover, on the eve of the July 31 BOJ and FOMC meetings, the derivatives market had two Fed rate cuts fully discounted and a little more than a 70% chance of a third cut this year. The lack of transparency around the size of carry trades makes many skeptical of estimates that suggest a greater knowledge that seems reasonable. The
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There is no need to debate whether it was tightening by the Bank of Japan or the fourth consecutive rise in the US unemployment rate that spurred the dramatic market reaction at the start of last week. It seems reasonable that both played a role. And the dramatic unwinding of short yen positions, which appeared to help fuel a recovery of the Swiss franc, Chinese yuan began before the Bank of Japan meeting and the US employment report. Moreover, on the eve of the July 31 BOJ and FOMC meetings, the derivatives market had two Fed rate cuts fully discounted and a little more than a 70% chance of a third cut this year.
The lack of transparency around the size of carry trades makes many skeptical of estimates that suggest a greater knowledge that seems reasonable. The price action itself will tell. Barring a new shock or escalation of Middle East tensions, the quiet economic calendar for the first couple sessions next week is conducive for further consolidation after a tumultuous period. Beginning in the middle of last week, the data reports pick-up. The US July CPI may not see much change from June but the bar to a Fed cut in September is low. The UK's July CPI will also be reported on August 14. Japan reports Q2 GDP, which most likely bounced back after contracting in Q1, but the weekly portfolio flows may be more instructive. In the week through August 2, Japanese investors were sellers of yen for foreign stocks and bonds. The Reserve Bank of New Zealand meets on August 14 and the swaps market has about a 70% chance of a cut discounted. Norway's central bank meets the following data and policy is seen on hold (4.50%). China reports real sector data on August 15, but there is little doubt that the economy is struggling to sustain a pace that would allow it to grow 5% this year. The seems more sensitive to the broad carry trade developments (JPY) than the China's economic data.
United States: The series of weaker labor market data have seen a new gap open between what the Fed is signaling and what the market expects. The market is pricing in slightly more than 100 bp of easing over the next three FOMC meetings. This seems aggressive, even if not quite as aggressive as it had been earlier this year. Still, it does seem that the bar to a September cut is very low, and the July CPI is unlikely stand in the way. A 0.2% rise in the headline rate would keep the year-over-year rate at 3.0%. However, the three-month annualized rate would fall to about 0.4%, down from about 0.8% in the previously three months. The six-month annualized rate would about 2.4%. A 0.2% rise in the core rate would also keep the year-over-year increase at 3.3%. The three-month annualized pace would slip to 2.0% from 2.4%. The six-month annualized rate would be 3.2%, down from 3.6% in the previous six months. PPI, due August 13, a day before the CPI is not typically a market mover, but participants have greater appreciation in this cycle of how components of PPI are used alongside the CPI to project the PCE deflator, which the Fed targets (it often talks about the core rate but targets the headline rate). Headline and core PPI are also expected to rise by 0.2%. This will see the year-over-year headline rate fall toward 2.2% (from 2.6%) and snap a five-month advance (from 1.0% in January). A 0.2% rise in the core PPI would allow the year-over-year rate to fall to 2.6% from 3.0%. That would mark the first slowing on a year-over-year basis this year. Separately, the US also reports July retail sales, industrial production, and housing starts/permits. Once the uptick in auto sales (after the computer problems in June) is discounted, retail sales are likely to slow. The consumer is expected to pullback this quarter. Industrial production is seen slowing after rising by 0.6% in June. Housing starts are expected to edge up. If so, it would be the first back-to-back gain this year. Still, in H1 24, housing starts fell by nearly 14%. The US TIC data may draw more attention than usual after the May report showed a record divestment by Chinese investors. Lastly, the University of Michigan survey of consumer confidence has fallen for four consecutive months through July and at 66.4, it was the lowest since last November.
The Dollar Index fell to seven-month lows at the start of last week (~102.15) before gradually but consistently rising in the past four sessions to reach about 103.40. Near-term corrective potential extends into the 103.80-104.20 area. The correction to the (likely) exaggerated expectations of Fed easing may lend support to DXY. On the other hand, evidence that economic activity is slowing will likely limit the upside.
China: Beijing recognizes the need for more support for the economy, but not the type of regime change that many critics advocate. China has taken four new initiative recently: 1) CNY300 bln (~$42 bln) lending program for local governments to buy finished but unsold houses; 2) CNY300 bln of ultra-long special Treasury bonds to incentivize large-scale capital equipment renewals and replace household appliance, 3) a new framework to bolster financing support for small and micro service sector businesses, and income tax deductions to subsidies houses with small children, education costs, and support for the elderly, and small rate cuts. It rejected an IMF proposal that the central government finances the resolution/liquidation of insolvent property developers on the good old liberal grounds that it would create moral hazards. On August 15, China reports July industrial production and retail sales. Both look to have improved sequentially. Houses prices continue to decline, and the property market continues to be a drag on economic activity.
The yuan movement is more understandable through the lens of the Japanese yen than Chinese economic data. The correlation between changes between changes in the offshore yuan and yen over the past 30 and 60 days is high (~0.70). The movement of the yen still seems to be the best single indictor or the direction of the yuan. It is not causal, but a reflection of similar considerations, like the role of carry.
UK: The Bank of England began an easing cycle on August 1 and the swaps market is discounting another 50 bp before the end of the year. The BOE's chief economist Pill voted against the cut (5-4 vote where Governor Bailey cast the deciding vote) and cautioned against anticipating addition reductions soon. The market partly recognizes that and has less than a 50% chance of a cut at the next month's meeting. The data in the coming days will shape expectations. The two most important high-frequency economic reports, the labor market update and the consumer price index are on tap. Given the base effect (CPI fell by 0.4% in July 2023) warns that the year-over-year rate will likely rise from the 2.0% target reached in May and June. UK's CPI rose at 2.8% annualized pace in Q2 after a 2.4% annualized rate in Q1. The UK's labor market appears to be slowing and the claimant count in Q2 was rose by nearly 100k, which was the most since the early days of the pandemic. Wage growth is moderating. The three-month year-over-year pace was 5.7% in May compared with 7.2% in May 2023. The UK's Q2 GDP will be reported on Thursday. It poses headline risk, but the components have been taken onboard already. The median forecast in Bloomberg's monthly survey anticipates growth slowing to 0.3% quarter-over-quarter from 0.7% in Q1 (after H2 23 contraction). June details are due, but the BOE's rate cut likely diminishes their market significance.
Sterling fell from the high for the year set on July 17 near $1.3045 to $1.2665 on August 8. The move looks exhausted, and sterling posted a potential key reversal on August 8, falling to a new one-month low before rallying to settle above the previous session's high. Follow-through buying was limited before the weekend, but the momentum indicators are poised to turn higher, and the five-day moving average has stopped falling. Nearby resistance is seen in the $1.2810-50 area, and then $1.2900. A break below $1.27 would be disappointing.
Japan: The performance of the yen and Japanese equities are the main considerations, underscored by the light economic agenda in the next few days. Early Thursday, Japan will report is first estimate of Q2 GDP. Recall that the economy contracted at an annualized pace of 2.9% in Q1, dragged down by the disruption from the natural disaster at the start of the year and the auto scandal. The economy rebounded in Q2 but probably not by enough to recoup the loss of output in Q1. The median forecast in Bloomberg's survey is a 2.5% expansion. Of note, consumer spending looks to have snapped a four-quarter contraction. Net exports also look stronger, while private investment likely fully recovered from the 1.6% decline in Q1. The GDP deflator peaked in Q3 23 at 5.2%. It fell to 3.9% in Q4 23 and 3.4% in Q1 24. Economists look for a continued pullback and the median in Bloomberg's survey is for a 2.5% year-over-year pace, which would be the lowest since Q1 23. Given the policy divergence, the dramatic recovery of the yen, and the precipitous drop in the US 10-year premium over Japan to below 300 bp for the first time in 15 months, (though since rebounded to around 310 bp), portfolio capital flows will draw attention. The most recent MOF data showed Japanese investors were net buyers of foreign stocks in and bonds in the week ending August 2.
The dollar bottomed at the start of last week near JPY141.70 and rallied back to JPY147.90 in the middle of the week before consolidating. We think the extent of the yen carry trades is not particularly transparent. It is difficult to estimate size or the extent that it has been unwound. Japanese purchases of foreign bonds and stocks seems relatively more strategic, while foreign borrowing of yen to buy higher yielding or more volatile assets, appears more opportunistic and therefore more vulnerable to being squeezed out. The price action looks as if the current shakeout may be over. Nearby dollar resistance will likely be encountered in the JPY148.00-JPY148.45 area. The momentum indicators look poised to turn higher. Still, a move below JPY145.50 would warn that a forging a bottom will take more time.
Eurozone: The eurozone economic calendar is light and the updated look at Q2 GDP, albeit with more details, is unlikely to move the needle. The market remains highlight confident of a September rate cut. In fact, with three meetings left in the year, the swaps market has almost 70 bp of cuts discounted and nearly another 70 bp in the first half of 2025. Germany is seen once again the "sick man" in Europe, underscored by the unexpected contraction in Q2 GDP. On a year-over-year basis, Europe's biggest economy has not grown since Q2 23 when it eked out a 0.1% expansion. The August ZEW survey may draw interest. In July, the expectations component fell for the first time since July 2023, while the current assessment was the least negative since then. The preliminary forecast for Germany's Q3 GDP is 0.3%, which, if accurate, would be match the best since Q3 22.
Between Friday, August 2, US jobs report, and Monday, August 5, the euro record a range of more than two cents, closer to a typical month this year than a couple of days. It spent the last four sessions consolidating in a roughly $1.0880-$1.0960 range. The consolidative phase does not appear over. There may be scope for the US two-year premium over Germany to widen if the market reassesses the likelihood of a 50 bp cut by the Fed in September. The premium fell to about 157 bp on August 2, its smallest since July 2023. It recovered to about 165 bp at the end of last week.
Canada: Canada's economic diary is light on market-moving high-frequency data in the coming days. The highlights in July housing starts and existing home sales, and June portfolio flows. An important shift in expectations has taken place and this may begin allowing the Canadian dollar to forge a low, not far from the lows seen in 2022 and 2023. The peak in the policy divergence expectations may be behind us. The swaps market is discounting slightly more than 75 bp of Canadian rate cuts in the remainder of the year. The swaps market was pricing almost 75 bp of Fed cut before the disappointing US jobs data. The US two-year premium over Canada peaked in early June near 90 bp, the most since 2005 (~97 bp), which itself was the highest since early 1997. It is near 70 bp now. Still, the correlation of changes in the exchange rate and the two-year interest rate differential over the past 30 and 60 days is 0.2-0.3. The correlation with WTI is around there as well. Changes in the exchange rate and the S&P 500 (proxy for risk) is 0.3 and 0.4 over the past 30 and 60 days, respectively. The correlation with the Dollar Index (proxy for the broader dollar performance) is 0.4-0.5.
Amid the dramatic loss of risk appetites as the start of the last week, the US dollar surged to a two-year high near CAD1.3945. As soon as the markets showed a preliminary sign of stabilizing the Canadian dollar recovered. It finished the week near its best level in almost three weeks and begins the new week with a six-day advance in tow, matching the longest streak of the year. The greenback posted a potential key reversal on the weekly bar charts. It traded on both sides of the previous week's range, making a new high before settling below the previous week's low. At CAD1.3725, the US dollar met the (61.8%) retracement of the rally from the July 11 low (slightly below CAD1.36 and the 200-day moving average. A break of CAD1.3700 targets the CAD1.3660 area. The five-day moving average crossed below the 20-day moving average before the weekend and the momentum indicators are trending lower.
Australia: The Reserve Bank of Australia delivered a hawkish hold, but the market was not persuaded. The futures market is discounting a slightly greater chance of a rate cut this year than it did a week ago (almost 100% vs. 80%). The July employment report on August 15 may not change views much. In H1 24, Australia created (slightly) more full-time positions than in H1 23. The unemployment rate is expected to be steady at 4.1%. It was at 3.8% in July 2023. The participation rate is holding slightly below the record high set last November at 67%. The Australian dollar traded on both sides of the previous week's range but settled with it, denying it an outside up week. The Aussie stalled around $0.6600, the lower end of its previous trading range and where the 20- and 200-day moving averages converge. The (61.8%) retracement of the Australian dollar's fall from the July 11 high (~$0.6800) to last Monday's panic low ($0.6350). Despite the less than inspiring price action before the weekend, the momentum indicators have turned higher.
New Zealand: The Reserve Bank of New Zealand meets on August 14. The swaps market discounts a little more than a 70% chance of a cut. The market has 50 bp of cuts fully discounted at the October 9 meeting. There are three RBNZ meetings before the end of the year and the swaps market has 93 bp of easing discounted compared to about 77 bp at the end of July. The New Zealand dollar recovered from its marginal new low for the year (~$0.5850) and recovered to $0.6035 before the weekend. It nearly met the (61.8%) retracement objective of the slide from July 8 high (~$.6140). The 200-day moving average is closer to $0.6080. Like the Canadian dollar, the Kiwi also posted a potential key reversal on the weekly bar charts and the momentum indicators are trending higher.
Mexico: Mexico's economic diary lacks market-moving events in the week ahead. Investors and businesses will continue to digest the implications of the central bank's cut last week. The rate cut was delivered even as Banxico revised up its inflation forecast to 4.4% from 4.0% for Q4 24 and 3.7% from 3.5% in Q1 25. The central bank is looking through the headline inflation and focusing on the continued decline in the core rate and the fading growth impulses. The 3-2 vote saw Espinosa and Heath dissent. The swaps market seemed emboldened by the dovish cut and is pricing about 65 bp in cuts over the next three months and about 100 bp over the next six months. The greenback surged to MXN20.2180 amid the panic at the start of last week and set the low of the week near MXN18.7750 before the weekend. The momentum indicators have turned down. The MXN18.6050 area corresponds to the (61.8%) retracement objective of the rally that began on July 12 (~MXN17.6065), and below there is the 20-day moving average (~MXN18.5250).
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