There are three main talking points today: 1) The divergence in the trajectory of monetary policy, illustrated by the Atlanta Fed's Lockhart yesterday, and to be tested today by the ADP private sector employment estimate; 2) The July service sector PMIs; and 3) The IMF's update on the yuan's inclusion in the SDR (Special Drawing Rights).
Lockhart suggested for some, like himself, the burden of proof has shifted. Rather than the economy having to prove itself ready for the beginning of the normalization of monetary policy, only significantly disappointing data now would get him not to favor a rate hike in September.
The dollar advanced in response to his comments and has retained most of its gains. The US 2-Year premium over Germany neared 100 bp earlier today, which is the highest level since early 2007. Various market-based measures of Fed expectations, like the Fed funds futures, a more complex use of Fed funds futures and options that Bloomberg has devised, and OIS all show that a rate hike next month is still not full discounted.
The dollar is trading on the firm side of its recent ranges. Key support for the euro is at $1.08. A convincing break of this area would signal a retest on the multiyear low set in March near $1.0450. The dollar's near-term ceiling against the yen in the JPY124.50-60 area is not as significant, but we note that the dollar has only traded above JPY125 on three occasions this year and managed to close above it once.
For its part, sterling is in the middle of its three-week range of roughly $.15470-$1.5670 range. The prospects of as many as three hawkish dissents at tomorrow's BOE meeting, and a quarterly inflation report that upgrades the prospect that the inflation target will be reached in the medium term, underpins sterling.
The Bloomberg consensus calls for a 215k increase in the ADP estimate for private sector job growth. While off June's 237k pace, we note that the consensus is still above the 3- and 6-month averages, and if borne out in the national survey at the end of the week, would likely count toward the "some" improvement that the FOMC statement indicated policy maker wants to see.
Separately, the June trade balance will be reported as well. The significance lies with its ability to spur revisions in Q2 GDP. The ISM service release may pose some headline risk, but its importance lies in the employment component which some economists will use, along with the ADP report, to fine- tune estimates for the nonfarm payroll report.
The eurozone service PMI rose to 54.0 from the 53.8 flash reading. The composite reading stands at 53.9, a little better than the flash, and while below the 54.2 peak in June matches the 3-month average. Germany's reading was revised to 54.0 from the 53.8 flash report while France was unchanged at 52.0 (down from 54.1 in June). Italy also fell to 52.0 from 53.4. Spain continues to impress. The July service PMI rose to 59.7 from 58.5. The consensus had expected a decline.
The euro area also reported disappointing June retail sales, illustrating the ongoing weakness in domestic demand despite the expanding economies. Retail sales fell 0.6% in June after the May series was revised to show a 0.1% rise rather than 0.2%.
The UK's services PMI also disappointed. It fell to 57.4 from 58.5, which leaves it just below the 3- and 6-month averages of 57.5 and 57.9 respectively. Sterling barely reacted to the news with the focus on tomorrow's events. We note that the tube strike later today (and all day tomorrow) may make for unpleasant commutes, and may make for somewhat thinner market conditions.
Japan PMI for services slipped to 51.2 from 51.8, though the composite was unchanged at 51.5. Although the composite remains in an expansion mode, it appears that the Japanese economy contracted in the April-June period. GDP will be reported on August 16. The Bloomberg consensus forecasts a 0.5% quarterly contraction after a 1% expansion in Q1.
China’s Caixin services PMI rose to 53.8 in July from 51.8 in June. This was insufficient to lift the composite after the weak manufacturing report out earlier. The composite PMI slipped to 50.2 from 50.6. There was good two-way activity in Chinese shares, but ultimately the sellers prevailed, and the Shanghai Composite fell 1.7%. Volume was about a third of what it has averaged over the past month. The restrictions on intra-day short sales and the investigations into algorithmic trading appear to have deterred activity.
The IMF provided a timely update to the SDR review. While it recognizes important progress, it suggests that "significant work" is needed. Still, it appears to be a close call, and one which, the IMF acknowledged, is not simply a technocratic decision but rather a large scope for judgment. By most measures, such as reserves, global debt securities, and foreign exchange transactions, the yuan is not in the top five currencies. In cross border payments and letters of credit, the yuan ranks higher. However, the caveat—which we have emphasized in the context of the internationalization of the yuan, and which the IMF recognizes in the report—is it must still be determined whether yuan payments between Mainland China and Macau, Hong Kong, and Taiwan counts as international transactions.
The report mentions the possibility of a delay in the implementation of the decision until September 2016. It is indicating that this would make for a smoother transition. Technically speaking, the current SDR basket expires at the end of this year. In recognition of the challenges of January 1 launch, the IMF staff has proposed a nine-month extension of the current basket. It could be that in the interim period China would likely be committed to meeting additional measures.
Chinese officials are in difficult position. They need to take additional measures to allow greater use of the yuan, while at the same time taking strong action in the equity market. As we have suggested, the intervention in the stock market is not particularly or directly relevant to the SDR decision. Lagarde confirmed as much in an interview last week. There has been much speculation that the PBOC will widen the allowable band for the dollar-yuan movement from 2% to 3% around the daily fix.
While this is possible, we do not see how that would bring the yuan any closer to inclusion in the SDR. The current band has not been used for months. Looking at a chart of the dollar against the other currencies in the SDR and a chart of the dollar against the yuan, it is quite clear which is the outlier. It appears that CNY has been re-pegged to the dollar.