The UK Surprises, Will Yellen?

The UK offered two surprises today, and they pulled the British pound in opposite directions. First, BRC sales figures were simply horrible, declining 0.8% year-over-year in June (like –for-like). The market had expected a 0.7% increase after a 0.5% rise in May. This is one of the poorest readings in a couple of years, and this saw sterling extend its losing streak into the fourth consecutive session.

It made the lows against both the dollar and euro just before the second surprise, and ultimately the more important one. The June CPI was well above expectations and this sent sterling just through yesterday’s high near $1.7145. Similarly, the euro is also posting an outside day against the sterling as it was driven through yesterday’s low by the CPI figures.

The market had expected a small uptick from the May 1.5% pace of CPI. The 1.9%, however, and 2.0% core, well more than was expected. Core CPI rose to 2% from 1.6%. The price pressures reinforce the fundamental argument for sterling which is that the BOE will be the first major central bank to lift rates. In fact, the stronger than expected consumer inflation report will fan speculation of votes, that is a dissent, in favor of a rate hike at the next BOE meeting (August 6-7) , and to be followed by a more hawkish Quarterly Inflation Report (August 13).

It is also important to note the other consumer inflation measure, the retail price index. This is important because it is the rate that is used for wage negotiations and the benchmark for inflation-linked bonds. It rose to 2.6% from 2.4%. Clothing and footwear and transportation prices rose 0.6%. Separately, the UK official measure of house prices accelerated to 10.5% in May, the most in four years. Excluding London, house prices rose 6.4%, which is also a four year high.

The short-end of the UK yield curve took it the hardest. The March 2015 short-sterling futures contract sold off. The implied yield rose from 104 bp to 111 bp. The UK 10-Year gilt was the only core bond market that is seeing yields rise today (2 bp to 2.62%).

The UK was the biggest surprise, but it was not the only surprise. The German ZEW survey was a disappointment. The German economy lost some momentum in Q2 and the ZEW warns that this had continued into Q3. The expectations component of this survey and others like it appears to have led the weakness in recent months. Today’s report showed a further deterioration as it fell from 29.8 to 271. The Bloomberg consensus was for 28.2. However, the greater disappointment was with sharp erosion in the assessment of the current situation. It fell to 61.8 from 67.7 in June. That June reading was a three-year high.

Pressured by the sales against sterling and the disappointing ZEW survey, the euro slipped to a six day low just below $1.3590. The nearby support is seen near $1.3575.

There were not surprises from the BOJ meeting, where this year’s GDP forecast was tweaked to 1.0% from 1.1%. Nor did the RBA minutes offer fresh insight. The dollar has been confined to a little more than a 10 tick range against the yen. For its part, the Australian dollar traded heavily. It is the weakest of the major currencies, off 0.3% and approaching support near $0.9350.

The North American session has potential for some surprises. There are three sources of surprise. The first are two economic reports issued at the same time: the July Empire State Manufacturing Survey, one of the first economic reports for this month and quarter, and the June retail sales report. Retail sales are around 40% of US consumption. Auto sales were strong, and this can lift the headline figure. From a GDP perspective, it is better to look at the sales figures excluding auto, gasoline and furniture (these are picked up elsewhere for GDP calculations). After a disappointing flat report in May, the June figure is expected to rise 0.4%.

The Empire State survey, the first of the regional readings, is expected to ease to 17.0 from 19.28 in June. This would still be a good report. The May and June readings put the survey at is highsest since mid-2010. At 17.0, it will still be well above its various moving averages. It would offer a small hint that Q2 momentum may be carrying over to Q3 as is widely expected.

The big event of the North American session, however, is Yellen’s testimony befor the Senate Finance Committee. The important point to bear in mind in this testimony—she represents the Federal Reserve and not only her personal views. This may make her appear a bit more hawkish than what may appear to be the case in other settings. The Fed’s main message is that the economy is recovering and its mandates are being approached.

There is still some slack in the labor market that can be absorbed. Tapering and hiking rates are two different issues. There has not been a single dissent at the FOMC to accelerate the tapering. While there are a couple regional presidents that may favor a rate hike this year, they do not represent a majority view or even a growing minority view, as is possible at the Bank of England.