Aggressive Tightening Sees Risk Appetites Evaporate

It might not have seemed that way in the cloud of hours following the FOMC conclusion, but risk appetites were taking the day off. Asia Pacific equites were mixed, but Europe’s Stoxx 600 was off nearly 2% to completely give back yesterday’s gains, which were the first in seven sessions. US futures were off 2-3%.

Benchmark 10-year yields jumped and are mostly 15-18 bp higher in Europe and the US. The dollar was broadly higher. Among the majors, the Swiss franc, bolstered by the SNB’s largely unexpected decision to hike rates by an aggressive 50 bp, was the strongest currency (~1.5%) followed by the Japanese yen (0.8%).

The Scandis and dollar bloc were suffering the most. Among the emerging market currency complex, the free-floating accessible currencies, like the Mexican peso and South African rand were tagged the hardest.

Gold was consolidating around $1830, while July WTI was trading near two-week lows below $115. It peaked a couple of days ago near $123.70. US natgas was up 3% for the second consecutive day.

The combination of the LNG fires in Texas that supplies about 10% of Europe’s natgas and Russia playing games was sparking a huge rally in Europe's benchmark. It was up 13% today after more than 19% yesterday and nearly 15.5% on Tuesday.

Iron ore fell for the sixth session and was off almost 12% in this run. Copper was poised for an outside down day. July wheat was stabilizing after falling for the past two sessions. 

Asia Pacific

Japan's May trade deficit swelled to JPY2.38 trillion (~$17.7 bln), the largest since 2014. Exports grew 15.8% year-over-year, faster than the 12.5% pace seen in April, but a bit slower than economists projected. Still, it was a 2.4% month-over-month increase.

On the other hand, imports surged an unprecedented 48.9% from a year ago after a 28.3% rise year-over-year in April. Higher oil and coal prices, worsened by the weaker yen drove the jump in imports.

Exports to China remained depressed by the COVID lockdowns and slipped by 0.2%. Imports from China jumped by almost 26% after falling in April. Separately, the BOJ's meeting concludes tomorrow and is expected to stand pat. 

Australia's May employment report was stronger than expected and it reinforced expectation that the central bank will hike by at least another 50 bp when it meets early next month. Economists in Bloomberg's survey expected a 25k increase in May employment and Australia reported a 60.6k increase that was totally accounted for with a rise in full-time positions (69.4k). The participation rate jumped to 66.7% from 66.4%. It stood at 65.9% before COVID. The unemployment rate was unchanged at 3.9% (compared with 5.1% at the end of 2019).

Despite firmer US Treasury yields, the dollar was trading heavily against the Japanese yen. It reached a seven-day low near JPY133.10 in the European morning, having been turned back from JPY135.60 yesterday. The greenback was finding a bid in the European morning, and the JPY134.00 area may offer initial resistance. A break of the JPY133 area, though, could see a quick move toward JPY132.

The Australian dollar extended yesterday's gains to reach $0.7035 before the risk-off mood sapped the enthusiasm and saw it fall back to the $0.6950 area. The $0.7000 may cap it now and the risk was a push toward $0.6925.

The greenback fell to a new low for the week against the Chinese yuan (~CNY6.6920) but rebounded to nearly CNY6.7175. The PBOC set the dollar's reference rate at CNY6.7099, a little stronger than the bank models (Bloomberg survey) pointed to (CNY6.7088).

Hong Kong Monetary Authority hiked the base rate 75 bp to 2.0%. We were waiting for confirmation, but it appeared that the HKMA may have intervened for the third consecutive session today to defend the peg by selling US dollars and buying Hong Kong dollars.

Europe

A few days ago, the UK unexpectedly reported the second consecutive monthly contraction in GDP. The market had about a 40% chance that the Bank of England, which had hiked by 25 bp three times already this year (and began the cycle with a 15 bp move last December), opting for a opt for a 50 bp move.

Three members have been advocating (dissenting) 50 bp moves, and they may do so again on a quarter-point move. The swaps market had 125 bp of tightening discounted for the three meetings beginning with today's and another 65 bp in Q4.

The base rate was seen finishing the year near 2.85%, somewhat above the neutral rate thought to be around 2%. The terminal rate, in about a year's time, was seen at 3.35%, which was about 100 bp higher than a month ago.

The Swiss National Bank surprised the market. It hiked the deposit rate by 50 bp, leaving it at minus 25 bp. In fairness, there had been some speculation of a rate increase, given the central bank's assessment that the currency was "highly overvalued." It was thought more likely to wait for the ECB to move first (next month).

In announcing its decision to hike rates for the first time in 15 years, the SNB lifted its inflation forecast, dropped reference to the exchange rate, and promised to remain active in the foreign exchange market.

The euro plunged from around CHF1.04 to briefly trade below CHF1.02, a two-month low. This year's inflation forecast was raised to 2.8% from 2.1%, and 1.9% next year and 1.6% in 2024 (both had been at 0.9%). 

Someone at the European central banks told the press that the ECB was working on a new mechanism to be used after the Asset Purchase Program wound down to prevent fragmentation of divergences in the debt market that distorted the transmission of monetary policy. Leave aside that the issue was raised last year, and a compromise was struck that allowed the central bank discretion in the reinvesting of maturing proceeds.

Still, nothing was forthcoming from the ECB. Then at the start of the week, the ECB's Schnabel, seeming to make a virtue out of necessity, argued it was not tactically astute to preemptively reveal a new tool, and the tool would need to be designed for the specific challenge. Yesterday, it tried playing investors by (needlessly?) announcing an emergency meeting and then failed to deliver anything but internal instruction to devise a new tool.

The debt markets held on to significant gains, but the euro, which briefly poked above $1.05 was sold below $1.04 by the close of the European session. A new tool will likely look like the old tools—the European Stabilization Mechanism and the Outright Monetary Transactions.

Recall that theoretical purchases under OMT were not to ease policy through expanding the balance sheet. Instead, the program called for the sterilization of the impact. Also, rather than buy long-term securities, OMT was aimed at the shorter end of the curve (1-3 years).

Lastly, the rub is often conditionality that is attached. The arguments may turn on the strings that the creditors insist on, and as we have seen in the past, if the conditions are too severe, the facility will not be used. 

The euro was trading within yesterday's range (~$1.0360-$1.0510). It made little headway after finishing North American session near $1.0445. It reached almost $1.0470 before being pushed to $1.0380. Consolidation may be the best that can be hoped for today. The euro reversed lower from CHF1.0480 yesterday and dropped to slightly below CHF1.0170. The lower Bollinger® Band was around CHF1.02 today. 

The demand for sterling after yesterday's 1.5% gain dried up. It briefly traded above $1.22 yesterday but sterling remained below there today. It tested the $1.2050 area in late Asian turnover and looked vulnerable from a technical perspective for a retest later today.

Lastly, note that the Hungarian central bank hiked the one-week deposit rate by 50 bp to 7.25%. It was the second hike in three weeks and surprised the market. The forint traded at record lows against the euro earlier this week and was at its best level for the week following the unexpected rate move.

America

A few hours after the Atlanta Fed's GDP tracker that had been estimating Q2 US GDP at 2.5% as recently as mid-May, shaved the last bit to zero after the disappointing retail sales report and the Fed delivered a 75 bp rate hike, warning investors and businesses to be prepared for a bumpy landing. 

The median forecast sees slower growth, more inflation, and higher unemployment. Chair Powell seemed to tie the decision to hike 75 bp instead of 50 bp to the CPI report and the inflation expectations surveys. It may be ill-advised to tie a rate decision, which has a variable lag before impacting the economy, with a high-frequency economic report and one that is subject to revisions. 

While Powell stressed that the Fed was "strongly committed" to achieving its inflation target, the market took away a more dovish message. The Fed funds futures market downgraded the chances of a 75 bp follow-up hike at the next meeting (July 27) to about 60% from nearly 100%. The implied yield of the December Fed funds futures fell 14.5 bp yesterday, snapping a five-day advance and only the second decline since May 26.

The peak rate was now seen a little below 4%. It finished Tuesday at 4.25%. In March, many critics pushed against the median forecasts that showed higher interest rates, slower growth, but little changed unemployment rates.

What seems incongruous now was Powell's repeated observation of the strength of the economy. We noted the Atlanta Fed's GDPNow sees the economy stagnating this quarter after contracting in the first quarter.

Today’s economic calendar features what is expected to be the third consecutive monthly decline in housing starts and the second for permits. The weakness was coming from elevated levels. The June Philadelphia Fed survey is due. The Empire State survey earlier this week disappointed.

The US also reports weekly jobless claims. Tomorrow sees May industrial production figures and Powell makes remarks at a conference on the US dollar.

Canada, Mexico, and Brazil's calendars are light. Brazil's central bank delivered the widely expected 50 bp hike yesterday to lift the Selic rate to 13.25%. The central bank was seen nearing the end of its tightening cycle and signaled that it will raise rates by 50 bp or less at its next meeting in August.

The recovery in the Canadian dollar that yesterday's price action gave some hope for has stalled. The US dollar was repelled after approached CAD1.30 yesterday and settled a little below CAD1.29. However, with risk appetites drying up, the Canadian dollar was under pressure again. A push above CAD1.30 targets last month's high closer to CAD1.3075.

Similarly, the greenback recovered from yesterday's downside reversal against the Mexican peso. It found support near MXN20.22 and surged above MXN20.56 in the European morning.

The Tuesday-Wednesday high was near MXN20.69. Above there, the next chart points of note are near MXN20.85. The dollar found support near BRL5.0 yesterday. Assuming this area holds, the greenback can re-test the BRL5.13-BRL5.15 area.