Market movers today
Today's highlight is the US and euro area PMIs. They will be crucial as pointers of the way the global cycle is going over the summer following the US-China trade war escalation. In May, the US PMI manufacturing index for new orders fell to the lowest level since the series was released 10 years ago, sending a clear warning of a recession in the manufacturing sector in the US. We expect a slight further weakening of EA PMI manufacturing, whereas we expect the service sector to still hold up decently.
Today, US existing home sales are released, which should be doing okay on the back of the recent sharp drop in mortgage rates and still very high consumer confidence. Tonight, the Fed's Mester (voter, hawk) and Brainard (voter, dovish) speak.
Selected market news
Global equity markets had a good day yesterday, with indices rising across the globe. In the US, the Dow Jones index rose 0.9%, the S&P recorded all-time highs and the European Eurostoxx 50 rose 0.4%. The global central banks changing their tune and the upcoming meeting at the G20 between Trump and Xi are all supporting risk sentiment. At the same time, global bond yields continue to fall. The 10Y treasury yield flirted with the 2% psychological threshold as Bund yields fell to -32bp.
As widely expected, Norges Bank (NB) raised policy rates by 25bp, taking the sight deposit rate from 1.00% to 1.25%. The rate path was adjusted marginally upwards at the short end and marginally downwards at the long end. The message is clearly hawkish, as a strong domestic business cycle suggests a further frontloading of monetary tightening despite elevated international uncertainty at present. We expect NB to hike the sight deposit rate again by another 25bp at the 19 September meeting.
The Bank of England meeting was rather uneventful yesterday. The BoE mirrored the recent central bank communication about the increased downside risks, although it noted that the 'perceived likelihood of no-deal Brexit has risen'. The FX was weaker on an emphasis on downside risks even if the moderate tightening bias was maintained.
The selection of the new UK prime minister after PM May announced she was stepping down has entered the final stage. The c.160,000 members of the Conservative Party will have to vote between the favourite Boris Johnson and Foreign Secretary Jeremy Hunt for who will head the UK as the new PM and lead the UK through the final stage of the Brexit process.
Brent continued higher yesterday, rising more than USD2/barrel. US-Iran tensions are rising after two tankers were hit last week and a drone was shot down in the strategically important Strait of Hormuz to transport oil, amongst other things. Trump tried to downplay the drone incident yesterday.
Talk over the EU top posts ended overnight with an agreement to discuss the matter again next week. As expected, there does not seem to be a consensus for any candidate. This is a set-back to the EPP and Manfred Weber as he has often been mentioned as the frontrunner.
Yesterday, the media reported that the telephone conversation between the US's Trump and China's Xi was at the request of Trump, which indicates that he is interested in getting trade talks going again. It raises the odds that the meeting will result in another ceasefire and renewed talks. But China has been very clear that it has 'red lines' in the trade talks that Trump will have to accept these to get a deal. Talks could also be complicated by the US attack on Huawei and potential upcoming sanctions related to Xinjiang internment camps that the US is preparing, see SCMP .
Fixed income markets
The rally in risk continues and the S&P500 hit an all-time high last night, as the BoJ yesterday morning joined in on what almost looks like a coordinated action to save the global economy by major central banks. It is noteworthy that BoJ Governor Kuroda seems to be quite flexible if 10Y JGB yields drop below the -20bp lower yield-target bound. Lower JGB yields will intensify the Japanese buying spree in the EGB market and, for example, in the Danish callable market going forward. Despite the risk rally, 10Y US treasury yields stayed close to 2%. Note that US yields moved higher after the European close.
The European curves continued to flatten except in Italy, which saw some profit-taking after the Treasury announced a debt exchange. We believe the EGB and EUR swap curves will continue to flatten 2s10s. Yesterday, we argued to do a 2s10s flattener in DKK swaps instead of EUR swaps. For more see FI Strategy Position for a flatter 2-10s DKK swap curve, 20 June 2019.
Yesterday, Norges Bank hiked rates and importantly signalled a new rate hike already in September. We still recommend to buy SEP19 or DEC19 NOK FRAs or to position for a flatter NGB/NOK swap curve. See Norges Bank Review Hike and tightening bias maintained; September hike due!, 20 June 2019.
Spain (A-/stable) is up for review by Fitch tonight. We look for no change, but if anything, there is a small possibility of a positive outlook, similar to the outlook from S&P. We are still positive on SPGBs despite the recent strong rally.
FX markets
This week has brought as much clarification on what themes FX markets are set to trade on going into Q3 as we could have hoped. The ECB has entered a state of high alertness and we think it will need to deliver an easing package in September. The Fed finally confirmed that it is going from merely on hold to outright easing. The Fed’s determination to fade the USD carry lure and deliver reflation is crucial for FX markets as it contrasts markedly with the very limited options a range of other – mainly European – central banks are left with. Notably, we expect to see USD weakness versus currencies where central banks are constrained on easing options such as the EUR, CHF, JPY (or outright hiking such as the NOK) and/or hold USD debt such as emerging market FX. Specifically on the NOK, yesterday’s Norges Bank meeting also confirmed that Olsen and Co put more emphasis on strong domestics than international uncertainty and lower global yields. That supported a very strong session for the NOK; we favour more upside in Q3, see Norges Bank Review: Hike and tightening bias maintained; September hike due!
USD/JPY crossed 107.35 due to a combination of dovish Fed and slight geopolitical concerns on US-Iran relations. The dominant theme, we think, will be a continued downward adjustment of US real rates to support global growth - but also strengthen the JPY. Hence, we continue to forecast 107 on a 3M (NYSE:MMM) horizon but clearly see downside risk towards 105 if more Fed adjustment is needed to turn global growth around. At the Bank of Japan’s meeting, the signal was quite muted. In the bigger picture, BoJ passiveness might be an acceptable strategy as broad dollar weakness could very well also lift global inflation expectations. We think the BoJ could start to contemplate a reaction if USD/JPY moves into a range of 100-105 and the downward pressure on inflation becomes stronger but such a scenario is still rather hypothetical.
Key figures and events
