Risk appetites were improving on the margin. Asia Pacific stocks still fell after the sharp losses on Wall Street on Monday. Still, China, Taiwan and Indian equities traded higher. Europe's Stoxx 600 snapped a four-day 6.5%+ slide and was up around 1.2% in late European morning turnover. US equity futures were up over 1%.
The 10-year Treasury yield that pushed to 3.20% yesterday was a little above 3%. European benchmark yields were 5-7 bp lower and the peripheral premium narrowed slightly.
US dollar trading was mixed. The Australian dollar, yen, and Canadian dollar were steady, while the Norwegian krone and the Swiss franc were laggards.
Most emerging market currencies were firmer, including the Indian rupee, which fell to record lows yesterday. The central bank reportedly intervened in the spot, forward and NDF markets. Today, the South Korean won, and Turkish lira were underperforming.
Gold was holding above $1850 support. June WTI initially extended yesterday's pullback from the $110 area to test $100 before steadying. US natgas tumbled 12.6% yesterday after the pre-weekend drop of 8.4%. Today, it was off another 1.3%, and was below $7 for the first time in nearly two weeks.
Europe's benchmark was off nearly 4% today after falling about 15% in the past two sessions. It was near last month's low.Iron ore fell 2.2% in Singapore. It was the sixth drop in the past seven sessions and had returned to levels last seen in mid-January.
The June copper futures fell to the year's low yesterday and had steadied today. July wheat fell for the first time in four sessions yesterday, but came back bid today.
Asia Pacific
As COVID restrictions were eased, pent-up demand helped boost household spending in Japan even though wage increases were not keeping pace with inflation. Spending surged 4.1% in March over February, which was more than expected. The quarter ended on a firm note but not enough to offset the earlier weakness and spending fell around 1.8% on the quarter. Japan reports Q1 GDP next week and economists (median, Bloomberg survey) anticipate a 0.5% contraction.
Japan's Foreign Minister Hayashi became the latest international official to visit the Solomon Islands after a secret pact was signed with China. Clearly, many countries in the region, were concerned about an extended China presence. Prime Minister Sogavare claimed that the Solomon Islands were being treated like children.
The government insisted that the treaty did not allow for a permanent Chinese presence. The US had downgraded its own presence in the islands in 1993 when it closed its embassy, which had been open for five years. The US said it would re-open the embassy earlier this year but also warned Sogavare that it would "respond accordingly" if China builds a base or secure capability.
The apt comparison may not be the Cuban Missile Crisis, but Ukraine. Kyiv has the right to choose its allies even if it is disruptive to some of its neighbors. Solomon Islands could be punished if it chooses wrong.
As US 10-year yields pulled back and briefly dipped below 3.0% after reaching 3.20% yesterday, the dollar slipped to a three-day low near JPY129.80. US yields stabilized and so did the greenback. It settled in a JPY130.20-JPY130.60 range. Last week's low was seen aroundJPY128.65 and this needed to be taken out to signal a corrective rather than just the consolidative phase.
The Australian dollar was sold to almost $0.6900, its lowest level since mid-2020, before rebounding to about $0.6985. Buying emerged in early Europe on a pullback toward $0.6940. A move above $0.7000 was needed to stabilize the technical tone.
The greenback traded on both sides of yesterday's range against the Chinese yuan. It briefly traded above CNY6.74 for the first time since November 2020 before being sold off to almost CNY6.69 where it found a new bid. The PBOC set the dollar's reference rate lower than expected (CNY6.7134 vs. CNY6.7139). After three days of gains, the greenback was trading softer.
Europe
It may not be particularly clear in the PMI data, which had been holding up fairly well for the euro area. The April Composite PMI rose to 55.8 from 54.9 in March and 55.5 in February before the Russian invasion of Ukraine. But the economy was weakening. Last week, we learned that retail sales fell 0.4% in March, which was more than expected.
At the end of this week, we will learn that industrial output slumped. Consider that last week Germany reported March industrial output plummeted by 3.5% (the median in Bloomberg's survey expected a 0.4% decline). French industrial production fell by 0.5%, more than twice what had been expected. It followed a revised 1.2% decline in February (from -0.9%). It was the fourth decline in five months.
Spain's industrial output contracted by 1.8% in March. The median forecast in Bloomberg's survey called for a 0.5% decline. Earlier today, Italy offered a pleasant surprise: Its industrial output was flat in March. Economists had forecast a 1.5% decline on the month. The aggregate figure for the eurozone was due at the end of the week. A 2% fall was expected, which would be the most since the pandemic first struck.
Sentiment was also falling. Last week, the EC confidence indicators for April were all weaker than expected. Yesterday, the May Sentix investor confidence measure fell to -22.6, worse than expected and the lowest since June 2020. Today was the ZEW survey. The eurozone expectations component approached the March 2020 low (-43.6) but recovered to -29.5 in May.
In Germany, the assessment of the current situation deteriorated (-36.5 vs. -30.8), but expectations stopped a two-month dramatic slide. It had fallen from 54.3 before the Russian invasion of Ukraine to -41.0 in April. The "rebound” lifted it to -34.3 in May. The latest survey on Bloomberg put the risk of a recession in the eurozone at 35% over the next 12 months. The odds of a recession in the UK and Japan were put at 30%. The US was at 25% and Canada 17.5%.
The euro was bouncing along its trough around $1.0480 for the better part of two weeks. The upside blocked last week in the $1.0630-$1.0640 area. So far, today, it was holding above $1.0550, which, if sustained, would be the highest low since Apr. 26. The intraday momentum indicators suggested there was scope for range-extension today to the upside and a close above $1.06 could lift the tone. However, the $1.0650 area needed to be overcome to signal a correction rather than consolidation.
Sterling traded on both sides the of the pre-weekend range yesterday but the close was a little lower. This was consistent with some sideways movement. Previous support at $1.2400 offered resistance. It was also the (38.2%) retracement of last week's BOE-induced slide. The intraday momentum indicators suggested a test on it was likely in North America today. Initial support was seen near $1.2320.
America
The Financial Times, citing the work of one bank, suggested that we were in "reverse currency wars." Was that a helpful or accurate framing of the issue or was "war" an inflammatory image that was the material equivalent of click-bait?
First, we would counter by saying that it was possible that the foreign exchange market became an arena of competition and beggar-thy-neighbor strategies. However, there was an arms control agreement, and even if the edges fray a little, it was holding.
Second, most central banks from high-income countries viewed the exchange rate in terms of financial conditions. When the monetary officials were reducing accommodation, they preferred to see currency appreciation.
Depreciation, on the other hand, would blunt or offset the tightening of financial conditions that was sought. What seemed like a race-to-the-bottom was that there was a common shock and central banks were easing policy.
Central banks from high-income countries were mostly tightening financial conditions. There were three notable exceptions. The Swiss National Bank and the Bank of Japan were clearly feeling no sense of urgency. For the European Central Bank, it appeared a rate hike was a question of time. The debate seemed to be between July and September. The signals from policy makers suggested an "expeditious" campaign to above zero before the end of the year.
Depending on several other variables, including openness of an economy, exchange rates can influence inflation. Given elevated prices in most many high-income countries, yes, it was given that exchange rates were being monitored. Yet, given the increase in volatility and the trend moves, foreign exchange rates did not seem to be particularly urgent.
And what was the policy implication that the "reverse currency war" was supposed to do? The FT says that the bank estimated it to be worth 10 bp extra of tightening that will be required.
This was a rounding error and spoke to the exaggerated precision economists often use, not the kind of damage fitting of war imagery.
There have been three key developments since last week's FOMC meeting. First, US rates were mixed. Since the night before the May 4 decision, the US 10-year yield had risen by about five basis points but was up closer to 23 bp at its peak yesterday. The two-year note yield fell 18 bp, and at yesterday's low point, had fallen 21 bp from the day before the FOMC hiked.
Second, followed from the first point and was that the US 2-10 yield curve steepened. Both of those were consistent with the Fed not being as aggressive as the market expected.
However, what challenged this narrative was that the 10-year breakeven (the difference between the conventional yield and the 10-year inflation protected security) had fallen. And it settled yesterday at its lowest level in two months (slightly below 2.75%).
Mexico's inflation accelerated last month, and the market expected the central bank to lift the overnight target rate by 50 bp on Thursday to 7.0%. The headline rate rose to 7.68% from 7.45%, which was slightly less than expected. However, the core rate rose slightly more than expected (7.22%, vs. 7.18%, the median forecast in Bloomberg's survey and 6.78% in March). The swaps market was pricing in about 115 bp of tightening over the next three months. This suggested two 50 bp moves with the risk of a 75 bp move.
The dollar traded above CAD1.30 yesterday for the first time since November 2020 as US equities cratered. Its gains were initially extended in the Asian turnover today (a little above CAD1.3035), but as equities stabilized, the greenback pushed back below CAD1.30. Note that the CAD1.3025 corresponds to the (38.2%) retracement of the US dollar's decline from the pandemic high (~CAD1.4670). Hedging the large ($3.35 bln) option that expires today at CAD1.2935 may have contributed to the upward pressure on the exchange rate.
Tomorrow, there was a $1.2 bln option at CAD1.30 that expires and $1.9 bln in options at CAD1.2950. We continue to see the key drag on the Canadian dollar coming from the dramatic slide in equities rather than Canada's fundamentals.
The greenback initially extended its gains against the Mexican peso. It rose to a five-day high near MXN20.44 to test the 200-day moving average before pulling back to around MXN20.3160 in the European morning. Nearby support was the MXN20.25-MXN20.30 band.