Overview: As the market reluctantly edges toward the Fed's guidance, the disappointing PMIs from Europe (but also Japan and Australia) helped boost the greenback. The Dollar Index is trading at seven-day highs above 103 after briefly dipping below 102 to set a new low since mid-May yesterday. The unwinding of cross positions is helping the yen hold its own today as it consolidates near its worst level of the year. The surging dollar and risk-off mood has dragged the emerging market complex lower. The JP Morgan Emerging Market Currency Index extended yesterday's loss and its lowest level of the year.
China and Taiwan markets were closed for holiday today, but the other Asia Pacific equity markets are a sea of red. Europe's Stoxx 600 is flat after four days of losses and US equity futures point to tough session for Wall Street. The weak flash PMI readings spurred concerns over growth and ignited a bond rally. European benchmark yields are mostly 10-11 bp lower and the US 10-year Treasury yield is off five basis points to about 3.75%. The lower yields appear to be helping gold stabilize after falling to new three-month lows (~$1910) in early Asia Pacific turnover. It is encountering offers near $1920. Demand concerns again weigh on oil prices. August WTI reversed yesterday from around $72.65 to below $69 and today, fell to almost $68. The month's low was near $67.
Asia Pacific
Japan saw the flash June PMI and May CPI. Japan's manufacturing PMI slipped back below 50 in June after moving above it in May for the first time since last October. The services PMI slowed to 54.2 from 55.9. The composite reached an 8 1/2-year high in April (54.3) and it eased to 52.3 in the preliminary June reading. The median forecast is for the Japanese economy to growing 1.1% (annualized pace) in Q2 after 2.7% in Q1. The May national CPI figures were in line with expectations. The headline and core measures slowed to 3.2% from 3.5% and 3.4%, respectively. The bigger issue is that measure that excludes fresh food and energy edged up to a new cyclical high of 4.3% from 4.1%. Still, next week will see Tokyo's June CPI, which may be more important ahead of next month's BOJ meeting when macro forecasts will be updated.
Australia's flash PMI is also not as important as next week's May CPI and retail sales reports. The PMI showed that the manufacturing sector remains challenged at 48.6 from 48.4 (below 50 for the fourth consecutive month). Services slowed to 50.7 from 52 and the composite eased to 50.5 from 51.6 in May. Forward looking new orders were notably softer. The futures market has downgraded the odds of a hike next month to less than 30% from over 50% at the end of last week. Meanwhile, May's CPI expected to slow to 6.1% from 6.8%.
Rising US rates and the divergence of policy lifted the greenback to new highs for the year against the Japanese yen. Despite the higher underlying inflation measure, Japan's five-year yield fell to a new seven-month low today. There is little to deter a move toward JPY145-JPY146. The note of caution comes from the dollar trading above its upper Bollinger Band (~JPY143). Yen weakness is not only about dollar strength, as it has been crushed on the crosses. Of particular note, it has fallen to a record low against the Swiss franc. The franc has gained nearly 11.4% against the yen so far this year, and about 1.5% over the past week. Here the carry seems secondary to the momentum. The Australian dollar's attempt to rally was stymied near $0.6800 yesterday after having been turned back from $0.6900 at the end of last week. It has been sold through support near $0.6730 area and into the $0.6680-$0.6700 area, which houses the 20- and 200-day moving averages and the (50%) retracement of this month's rally. Below there brings the next retracement objective (61.8%) into view (~$0.6625). Meanwhile, the greenback's broad strength and policy divergence will make it hard to for Chinese officials to stabilize the yuan even if they wanted. The risk is growing that the dollar challenges last year's high near CNY7.3275. Mainland markets remains on holiday, and the dollar rose to almost CNH7.23 offshore.
Europe
The eurozone flash PMI disappointed and the euro is being hit the hardest here in Q2, losing around 1%. The manufacturing PMI eased to 43.6 from 44.8. The last time it was about 50 was in June 2022. The services PMI fell for the second consecutive month. It is now at 52.4 from 55.1 in May. and is below the Q1 23 average of 52.8. The composite fell to 50.3 from 52.8. It spent H2 22 below 50 and spent H1 23 above 50. Like the services PMI, it slowed for the second month in a row. This was the general pattern seen in the German and France readings. The manufacturing sector is contracting while services are slowing. French services PMI fell below 50 for the first time since January, and at 47.3, the composite is at its lowest level since February 2021.
Wrapping up a disappointing week that saw inflation defying expectations for moderation, a new cyclical high in the core rate, a budget deficit in the first two months of the fiscal year running at twice the rate of last year's shortfall, and a 50 bp hike by the Bank of England. The BOE's assessment that the persistence of inflation requires further tightening helped encourage the market to discount around a 75% chance of another half point move at the next MPC meeting on August 3. Today, the UK has seen the flash PMI point to a slowing economy. The manufacturing PMI contraction deepened to 46.2, a new low for the year, and the service PMI slowed (53.7 vs. 55.2). The composite now stands at 52.8 drown from 54.0, after stalling in April at 54.9, the highest since April 2022. Separately, UK May retail sales held up better than expected. Rather than slip 0.2%, retail sales rose by 0.3%. They were flattered by gasoline sales, without which a 0.1% gain was recorded.
The euro reached a new high since May 8 yesterday (~$1.1015) before retreating. We have been suspecting a top was being formed and yesterday's advance was frustrating. We had anticipated a move toward $1.0860 and it looked unlikely until today's disappointing news. It was sold to $1.0845 in the European morning. The next target is around $1.0825 and then $1.0780. While the euro took out last week's highs yesterday, sterling failed to do so, and after a knee-jerk move higher (~$1.2835) on the BOE's 50 bp hike, it sold off nearly a cent. It traded below the $1.2690-$1.2700 support band in Europe today. There may be scope for a move toward $1.2570-80 in the coming days.
America
After extending its losses initially yesterday, the dollar reversed higher, supported by a further firming of US rates. It did not seem to be spurred by US data, which was mixed. While existing homes sales were stronger than expected, the Leading Economic Indicators Index continued to tumble and weekly jobs claims ticked up, with its four-week moving average rising to a new high (255k) since November 2021. As we have noted, the six-month annualized pace of the decline in the LEI has only been seen in a recession. Instead, we suggest two other things are taking place. First, Atlanta Fed President Bostic notwithstanding, Fed Chair Powell's assessment that a strong majority favor additional tightening seems to be a fair read of the table. Chicago Fed President Goolsbee is the only voting member of the FOMC that could dissent from a hike next month, yet even he said that the decision to pause was close for him, meaning that he too thought a case for another hike was reasonable.
Second, the market is gradually coming around to the FOMC's signal. The implied yield of the January 2024 Fed funds futures contract has risen for the past four sessions and at 5.27 is about 12 bp higher than it was on the eve of last week's FOMC decision. With the current effective average Fed funds rate around 5.08%, it still has not fully priced in one, let alone the two hikes the median dot indicated. From the Fed's point of view, the economy and the labor market are sufficiently robust and resilient that barring a significant surprise, a weak high-frequency data point will not derail is campaign.
As the market once again convergences to the Fed, rather than the other way around, the two-year yield is likely to climb back toward the March high (almost 5.10%) and the dollar will likely retrace its recent losses against the G10 currencies, while extending its gains against the Japanese yen. That said, as US rates rise, the other side of the scissors begins to cut. The KBW bank indices have rolled over. Both the bank index and the regional bank index settled below their 20-day moving averages for the first time in a month. Many fear that higher interest rates will exacerbate the pressure on banks, especially regional banks, emanating from exposure to commercial real estate. At least part of the skepticism of the Fed's forward guidance comes from the belief that what financial instability will prevent the Fed from doing what it says it will.
The broad strength of the US dollar has lifted it back above CAD1.3200 after probing a six-month low near CAD1.3140 yesterday. There is initial potential toward CAD1.3225-CAD1.3250 in the near-near term. The week's high was set Tuesday around CAD1.3270. The CAD1.3175-80 may offer the first level of support. As widely expected, Mexico's central bank stood pat yesterday. Increasingly, it seems the greenback is set to correct higher against the Mexican peso. A bottoming pattern seems to be in the process of being carved. A move above the MXN17.30-33 area could spur a move toward MXN17.50-60.