Absorbing The Fed’s Message

Markets absorbed a high inflation reading in the form of US core Personal Consumption Expenditure (PCE) price index without flinching at the end of last week, further acknowledgement that the Fed’s “transitory” inflation message is belatedly sinking in to the market’s psyche.  Core PCE inflation exceeded expectations for April, surging 0.7% m/m after a 0.4% gain in March (consensus: 0.6%). On a y/y basis, core PCE inflation surged to 3.1%—its highest level in almost three decades. High inflation readings are likely to persist over the near-term, if for no other reason than base effect, but price pressures will likely ease by the end of the year. 

The market’s sanguine reaction has helped US Treasury yields to continue to consolidate.  Also helping to restrain yields is the fact that positive US economic surprises (data releases versus consensus expectations) are close to their lowest level since June 2020 and barely positive (according to the Citi index), in contrast to euro area economic surprises, a factor that is helping to support the euro.

Cross-asset volatility measures remain very low, with the glut of liquidity continuing to depress volatility across equities, interest rates and FX.  Given that markets’ inflation fears has eased, it is difficult to see what will provoke any spike in volatility in the near term.  All of this this does not bode well for the USD.  Sentiment as reflected in the latest CFTC IMM speculative data on net non-commercial futures USD positions, remains downbeat.  This is corroborated in FX options risk reversal skews (3m, 25d) of USD crosses. 

In particular, USDCNY will be closely watched after strong gains in the renminbi lately.  Chinese officials are trying to prevent or at least slow USD weakness vs. CNY. The latest measure came from China’s central bank, the PBoC instructing banks to increase their FX reserve requirements by 2% to 7% ie to hold more foreign currency as a means of reducing demand for the Chinese currency.  Expect official resistance to yuan appreciation pressures to grow.      

Data so far this week has been mixed. China’s May NBS manufacturing purchasing managers index released yesterday slipped marginally to 51.0 from 51.1 previously (consensus 51.1) while the non-manufacturing PMI increased to 55.2 from 54.9 previously. Both remained in expansion, however indicative of continued economic expansion. China’s exports are holding up particularly well and this is expected to continue to fuel manufacturing expansion while manufacturing imports are similarly strong. 

Today’s Reserve Bank of Australia decision on monetary policy delivered no surprises, with policy unchanged and attention shifting to the July meeting when the bond purchase program will be reviewed.  On Friday it’s the turn of the the Indian central bank, Reserve Bank of India (RBI), with an unchanged policy outcome likely despite the growth risks emanating from a 2nd wave COVID infections cross the country and attendant lockdowns.  Last but not least, is the May US jobs report for which consensus expectations are for 650,000 gain in non-farm payrolls and the unemployment rate falling to 5.9% from 6.1% previously.

When Bad Means Good

Bad meant good on Friday as weaker than expected US April jobs data helped to dampen concerns over inflation risks and higher rates. At a time when markets were becoming increasingly fearful of rising inflation risks the softer US jobs data will act as a balm on such fears. It also complicates matters ahead of bipartisan talks between President Biden and congressional leaders this week. Democrats will likely use the data to outline their case for more stimulus to boost growth, while Republicans will highlight that excessive unemployment benefits are holding back hiring.  

US Payrolls increased by 266,000 in April, well below the 1 million consensus and the unemployment rate rose to 6.1% from 6.0%, above the 5.8% consensus.  The data supports the view of most Fed officials that progress has not been “substantial” enough for them to start signaling tapering.  Unsurprisingly Markets pushed back the pricing of the first rate hike from early-2023 to May 2023 in the wake of the weaker US jobs data. The US dollar (USD) took a hit and looks likely to kick off the week on the back foot.  High yielding currencies will likely benefit the most.  

This week inflation releases will come under scrutiny, with CPI data in the US (Wed), China (Tue) and India (Wed) in focus, albeit for different reasons.  In the US, base effects will likely push inflation higher, with a sharp pick up in core CPI in particular likely.  A similar story is expected in China, but base effects will likely act in the opposite direction in India.  Other highlights this week include a likely modest decline in US retail sales (Fri), further easing in China’s credit aggregates (9-15 May) and a material improvement expected to be revealed in Australia’s Federal Budget (Tue).  Last but not least, central banks in Mexico and Philippines (both Thu) are expected to leave policy unchanged.

Separately, markets will digest the outcome of UK local elections, especially those in Scotland, which revealed that pro-independence parties (SNP and Scottish Greens) gained a majority in the Scottish parliament. A constitutional battle with the Conservative UK government looms though UK Prime Minister Boris Johnson is showing no signs of acceding to demands for a new Scottish referendum.  There will also be focus on the aftermath of the ransomware attack on the Colonial Pipeline in the US, which has already pushed energy prices higher.  And finally, the much anticipated (among Krypto traders) appearance of Elon Musk on SNL hit Dodgecoin, after he called it “a hustle”. 

India Risks, Highlights For The Week Ahead

It was a strong end to last week for US markets, with S&P 500 up over 1%, helped by stronger than expected new home sales and April US Markit purchasing managers indices (PMI) data. As risk assets rallied the US dollar and US Treasuries sold off.  There are plenty of event risks this week. Also, there will be deluge of US earnings releases this week including most tech heavyweights while markets will likely remain nervous over President Biden’s tax plans.  Geopolitical risks will also remain on the forefront. 

Even as the progress on the vaccination front continues the renewed increases in virus cases in many countries, particularly in India, where the situation has deteriorated markedly, threatens to delay recovery. The acceleration in virus cases has been dramatic, with Prime Minister Modi noting how it has “shaken the nation”. Virus cases hit 349,000 on Saturday and show no sign of receding. The toll on the health system in India has been massive, but the variants also holds risks to the rest of the world while it will also lead to a major disruption in India’s vaccine exports, threatening vaccination programs in several countries.  

Friday’s economic data round was broadly firm. Alongside the US releases noted above, Euro area April PMIs were generally better than expected, with G10 manufacturing PMIs pointing to strengthening momentum overall.  Separately, Russia’s central bank, the CBR surprised with a bigger than expected 50bp rate hike.  Today’s data releases include the April German IFO business confidence survey; consensus expectations forecast an increase to 97.8 from 96.6 previously. In the US, durable goods orders are forecast to rise in March by 2.5% m/m following a weather-related 1.2% m/m drop in February.

The focus over the rest of the week will turn to central bank decisions in Japan, Sweden and Hungary (all on Tue) and the Federal Reserve FOMC (Wed).  Although the Bank of Canada’s shift last week will prompt a little more nervousness about G10 central bank tapering the policy meetings are likely to be largely uneventful, this week. Nonetheless, the Fed tone is likely to be more positive than in March, while in contrast the Bank of Japan may sound more cautious amid a third state of emergency in Tokyo. 

A key event this week will be President Biden’s address to a joint session of Congress.  After the hit to markets in the wake of the news of a proposal to hike taxes, markets will look for any further details.  Key data releases this week include Australia Q1 CPI inflation (Wed), US Q1 advance GDP (Thu), China’s April purchasing managers indices data (Fri) and Euro area Q1 GDP (Fri).  

Reflation Trade Is Back

A much softer than expected US January jobs report didn’t prevent US equities from closing higher at the end of last week as the reflation trade kicked back in.  One of the biggest driving forces for markets was the growing prospects that much of President Biden’s $1.9 trillion fiscal stimulus plan will be passed, albeit via a process of reconciliation, which allows Democrats to circumvent the need to gain the support of at least 10 republicans. This contrasts with prior expectations that the final stimulus was going to be less than $1 trillion. 

Pushing stimulus through this way highlights Biden’s urgency to inject more spending into the economy but could come at the cost of hurting bipartisan policy efforts. The impact of expectations of increased fiscal stimulus is particularly apparent in the US rates market, with US Treasuries selling off and bear steepening of the curve.  Although higher US Treasury yields failed to give support to the US dollar (USD) there is still scope for a short covering rally, which could still help give the USD relief.     

At the beginning of the year the US jobs market took a hit from renewed lockdowns and surge in COVID cases; US January non-farm payrolls increased 49k, and December was revised to -227k from -140k while more positively the unemployment rate fell to 6.3% from 6.7% though this was flattered by a drop in the participation rate as less people were looking for work.  According to the payrolls report there are still 9.9 million more unemployed compared to pre-COVID levels.  As such, the weak jobs data added more support to Biden’s fiscal stimulus proposals.   

This week focus will likely turn more to President Trump’s impeachment trial in the Senate than economic data.  Key data/events this week include China’s credit and monetary aggregates (9-15 Feb), central bank decisions in Sweden (Wed), Philippines, Mexico (Thu) and Russia (Fri).  Among these the consensus is for only Mexico to cut its policy rate. Also in focus are inflation readings in China (Wed), US (Wed) and India (Fri).  UK GDP (Fri) and US Michigan sentiment (Fri) will also garner attention. 

The return of the reflation trade, rally in risk assets and decline in cross-asset volatility bodes well for emerging markets (EM) assets.  However, there are definitely various cross currents impacting asset markets at present especially with US Treasury yields rising, which could potentially support the USD and pressure EM local bond rates markets.  EM assets were clearly favoured towards the end of last year, and while the positive story has not dissipated, EM assets may take a pause for breath before pushing higher again.  

In Asia, the Chinese-new-year holidays this week may dampen activity while China’s PBoC also appears to be limiting liquidity injections around the holidays, which could limit some of the gains in Chinese and impact China linked assets.  Chinese authorities have re-focussed attention on preventing an excessive build-up of leverage and credit metrics have peaked as a result.  As such, they may be less keen to inject a lot of liquidity into markets at present. 

Chinese Data Softens

It was a tough week for risk assets last week as stocks dropped, volatility increased and the battle between retail investors and hedge funds intensified, with the latter on the losing side. The end of the week saw US and European stocks drop.  Whether the decline in stocks is due to over extended valuations, vaccine variants, vaccine supply pressures, weak activity data or more likely a combination of all of these, asset markets go into this week on a more unstable footing, with risks skewed towards pull back extending further.  It’s hard to blame day traders for the drop given that most of activity from retail traders is buying of stocks, and now silver, with heavy short position, but they are likely contributing to the rise in volatility.  The US dollar (USD) could be a key beneficiary given the massive extent of short positioning in the currency.

Data in China is showing some softening in momentum.  China’s Jan official purchasing managers index (PMI) kicked off this week’s data and event schedule yesterday, with both the manufacturing and service sector PMIs disappointing expectations; the manufacturing PMI fell to 51.3 in Jan (consensus 51.6, last month 51.9) and services to 52.4 in Jan from 55.7 previously.  China’s softer PMI once again contrasted with a series of Asia manufacturing PMIs, released this morning. Later today the US Jan ISM manufacturing index is likely to register a modest decline (consensus: 60.0 from 60.7 previously). Also in focus today is India’s budget announcement, with the Fiscal Year 2021 budget deficit likely to be around 6-7% of GDP, much higher than the original 3.5% estimate.  

Over the rest of the week there are interest rate decisions in Australia (Tuesday), Thailand, Poland (both on Wednesday), UK (Thursday) and India (Friday).  Among these the Reserve Bank of India has the most potential for a surprise relative to market expectations, with a rate cut likely.  The highlight of the week is likely to be the US January jobs report at the end of this week (consensus 55k).  Deliberations on US fiscal stimulus will also be in focus, with a group of 10 Republican Senators writing to President Biden with a $600 billion stimulus proposal, well below the $1.9 trillion put forward by the administration.  Democrats have hinted that they may push through stimulus via reconciliation, which not require Republican support in the Senate, but such a move would likely sour any mood of cooperation in the Senate. 

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