Strong US Jobs Data And Hawkish Fed Speak Keeps Tightening Expectations Elevated

August 8, 2022 — Mitul Kotecha

US bond yields rose sharply on Friday, particularly on the front end of the curve in the wake of the above consensus US July jobs report, which showed a strong 528,000 (consensus 250,000) increase in non-farm payrolls and the unemployment rate dropping to 3.5% (consensus 3.6%).  The three-month moving average of US jobs gains now total 437,000. However, the drop in the unemployment rate was due in part to a drop in the participation rate so it wasn’t all good news.  Wage growth was firm, with average hourly earnings up 5.2% y/y. Overall the data highlighted a still strong jobs market and markets are now pricing in a greater probability of 75 basis points hike by the Federal Reserve at its September meeting. 

The firm US jobs data accompanied hawkish Fed speak over the past week, with various Fed officials pushing back against more dovish rate expectations that had been built into markets over recent weeks. The Fed’s Evans, Kashkari and Daly are scheduled to speak this week and are likely to maintain the run of hawkish Fed comments, pushing back against residual expectation of an early peak in the Fed Funds rate. Despite weaker closes for equities on Friday, stocks still ended higher over the week, but may struggle given the renewed hawkish shift in rate expectations.  That said, with the bulk of second quarter earnings out of the way equities have held up well. 

The data and Fed speakers also give further reason to be cautious on extrapolating the recent pull back in the US dollar, with the currency bouncing at the end of the week and starting this week on a firm note.  The USD index has bounced off trend line support and has bounced off its 50-day moving average level, which has been a good support over recent months.  In the near term some consolidation in the USD is likely though this week’s US CPI inflation report is likely to provide more direction.  Conversely, while the euro appears to have found a short-term bottom, it’s hard to see a significant bounce in the currency. 

Data over the weekend revealed a stronger than expected increase in Chinese exports in July at 18% y/y (cons. 14.1%) and lower imports at 2.3% y/y (cons. 4.0%), resulting in a surge in the trade surplus to $101.26bn (cons. $89.04bn).  The weak imports data highlights ongoing pressure on domestic demand while exports will likely struggle to maintain firm momentum amid a likely slowing in external demand.  China’s July inflation data this will be in focus (Wed) this week while more reaction by China to last week’s visit by Speaker to Pelosi to Taiwan will also be expected. 

In the US, the key data will be the July CPI report (Wed); the consensus expects elevated readings of 8.7%/6.1% y/y for total/core prices.  Headline CPI will have moderated from June, but core CPI is likely to have ticked higher.  Long term inflation expectations as measured in the University of Michigan August confidence survey (Fri) will also be in focus.  On the policy rate front, a 25bp hike from the Bank of Thailand kicks of its tightening cycle (Wed) and a 75bp hike from Mexico’s central bank, Banxico.  However, unlike Thailand Banxico is likely nearing the end of its tightening cycle.   

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Recession vs. Inflation Battle Rages On

July 26, 2022 — Mitul Kotecha

The recession vs. inflation battle is increasingly shifting towards the former as reflected in the recent paring back in US Federal Reserve tightening expectations and growing market pricing of rate cuts beginning as soon as early next year.  The weakness in the US July Services purchasing managers index (PMI) added more weight to this argument.  This week’s second quarter US Gross Domestic Product (GDP) data is likely to confirm two quarters of negative growth, which should mean technical recession though in the case of the US, recession is defined by the US National Bureau of Economic Research (NBER) as “a significant decline in economic activity that is spread across the economy and lasts more than a few months”.  Either way, the US economy is on a softer path.

This week is a big one for events and data. The Fed is widely expected to hike US policy rates by 75 basis points tomorrow. Expectations of a bigger 100bps move have been pared back. If the Fed does hike by 75bp it will likely result in interest rates reaching a neutral rate (the theoretical federal funds rate at which the stance of Federal Reserve monetary policy is neither accommodative nor restrictive). At this meeting there will be a lot of focus on the Fed’s forward guidance but in reality the magnitude of hikes at the next FOMC meeting in September will be contingent on key inflation releases and other data, with two inflation reports (10 August and 13 September) to be published ahead of the next Fed meeting.

In Europe there was yet more disappointing economic news this week, with the German July IFO business sentiment survey falling sharply. The data gave a similar message to last week’s weak PMIs, provides yet more evidence that the German economy is falling into recession.   News that Russia has cut gas deliveries to Europe through Nord Stream 1 will only add to such concerns.  After surprising with a 50bp rate hike last week, the ECB arguably faces a bigger problem than the Fed.  At least in the US, the consumer is still quite resilient, with demand holding up well, while in contrast, demand is weak in Europe and the economy is sliding into recession at a time when inflation is around four times higher than target. 

Emerging markets have found some respite from the pull back in the US dollar over recent days, but it is questionable how far the dollar will sustain any pull back.  Increased worries about the US economy and a paring back of Fed tightening expectations could damage the dollar further, but let’s not forget that the Fed is still tightening more rapidly than many other major central banks, which ought to limit any US dollar weakness.  Even so, even if it’s a short-term phenomenon, emerging market currencies and bonds will find some relief from a softer dollar tone for now.  That said, many frontier economies such as in North Africa and South Asia are likely to struggle from higher food and energy prices for some months to come. If the dollar does resume its ascent it will only add to their pain. 

Posted in Asia, Asian currencies, Bond markets, bonds, central banks, Currencies, ECB, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, FX, Germany, inflation, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , . Leave a Comment »

Central Banks Deliver Hawkish Surprises – What Will The Fed Do?

July 18, 2022 — Mitul Kotecha

Following a series of more hawkish central bank action recently, 50 basis points (bp) hikes have become the new 25bp.  Several central banks surprised last week including a 100bp hike in Canada, 75bp hike in the Philippines and an inter-meeting tightening in Singapore. 

Meanwhile, while the upward surprise in US June CPI inflation (1.3% m/m) increased the chance of a 100bp hike from the Fed this month the University of Michigan sentiment survey revealed a decline in inflation expectations, with consumer sentiment languishing near all-time lows, dampening expectations of a larger move. 

While a 100bp hike at the 26/27 July FOMC meeting is quite possible after the Fed raised rates by 75bp last month, some Fed officials have dampened expectations of such a large move.  Officials such as Atlanta Fed President Bostic and Kansas City President George, have highlighted the risks that more aggressive rate increases would hurt the economy at a time when recessions risks have intensified. 

As we go into the Fed blackout period, with no Fed speakers ahead of the FOMC meeting and with the key June CPI print out of the way, there will be limited new news for markets to chew on.  Markets have fully priced in a little more than 75bp of Fed tightening this month, which seems reasonable, with a 75bp hike the most likely outcome.

This week has kicked off with another outsize increase in CPI inflation, this time in New Zealand where the Q2 CPI reading came in at 7.3% y/y (consensus. 7.1%, last 6.9%) reinforcing expectations of a 50bp hike by the RBNZ at its August meeting. 

There are several central bank decisions on tap in the euro area, Japan, China, Turkey, South Africa, Indonesia, and Russia.  The outcomes will differ.  The European Central Bank is primed to hike by a tepid 25bp, with focus on the likely announcement of an anti-fragmentation tool.  Not surprises are expected in Japan (Thu), China (Wed), Indonesia (Thu) and Russia (Fri), with policy likely on hold in all four cases. 

In contrast a 50bp rate hike from the SARB in South Africa (Thu) is likely while Russia is expected to cut policy rates by as much 100bp.   Aside from central bank decisions earnings releases gain momentum this week while Italian politics will remain in focus.  

The US dollar has kicked off this week on a weak footing after ending last week on a softer note. USD positioning remains heavily long though its notable that speculative positioning in the USD index (DXY) has slipped over recent weeks (according to the CFTC IMM data). 

Still stretched positioning and lower yields as markets pull back from aggressive Fed tightening expectations will likely cap the USD in the short term.   However, it’s hard to see the currency losing much ground, with EURUSD parity continuing to act as a magnet.  

Posted in Asia, Asian currencies, Bank of Japan, Bond markets, bonds, Canada, central banks, China, Currencies, ECB, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, FX, Indonesia, inflation, Interest rates, Italy, Japan, Monetary Policy, Philippines, Russia, Singapore, South Africa, UK, US. Tags: , , , , , , , , , , . 1 Comment »

All Bets Are Off!

June 13, 2022 — Mitul Kotecha

For anyone thinking that markets had already fully priced aggressive Federal Reserve and European Central Bank (ECB) rate hikes, last week’s message from the US May CPI inflation report as well the ECB meeting was crystal clear.  All bets are off!  The US CPI report destroyed any hopes that US inflation had peaked with headline CPI surging 1% on the month and the annual rate hitting a new post-COVID high of 8.6%.  If there was ever any doubt, the data not only seals the case for at least a 50 basis point (1/2 %) hike at this Wednesday’s Fed FOMC meeting but increases the risk of a 75bp move though the latter still seems unlikely.  More likely, the Fed embarks on a series of 50bps hikes. . 

Separately, the ECB shifted away from its long held dovish stance and announced an expected end to its bond purchase plan (APP) at the beginning of July, effectively pre-announced a 25bp policy rate hike in July and 25-50bp hikes in September, with the central bank expecting to maintain a tightening cycle beyond September.  Many other central banks are scrambling to catch up the curve as inflation pressures end up being much higher than many of them previously anticipated.  There are exceptions of course such as Japan (see below), Russia recently cut its policy rate by 150bp and China which may still cut policy rates in the weeks ahead (watch this week’s 1y Medium Term Lending Facility decision, with a small 5-10bp cut possible), but these exceptions are few and far between.

The jump in US inflation will also further support the US dollar, keeping it on the front in the days ahead against most other currencies.  Already at the start of the week, most currencies were hurt in the face of a resurgent US dollar, especially high beta emerging market currencies. Separately, market volatility measures (e.g. MOVE and VIX) are likely to rise while liquidity is likely to remain poor.  Risk assets overall are likely to struggle against this background. Overall, it’s hard to see sentiment turn around quickly.

This week the main focus will be on the Federal Reserve FOMC meeting (Wed) but there are also several other central bank decisions of interest including the BCB in Brazil (Wed) where consensus expects the pace of hikes to slow to 50bp.  Additionally, 25bp rate hikes from the Bank of England and CBC in Taiwan (both Thu) are expected while the Bank of Japan (Fri) meeting is likely to be uneventful as BoJ governor Kuroda has doubled down on his aggressive stimulus stance while noting that a weaker Japanese yen benefits the economy.  Key data this week includes likely yet more weak Chinese activity data in May (Wed), jobs data the UK (Tue) and Australia (Thu) and a likely stronger than consensus increase in May  US retail sales (Wed).  

Posted in Asia, Asian currencies, Australia, Bank of England, Bank of Japan, Bond markets, bonds, Brazil, central banks, China, Commodities, COVID-19, Currencies, ECB, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, FX, inflation, Interest rates, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , . Leave a Comment »

Action Shifting To Currencies as Rates Volatility Eases

May 23, 2022 — Mitul Kotecha

US stocks barely closed higher at the end of last week and flirted with bear market territory. US consumer and retail stocks remain under pressure alongside industrials as recession fears intensify.  Indeed while inflation concern remain elevated, recession fears are increasing. US Treasury yields are finally coming off the boil amid such fears, with May seeing a significant pull back in yields; the biggest decline has been in the 3-10 year part of the yield curve over recent weeks.  This has been met with a decline in interest rate volatility unlike equity and implied currency volatility measures, which have pushed higher.   For instance, major currency implied volatility measures have reached their highest since around March 2020. Emerging markets volatility breached its March 2020 high in March 2022 and after a brief fall is moving back higher.  

Action is shifting to currencies and the drop in the US dollar from its highs, with the currency increasingly undermined by lower US yields.  In Asia, the 3 most sensitive currencies to yield differentials (US 10 year yield minus 10 year local currency bond yields) are the Thai baht, Indonesian rupiah and Korean won.  As such, Korean won is likely to rally the most in Asia should US yields fall further.   The Chinese yuan has strengthened amid US dollar weakness though underperformance of the Chinese currency is likely versus its peers as the authorities likely aim to weaken it on a trade weighted (CFETS) basis. 

In China, the surprisingly large 15 basis point cut in 5-year loan prime rate last week will be seen as a boon for China’s property market.  However, while support for the property market has increased there does not seem to be much more stimulus ready to be unleashed despite various pledges.  China’s April data slate was weak highlighting the risks of a contraction in GDP this quarter and providing evidence that the “around 5.5%” official growth target looks increasingly out of reach.  COVID restrictions across the country are easing gradually pointing to some pick up in activity though consumption and the service sector are likely to remain under pressure for months to come as mass testing, quarantines and border controls continue to restrict mobility.  

There was relief for China’s markets today as President Biden highlighted the potential for a reduction/removal of tariffs implemented by President Trump, stating that he will discuss tariffs with Treasury Secretary Yellen when he returns from his Asia trip.  Removing tariffs is by no means a done deal given there will be plenty of pressure to maintain some level of US tariffs on China. A reduction in tariffs would be beneficial for the US in that it would help reduce imported inflation pressures while it would also help to support Chinese exports at a time when they are slowing down and adding pressure on China’s current account position.  However, some of this impact would likely be mitigated by a relatively stronger yuan, which would undoubtedly benefit as tariffs were cut.  

Key data and events highlight this week include monetary policy decisions in Indonesia (Tue), New Zealand (Wed), South Korea and Turkey (both Thu).  Federal Reserve FOMC meeting minutes will also be released (Wed). Although not expected by the consensus there is a good chance that Indonesia hikes policy rates by 25 basis points. In New Zealand a 50bp hike is likely while a 25bp hike in South Korea is expected.  In contrast despite pressure on the Turkish lira and very elevated inflation no change in monetary policy is expected in Turkey this week.  Meanwhile the Federal Reserve FOMC minutes will provide further detail on how quickly the Fed wants to get to neutral rates and beyond and on its quantitative tightening policy. 

Posted in Asia, Asian currencies, Biden, Bond markets, bonds, central banks, China, Commodities, COVID-19, Currencies, Economics, Economy, emerging markets, equity markets, Europe, Federal Reserve, FX, Geopolitics, Indonesia, inflation, Interest rates, Monetary Policy, New Zealand, Politics, Trade, Trump, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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