Week Ahead: For the Millionth Time, Markets Exaggerate

After experiencing one of its worst weeks of the year, the US dollar is stretched from a technical point of view while the short-term interest rate adjustment has gone as far as it can without resurrecting ideas of a Fed rate cut this year. Given the lighter economic calendar in the coming days, we suspect that the greenback may consolidate ahead of the FOMC meeting that concludes on July 26. The derivatives market shows that a quarter-point hike is seen as a practical certainty. However, even as the US two-year yield jumped back a dozen basis points ahead of the weekend, the dollar drew little support against the euro and sterling. The shallowness of their pullbacks speak to the underlying demand. Some suspect "stealth intervention" by Japan and/or China, but by the very nature of it, evidence is elusive, and the price action can be explained without resorting to subterfuge Japanese rhetoric increased as the dollar moved above JPY140 and speculation of an adjustment in BOJ monetary policy (July 28) increased, while disappointing jobs data and softer CPI and PPI data saw US interest rates fall sharply. The Mexican peso rose to new eight-year highs against the dollar as its high interest rates, strong international accounts, near- and friend-shoring memes, and strong and independent central bank and Supreme Court contribute to its attractiveness.

The macroeconomic data highlights include US retail sales and industrial production. The UK and Canada report inflation and retail sales figures, while Australia sees the June employment data. China is first of the large economies to report Q2 GDP While, the June data that will also be released may confirm suspicions that the economic momentum seen earlier this year has evaporated, it is still on track to achieve its 5% GDP target. New support, especially for the property market is widely expected, but after cutting rates last month, it seems too early to expect more monetary support. The US dollar's broad weakness, especially against the Japanese yen, and speculation that more stimulus will be forthcoming helped Chinese official efforts to steady the exchange rate. The yuan strengthened for the second consecutive week, and its 1.2% advance was the most in six months. 

United States:  The bulk of the base effect that has more than halved the pace of headline CPI to 3.0% year-over-year in June from 6.5% at the end of last year is behind us. CPI was flat in July 2022 and in Q3 22, CPI rose at an annualized rate of 2.4%. Attention turns to the real sector in the upcoming week with June retail sales, industrial production, and housing data. We already know that June auto sales were stronger than expected (15.68 mln SAAR, compared with 15.05 mln in May and 13.0 mln in June 2022). Excluding auto sales, the median forecast in Bloomberg's survey is a for a 0.3%. Core retail sales, which excludes auto, gasoline sales, building materials, and food services, are seen rising by 0.2%, which would put Q2 pace slightly above Q1, but remember this reflects price changes too. Real consumption looks to slow in H2. Industrial production looks flattish and such an outcome would translate into a 3% annualized increase in H1. That said, even though the Q2 GDP has yet to be released, data from the April-June period seems dated and is unlikely to deter the Fed from hiking later this month. However, for the record, the Atlanta Fed's GDP tracker puts Q2 growth at 2.3%. The economy is expected to grind to a halt in Q3, according to the median forecast in Bloomberg's survey before contracting in Q4. The median forecast by Fed officials sees this year's growth at 1.0%. That this would be achieved in H1 is consistent with the economy stagnating in H2. Meanwhile, housing start permits, and existing home sales, which rose in May look set to give back some of those gains in June.

The Dollar Index's 2.25% drop last week was the largest in eight months Although, we turned bearish, the move seemed excessive from a technical perspective, settling below the lower Bollinger Band for the last three sessions. The Dollar Index gapped lower in the middle of the week (it is found between roughly 101.60 and 101.65). We anticipate consolidative activity in the coming days, during which time the Dollar Index may have potential toward 100.80-101.00 On the downside the 99.00 area is the (61.8%) retracement objective of the gains from the January 6, 2021, low (~89.20) to last September high (~114.80)

China:  With the threat of deepening deflationary forces, most other central banks would likely consider easing policy. However, the PBOC signaled a 10 bp cut in key rates last month and is unlikely to follow-up with back-to-back reductions, which is has not done under this monetary regime (~2016). And without a cut in the one-year medium-term lending rate, banks are not incentivized to reduce the loan prime rates. China is expected to announce Q2 GDP figures and June details on July 17. The median forecast in Bloomberg's survey is a for a 0.8% quarter-over-quarter expansion, which follows a 2.2% expansion in Q1. Even though such an outcome keeps the economy on track to meet the 5% growth, the recent PMI reading, and the June figures will show the economy finished the quarter with weak momentum. Several real estate support measures have been extended through the end of next year, but more efforts are expected to come out of the Politburo meeting later this month.

The dollar will begin the new week with a four-day downtrend into against the Chinese yuan Indeed, the greenback has fallen in eight of the last ten sessions Last week's slightly less than 1.2% decline was the largest dollar fall since mid-January. It is not coincidental, we think, that the yuan recovered alongside the other major currencies, and especially the yen The dollar's five-day moving average against the yuan broke below the 20-day moving average for the first time since in almost three months However,  a period of consolidation is likely in the coming week, broadly in line with our large dollar view, ahead of the FOMC meeting and Politburo meetings. 

Japan:  Two notable macroeconomic data points will be published in the week ahead, but only one will contain new information The national CPI for June is due July 21, but most of the details were already seen in Tokyo's CPI. The BOJ has warned inflation price pressures will ease in H2, and the Tokyo CPI showed prices stabilized in June, with the headline and core (excluding fresh food) steadied 3.1%-3.2%. The measure that excludes fresh food and energy stabilized too but at a higher level (3.8%). The June trade figures are new. There is a strong seasonal pattern toward improvement over May (in 19 of the past 20 years). The weakness of the yen has not translated to stronger exports. In fact, May exports (0.6% year-over-year) were the weakest since February 2021. Imports fell 9.8% year-over-year in May, the second consecutive decline, and the most since December 2020. This likely reflects the decline in energy, food, and commodity prices in general. Despite media and other accounts of Japan's trade prowess, the last time it ran a monthly trade surplus was nearly two years ago. It has not had a rolling 12-month trade surplus since October 2021.

The combination of the speculation that the BOJ may adjust policy later this month and the decline in US rates helped lift the yen for six consecutive sessions before it stalled. In fact, the dollar made new lows (~JPY137.25) ahead of the weekend and then reversed higher and took out the previous session's high (~JPY138.95) but closed below it. The JPY139.40 area offers initial resistance and then JPY140.00-25. After closing below the lower Bollinger Band for two consecutive sessions, the dollar moved back inside it (~JPY138.25) before the weekend.

United Kingdom: The UK reports June CPI, retail sales, and the government's budget balance. The capital markets have shown sensitivity to each of these data points. Headline CPI is expected to moderate to a still lofty 8.2% (from 8.7%), but the core rate is seen unchanged at 7.1%. A 0.4% increase headline CPI (median forecast in Bloomberg's survey) would mean that UK consumer prices rose at an annualized rate of about 9.2% in Q2 after a 5.2% annualized pace in Q1. Retail sales may have eked out a small gain in June, while the government's deficit is running well ahead of last year's. Of note, the UK is expected to formally join the Comprehensive and Progress Trans-Pacific Partnership (CPTPP) Both China and Taiwan have applied for membership as well. Yet, this is not what is driving sterling. The key is that the market expects the Bank of England to hike rates by at least 100 bp between the August 3 meeting and the end of the year. Sterling pushed a little above $1.3140 in the last two sessions but stalled. It is still stretched and was unable to return into the Bollinger Band ahead of the weekend (~$1.3075). Still, it finished on session lows. Further backing and filling is likely in the coming days. Initial support may be in the $1.30 area and then $1.2935.

Eurozone: There are not many important economic reports ahead of the ECB's July 27 meeting, where a rate hike, for all practical purposes is a done deal. Two data points stand out but neither will likely deter the hike. The first is next week's May current account. Unlike Japan, which runs a trade deficit and a current account surplus, the eurozone's trade balance drives its current account. Before the weekend, the eurozone reported a trade deficit of about 300 mln euros. Of note, its combined trade surplus with the US and UK is slightly smaller than its trade deficit with China (117.3 bln euros vs. 126.4 bln euros). The second is preliminary July PMI on July 24. Recall that in June, the composite PMI fell below the 50 boom/bust level for the first time this year. While China's re-opening has disappointed, the fact that the eurozone avoid an energy crisis this past winter has not led to robust growth either. The euro seemed to draw support from short-covering and rate developments. The US two-year premium over Germany widened to three-month highs earlier this month near 173 bp. It fell to around 147 bp last week, the lowest since mid-May. It finished last week a little above 151 bp and could recover into the 155-160 bp area. The market is more confident of two more ECB rate hikes this year than it is of the Federal Reserve.

The euro reached $1.1245 before the weekend. The (61.8%) retracement objective of the euro's decline since peaking on January 6, 2021 (~$1.2350) is near $1.1275 A move above there would target the $1.15 area. Still, the euro is stretched and is well above its upper Bollinger Band (slightly below $1.1180). Initial support may be around $1.1150 and then $1.1085-$1.1100.

Canada:  StatsCan reports June CPI and May retails sales in the coming days. When hiking rates last week, the Bank of Canada cited the slowness of the improvement in the underlying core inflation measures and excess demand. The market expects inflation to continue to trend lower and for May retail sales to slip lower after the heady 1.1% rise in April. Moreover, by the time the Bank of Canada meets again on September 6, it will see another CPI, retail sales, and employment report, along with June GDP. The swaps market thinks the Bank of Canada is done with its hiking, while the balance sheet continues to unwind. The US dollar fell to new 10-month lows against the Canadian dollar (~CAD1.3095) at the end of last week and recovered to nearly CAD1.3230 ahead of the weekend. The greenback posted a key reversal by setting new lows for the move and then rallying and settling above the previous day’s high. The Canadian dollar was the worst performing of the G10 currencies last week, gained a little less than 0.4% against the dollar over the past five sessions. A move above the CAD1.3250 area may target the CAD1.3300-20 initially, but possibly a retest of this month’s high near CAD1.3385. 

Australia:  Australia has created 220k jobs in the first five months of the year, of which 176k have been full-time positions. The comparable figures for the Jan-May period last week were 254k and 319k for overall jobs and full-time posts, respectively. The labor market is cooling but the question is how fast. The 2.5% drop in June jobs postings, the most in Q2, warn of the downside risks with the report. Reserve Bank Governor Lowe seemed to be maximizing the central bank's flexibility. Its next meeting is August 1. The futures market sees the RBA on hold with a risk of a hike in late Q3 or early Q4 and another hike is fully discounted by the end of the year.

The Australian dollar rallied about 3% last week before stalling near $0.6900, which is also what capped it in mid-June. That area corresponds to the (61.8%) retracement of the Aussie's decline since peaking near $0.7160 in early February. It is also around where the upper Bollinger Band was found. Although some aggressive bears may see a double top, technically it has to go through the neckline (the low in between the two tops). It is not found until $0.6600. And the measuring objective would be around $0.6300. More immediately, a break of $0.6800-25 could signal a move back toward $0.6750.

Mexico:  May retail sales are Mexico's data highlight of the week. They are due on July 20. It is a volatile series, but retail sales are sluggish. In Q1, retail sales fell by a cumulative 1.2%. They made it all back with April's 1.5% gain. May's sales could be boosted by tourism, which rose by 9.3%, though they spent less per person, the overall spending rose by 1.2%. Separately, it was reported that Mexico's vehicle sales increased by more than 5% in May. They are not included in the retail sales figures. In the first five months of the year, Mexico's vehicle sales up about 20% over the same period last year. The economy grew by 1% in Q1 (quarter-over-quarter) but is seen slowing dramatically to 0.2% in Q2 and 0.1% here in Q3 The dollar took another leg down against the peso after the soft US CPI figures It recorded a low near MXN16.7350 at the end of last week, which the greenback has not seen since the end of 2015 Initial resistance may be in front of MXN16.93. The dollar settled below its lower Bollinger Band for the past three sessions (~MXN16.8655 ahead of the weekend). Mexico's high interest rates makes the peso an attractive place to park funds ahead the flurry of central bank meetings in the last week of July. The next target may be near MXN16.50. 



Week Ahead: For the Millionth Time, Markets Exaggerate Week Ahead:  For the Millionth Time,  Markets Exaggerate Reviewed by Marc Chandler on July 15, 2023 Rating: 5
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