Kuroda Hesitates, Yen Advances, Focus Turns to Europe and North America

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  • The BOJ increased its ETF purchases from JPY3.3 trillion a year to JPY6 trillion
  • There was a last minute private sector attempt to buy Monte dei Paschi, Italy’s troubled bank
  • The European bank stress test results will be reported at the close of the North American session today
  • US reports Q2 GDP and Canada reports May GDP
  • Central bank of Russia meets and the market is split; Colombia’s central bank is expected to hike rates 25 bp to 7.75%

The dollar is mostly softer against the majors in the wake of the BOJ decision. The yen and the Swiss franc are outperforming while the Norwegian krone and the Loonie are underperforming. EM currencies are mixed. KRW and SGD are outperforming while RUB and MYR are underperforming. MSCI Asia Pacific was up 0.5%, with the Nikkei rising 0.6%. MSCI EM is down 0.6%, with Chinese markets down 0.5%. Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is up 2 bp at 1.52%. Commodity prices are lower, with oil down 1%, copper down 0.4%, and gold down 0.2%.

Bank of Japan Governor Kuroda appears to be the central banker that the markets have the most difficulty reading. The activist Governor provided the barest of tweaks to what is by nearly any reckoning among the most aggressive monetary policies by a high income economy. Moreover, much of the important data reported during the BOJ’s meeting, including inflation and consumption, were weaker than expected.

The BOJ increased its ETF purchases from JPY3.3 trillion a year to JPY6 trillion. This was the lowest hanging fruit for the central bank, and there was broad agreement that this step would be taken. The BOJ also doubled its dollar-lending facility. And that was it. No cut in the negative deposit rate. No additional JGB purchases. No pushing out the inflation target or increasing the JPY80 trillion monetary base growth.

The market’s response was clear and not surprising. The yen strengthened. The dollar plunged to JPY102.70 after having been squeezed to JPY105.50 in the NY afternoon yesterday. The JPY102.25 area corresponds to a (61.8%) retracement of the greenback’s rally from the Brexit low of JPY99 to last week’s high near JPY107.50. Moving beyond that retracement objective may embolden participants to look for another test on JPY100. On the topside, the dollar has been unable to retake the JPY104 handle since the BOJ announcement.

Kuroda’s pledge of a comprehensive review of the monetary policy framework at the September 20-21 meeting is not the main focus now. However, it promises to inject fresh volatility in the market after the summer. Draghi also flagged the September ECB meeting as important.

Japanese government bonds sold off hard, with the benchmark 10-year JGB yield rising eight bp, which leaves it at minus 20 bp. Japanese stocks overcame initial weakness to close higher, with the Topix up 1.2% and the Nikkei gaining almost 0.6%. On the week, both indices lost about a third of a percent. Nearly all of the other markets in the region fell, but Tokyo was sufficient to lift the MSCI Asia Pacific Index 0.5%, the fifth consecutive advance and 13 of the past 15 sessions.

In Europe, there are two main developments. First, the economic data. The preliminary July CPI estimate came in at 0.2% after 0.1% pace in June. The market had expected a 0.2% increase, but after the firmer than expected German data yesterday, the risk was on the upside. The core rate was steady at 0.9%. The median guesstimate was for slippage to 0.8%. June unemployment was steady at 10.1%.

The initial estimate of GDP showed a 0.3% expansion, which was in line with forecasts, and it follows a 0.6% expansion in Q1. The year-over-year pace held in at 1.6% after 1.7% in Q1, which is seen as a bit better than a trend. Details will be available in a couple of weeks.

We do know that the French growth disappointed by there not being any. A 0.2% expansion was expected. However Q1 GDP was revised up to 0.7% from 0.6%. Spain’s 0.7% expansion may be the envy of most in Europe, but it matches the country’s slowest pace since Q3 14. Separately, Spain reported an easing of deflationary forces. CPI fell 0.6% from a year ago after a 0.8% fall in June. Lastly, German retail sales disappointed by falling 0.1% (median forecast was for a 0.1% gain) and the May gain was shaved to 0.7% from 0.9%.

The second development in Europe today is the last minute private sector attempt to buy Monte dei Paschi, Italy’s troubled bank. Reports indicate that a local businessman has proposed to team up with a Swiss bank, which is rivaling another offer from a US bank and an Italian bank combine. The market’s initial response is favorable. The Milan bank index is up nearly 4.5% near midday in Italy. The gain is enough to turn the week positive, and it is the fourth consecutive week Italian banks have recouped some of the year’s steep decline.

The development in Italy is helping lift European banks. While the Dow Jones Stoxx 600 is up 0.25%, the financials are the strongest sector, up 1.8% at pixel time. Overall, the index is up about 3.25% this month, which is its biggest advance since last October.

The European bank stress test results will be reported at the close of the North American session today. The potential deal for Monte Paschi may reduce the anxiety over the results. Moreover, it is not as simple as a pass/fail grade, or specifying precisely how much capital particular institutions must raise. However, many investors are not convinced European banking challenges have been addressed. As such, the test’s credibility will require some actionable results.

Attention now turns to North America. US reports Q2 GDP and Canada reports May GDP. The wider trade deficit and weaker inventories that were reported yesterday prompted economists to slash their forecast for today’s US report. Many economists more or less matched the Atlanta Fed’s GDPNow tracker, which cut its estimate to 1.8% from 2.3%. One thing to watch out for today is whether the more severe inventory correction in Q2 will increase the prospect for Q3 GDP and this may be seen in the NY Fed’s GDP tracker that is published on Friday’s.

Separately the US reports the Chicago PMI, which is notoriously volatile, and the University of Michigan’s consumer sentiment report. In addition to the headline, where consumer confidence remains elevated even if not accelerating higher, the inflation expectations will be watched, as the FOMC statement referred to survey-based measures as stable. The 2.6% pace expected for July matches the 6- and 12-month averages.

Canada’s May GDP is expected to have contracted by 0.5%. While Alberta’s fires and the related disruption did not help matters, the Canadian economy has faltered this year after a reasonably good Q4 15, which was the first quarter since Q2 14 that the economy expanded in each month. Canada began the year with good momentum. In January, the economy grew 0.5%. And that’s been it. Small contractions were reported in February and March before the 0.1% growth in April. The Bank of Canada seems willing to write off the first half and anticipating (hoping?) for better traction in H2.

Oil prices are closing the week on a soft note and this is not particularly helpful for Canada. Oil prices are off 7.8% this week. It is the largest weekly fall since January. It brings the loss on the month to an eye-catching 15.7% on the continuation futures contract, the largest monthly drop since the end of 2014.

Central bank of Russia meets and the market is split. Of the 39 analysts polled by Bloomberg, 29 see no change and 10 see a 50 bp cut to 10%. We lean towards a rate cut but it’s a close call, especially with the ruble weakening. USD/RUB traded at multi-month lows near 62.60 as recently as July 15, but has since reversed higher. Note that RUB one of the worst EM performers over the past five days at -3.2%. This is second only to COP at -4.6%. Lower oil and copper prices are a major culprit, as MXN (-2.1%), CLP (-2.0%), and PEN (-1.3%) round out the other top EM losers over the past five days.

Colombia’s central bank is expected to hike rates 25 bp to 7.75%. Higher than expected inflation in June may force the bank’s hand, as officials seemed to signal an end to the tightening cycle after its June hike. Yet as stated above, lower oil prices are the main driver for COP right now.

Brazil reports June consolidated budget data. The central government primary deficit was lower than expected, and so there is risk of a better consolidated primary deficit too. Consensus is at –BRL16.3 bln. June manufacturing PPI will also be reported today.