- The Australian dollar has taken over leadership in the dollar bloc from the Canadian dollar
- Ahead of the weekend, the chief focus is on the flurry of US economic data that will be reported today
- A few large US banks report earnings today
- Late yesterday, Chile kept rates on hold while Peru cut 25 bp, both as expected; S&P downgraded Chile one notch to A+
- Colombia reports May IP and retail sales
The dollar is mostly weaker against the majors as the week winds down. The Aussie and Nokkie are outperforming, while the Loonie and Swissie are underperforming. EM currencies are mostly firmer. RUB and KRW are outperforming, while PHP and TWD are underperforming. MSCI Asia Pacific was up 0.4%, with the Nikkei rising 0.1%. MSCI EM is up 0.2%, with the Shanghai Composite rising 0.1%. Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open. The 10-year US yield is down 2 bp at 2.33%. Commodity prices are mostly higher, with oil up 0.6%, copper up 0.3%, and gold up 0.2%.
The Australian dollar has taken over leadership in the dollar bloc from the Canadian dollar. The Aussie is up about 0.35% today to extend this week’s gains to more than 2% and reach a new high for the year a little more than $0.7760. The Canadian dollar is up 1.1% this week, in comparison. The softer yields in Europe and the US appear to be behind the flows to Australia, which offers about 45 bp more than the US on two-year money, an 18 bp increase over the past month.
The New Zealand dollar cannot keep pace here with its Tasmanian cousin following the disappointing June manufacturing PMI. It fell to 56.2 in June from a downwardly revised May reading (to 58.2 from 58.5). The Australian dollar appears to be breaking out of a bottoming pattern against the New Zealand dollar after underperforming for most of the Q2. After large gains (~1.3%) in the middle of the week in response to the Bank of Canada rate hike, the Canadian dollar is consolidating in narrow ranges.
Ahead of the weekend, the chief focus is on the flurry of US economic data that will be reported today. Given investors and policymakers sensitivity to inflation, we have highlighted the importance of today’s CPI report. Core CPI fell for the past four months, and if this trend is arrested in June, as we expect, it could give Yellen instant gratification and move the flag a bit toward the Fed’s argument about the transitory nature of the recent softening. Despite many insisting that Yellen was dovish, we take seriously the line which the chair repeated in both her sessions, namely that it was “premature” to conclude that underlying inflation was falling short of its target.
A steady or even a small increase in core CPI will not end the debate by any means. The Fed targets the core PCE deflator. One month does not make a trend. In our view, the various Fed comments are consistent with a sequencing that favors beginning of the balance sheet adjustment before the new move on rates.
The US reports June retail sales at the same time as CPI. It may be difficult to determine which the market is reacting most to, but ideally, both reports will point in the same direction. Retail sales are expected to have improved after the 0.3% decline was recorded in May. That said, note that although retail sales are roughly 40% of personal consumption expenditures, the two times series do not always dovetail. In any event, keep an eye on the GDP components of the retail sales report, which excludes items like autos, gasoline and building materials. It was flat in May and is expected to have risen by around 0.3%. The average for the first five months of the year is 0.36% and last year’s average was 0.23%.
Also, June industrial production figures will be released shortly after the CPI and retail sales. Industrial production and manufacturing output are also expected to have improved from May. Industrial production is expected to increase by 0.3% after a flat reading, and manufacturing output can recover some of the 0.4% decline posted in May. We note that capacity utilization peaked in late 2014 a little below 80%. It stood at 76.6% in May. The relatively low capacity utilization may speak to the subdued investment in plant and equipment, as well as the modest price pressures.
A few large US banks report earnings today. Investors will also be monitoring developments with the Senate health care reform bill. Two Republican Senators have already come out against it. The challenge is illustrated by the fact that one is a moderate and the other hails from the libertarian wing of the party. Several other Senators are on the fence and waiting for the CBO scoring. The CBO scored the administration’s budget in a similar way that the IMF judged the outlook for the US: slow growth, a higher deficit, and more debt.
Sterling is firm, at new highs for the week near $1.2970. It bottomed in the middle of the week just ahead of $1.2810. Last week it reached almost $1.30. The UK reports June CPI next week and retail sales. The latter is expected to have fallen, but the median in the Bloomberg survey shows steady inflation. We expect sterling to be particularly sensitive to inflation and any softening could further dampen rate hike pressure.
Separately, we see the UK Brexit stance as gradually capitulating to the EU. The UK has been forced to accept that the divorce negotiation precedes talks of a new agreement. In apparent contrast to UK Foreign Secretary Johnson’s suggestion earlier this week that the EU could “go whistle” if it expected the UK to be paying the EU after the amputation, UK Brexit Secretary Davis, who is a possible successor to Prime Minister May, appears to have accepted the obligation (“financial settlement”). This is a potential softening of the UK stance, but we continue to warn against a soft Brexit, which has meant access to the single market while parting from the free movement of labor and other freedoms (EU red lines).
The week is ending on a firm note for equities. The MSCI Asia Pacific Index finished with a 2.7% gain on the week; its best performance in four months, and new highs for the year. The Hang Seng was the best performing bourse with a 4.1% gain on the week. We note that the Hang Seng China Enterprises Index, which tracks the H-shares, rose 4.65% this week, which is the largest gain since last November. European equities are paring this week’s gains. Modest losses in most sectors, but energy and materials are behind the slippage.
European bonds are firm, and the mini-taper tantrum appears to have eased. Outside of Germany, where the 10-year yield is up four basis points in the week, other countries’ including France, Holland, Italy, Spain, Portugal, and Greece have seen yields ease this week. The ECB meets next week. At most, it is expected to tweak its forward guidance and remove the assurances that asset purchases can be increased if necessary. In September, we expect the ECB to announce an extension of its purchases into next year while tapering the amount.
Late yesterday, Chile kept rates on hold while Peru cut 25 bp, both as expected. If growth remains sluggish, Chile may resume cutting rates. Meanwhile, S&P downgraded Chile one notch A+ with a stable outlook. The agency said a prolonged period of slow growth is likely to hurt the fiscal outlook and debt burden. Our own sovereign rating model has Chile’s implied rating at A-/A3/A- and so actual ratings of A+/Aa3/A+ are still facing downgrade risks.
Colombia reports May IP and retail sales. Both are expected to rise 1.2% y/y. The central bank will also release its minutes. At that meeting, the bank cut rates by 50 bp to 5.75%. Next policy meeting is July 27, and another 50 bp cut seems likely. Inflation was 4.0% y/y in June, the lowest since January 2015 and right at the top of the 2-4% target range.