The Commentariat Makes a Big Deal of Yellen’s Comments, Markets Don’t
Overview: Disappointing German, French, and Italian PMI reports helped send the euro to almost $1.1985, its lowest level in about two and a half weeks, and weighed on other regional currencies. The dollar-bloc currencies are doing firmer, led by the New Zealand dollar. The Reserve Bank of New Zealand indicated it was prepared to tighten mortgage restrictions further, and it reported an unexpected decline in unemployment in Q1. Emerging market currencies are mostly lower, led by Eastern and Central Europe. Asian currencies were quiet, with China, Japan, and South Korea markets closed for holidays. The JP Morgan Emerging Market Currency is lower for the second session and the fourth in the past five. The large equity markets in the Asia Pacific region were mixed. Hong Kong and Taiwan fell, while Australia and India posted modest gains. Europe’s Dow Jones Stoxx 600 is up over 1.3%, for what could be its biggest gain in two months, led by materials, information technology, energy, and industrials. US futures are 0.3%-0.5% better. The US 10-year yield is slightly firmer at 1.60%, while European yields are 1-3 bp higher. New Zealand’s benchmark jump 4.5 bp (to 1.70%), while Australia’s yield slipped a couple basis points (to 1.73%). Gold again was capped below $1800 and consolidated ahead of yesterday’s lows (~$1771). A sharp fall in US oil inventories, according to API, is helping oil continue its rally. June WTI is higher for the third session and six of the past seven. This follows the 7.4% advance last month. The June contract is extending yesterday’s gains above $66. This year’s high was set in early March near $67.30.
China and Japanese markets open tomorrow for the first time this week. Japan will report labor earnings and the final PMI. The preliminary estimate of the composite was above the 50 boom/bust level for the first time since January 2020 and the highest since September 2019. China reports the Caixin PMI for non-manufacturing and the composite. It may also report the April trade figures. In dollar terms, the surplus is expected to double to $28 bln from $13.80. On a year-over-year basis, imports are forecast to grow faster than exports, as they did in March. April reserve figures may also be released. A small increase is expected to $3.2 trillion.
The dollar is in about a 30-pip range below JPY109.50 today. However, it remains within the range set on Monday (~JPY108.90-JPY109.70). Recall that before the Japanese holiday, the dollar finished last week near JPY109.30. Japanese leadership is arguably awaited. Australia reported a 17.4% jump in building approvals, as its property market remains strong. The Bloomberg survey median forecast was for a 3% gain, but the Australian dollar is within yesterday’s range (~$0.7675-$0.7765). It finished last week near $0.7715 and is slightly higher now. An expiring option for A$960 mln at $0.7750 may be a stretch. The New Zealand dollar is also inside yesterday’s range (~$0.7115-$0.7205) but has resurfaced above the 20-day moving average, which it settled below yesterday for the first time since mid-April. A move above $0.7600 would lift the tone. The greenback is firmer against the offshore yuan for the second consecutive session. It is the first back-to-back gain in nearly a month. Recall that it settled near CNH6.4735 before the mainland markets shut for the extended holiday. It is now trading near CNH6.4875, warning of downside pressure on the onshore yuan tomorrow.
German and French final PMI disappointed. German services slipped back below 50 to 49.9 from 50.1 of the flash estimate and 51.5 in March. The composite fell to 55.8. The preliminary report has seen a pullback from 57.3 to 56.0. In France, the final reading pared the gains of the preliminary estimate. The services PMI rose to 50.3 rather than 50.4 after March’s 48.2. This pushed the composite to 51.6, not 51.7 after the 50 reading in March. Italy disappointed as well. The services component fell to 47.3 from 48.6. The Bloomberg survey median forecast was for a gain to 50. The composite slipped to 51.2 from 51.9. The survey projected 53.0. Spain, who has been the weakest of the large EMU members, shined. The services PMI jumped to 54.6 from 481, and the composite now stands at 55.2, up from 50.1. Both exceeded expectations. On the other hand, Spain reported that unemployment fell by 39k in April, almost half the decline. Separately, we note that Madrid’s mayor (Isabel Diaz Ayuso) was re-elected. From the center-right People’s Party, she may emerge as Prime Minister Sanchez’s (Socialist Party) chief rival.
The tension over fishing rights in UK waters remains unresolved. However, Paris is threatening to cut power to Jersey if the UK does not amend the fishing licenses granted to French fishermen. The UK holds local elections tomorrow. It appears that the government’s successful vaccine rollout and plans to re-open the economy in around 6 weeks is offsetting the criticism of the handling of the pandemic last year and some frustrations over Brexit. The election in Scotland is also the focus as strong showing for those favoring independence sets up a clash with Prime Minister Johnson. It could be a Catalonia-type situation where the central government refuses to grant permission to have a referendum. The Bank of England also meets tomorrow. It is expected to be upbeat and revise its economic forecasts. Tapering of its bond purchases seems reasonable, likely later this year.
The euro, which closed softly yesterday, saw its losses extended to almost $1.1985 in early European turnover. However, it has stabilized near $1.2000. The initial cap looks to be ahead of $1.2020. Options for a little more than one billion euros in the $1.2050-$1.2055 area will roll off today, but there is a 960 mln euro option at $1.20 that expires tomorrow. It is the fourth session that the euro is recording lower highs. Note that the $1.1980 area corresponds to a (38.2%) retracement of last month’s rally and the 200-day moving average is a little below $1.1950. Sterling is less interesting. It is in the middle of the $1.38-$1.40 trading range that has largely confined the exchange rate since the middle of last month. Ahead of tomorrow’s events, look for a subdued session.
Treasury Secretary Yellen acknowledged that the Fed may have to raise rates at some juncture to prevent the economy from overheating if Biden’s roughly $4 trillion initiatives were to be adopted. However, the markets mostly closely linked to a policy shift did not bite. The Fed funds futures strip’s implied yield going out through January 2023 was half to a full basis point lower. The Eurodollar futures strip was even less impressed. Yields were within half a basis point of unchanged. The yield on the generic two-year note was flat. The 10-year finished below 1.60% for the second day. Even when informed through a spokesperson that President Biden agreed with Yellen, the interest rate market hardly moved. Why? There is nothing new here. Yellen has said before that it is possible, though she did not expect that price pressures rise outside of technical and transitory factors. The Federal Reserve has the tools and will to keep it in check. By framing it in terms of “may have to” and “if” claims of her crossing lanes (encroaching on the Fed’s independence), or even “bullying” as one journalist suggested, is not just a little wrong, but the truth is diametrically opposite. If anything, she signaled that Fed has the independence to respond to inflation if needed.
The only reason that the March US trade deficit was a record is that the April shortfall has not been reported yet. The 12-month moving average of the deficit has doubled in seven years. Leave aside any frictions for a second; growth differentials alone would suggest the trade deficit will continue to widen. However, there is one component that will likely begin improving shortly. Americans will begin traveling abroad again when they can do so safely. This travel is picked up in the service trade. In fact, the US service trade, which is consistently in surplus (though few call foul on this chronic surplus), stood at $17.1 bln in March, the smallest since August 2012. The surprise on trade was not the US record, but that after reporting two months of surpluses, Canada fell back into deficit and its largest since May 2019 (C$1.1 bln), About a fifth of the roughly C$2.5 swing in the trade balance was due to the surge of both crude oil and refined products. Exports by 0.3%, helped by a 10.2% rise in auto and parts exports (see the US strong auto sales). Growth differentials are evident. In volume terms, imports are 7% while the volume of exports fell by 0.3%.
The US sees the final Markit PMI for services and the composite, while ISM reports its services index. The market may shrug off any disappointment, as confidence in the strength of the US recovery remains high. In fact, many are talking about a low double-digit expansion here in Q2. The Atlanta Fed, for example, sees it tracking now 13.6%. The ADP private-sector job estimate may draw some attention, but its estimate of 571k for March was wide of the mark. Bloomberg’s survey median forecast is for an 850k gain in April, while the median forecast for Friday’s non-farm payroll has crept closer to 1mln. Canada and Mexico’s economic calendars are light until Friday’s jobs data and CPI, respectively. The tragic rail collapse yesterday in Mexico may have political implications as the current and previous mayors of Mexico were seen as likely successors of President AMLO.
After reaching a four-day high near CAD1.2350 yesterday, the US dollar was turned back in front of our CAD1.2355 cap. Still, support has been found in the CAD1.2265-CAD1.2275 area consistently over the past five sessions. The low from 2018 is near CAD1.2250, and then there appears to be little support until CAD1.2200. Meanwhile, the greenback is in an MXN20.14-MXN20.32 trading range. Rising price pressure in Brazil will likely force the central bank to hike another 75 bp today, lifting the Selic rate to 3.50% compared with Mexico’s target rate of 4%. Over the past month, the Brazilian real has gained about 4%, while the peso is up a little more than 0.5%.