The Australian dollar has taken
over leadership in the dollar bloc from the Canadian dollar. The
Aussies are 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 European and the US appear to be at
flows in 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 fell to 56.2 in June from a
downward revision to the May series (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, 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 and 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 seen as a possible successor to Prime Minister May,
appears to have accepted the obligation (“financial settlement”).
This is
seen as 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 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 expected the ECB to announce an extension of
its purchases into next year while
tapering the amount.