Limited Immediate Impact from Quebec

Following what was the worst G7 summit and US officials pressing their case in the media, investors showed a modest reaction.  The Canadian dollar and Mexican peso were marked lower on fears that vitriolic US response boosts the likelihood that the US withdraws from NAFTA.  

If there was a winner at the G7 summit, and leaving aside the claims that America First looks a lot like Russia First,  Italy did well.  Reports suggest that Italy’s new Prime Minister Conte was congenial and this has been followed up with an interview with Finance Minister Tria.  Tria has taken an investor-friendly tact.  He talked more about structural reforms than the mini-BOT idea.  He recognized the importance of financial stability and the importance to reduce the country’s debt burden.

Investors responded accordingly.  Bonds and stocks have been bid up.   The 10- year yield is off about 15 bp to 2.95%, and is helping to push up peripheral yields more broadly.  Core bond yields are 1-2 bp higher.  Italian equities have rallied strongly (~2%), while the Dow Jones Stoxx 600 is up 0.4%  to snap a four-day slide.  Financials are leading European bourses higher, and Italian bank shares are up 3.6%, recouping what was lost last Thursday and Friday.  

The market has shrugged off the disappointing Italian industrial output figures.  Production fell 1.2% in April, offsetting the rise in March.  Germany and France reported lower than expected output last week.  The pullback in the eurozone economy in Q1 has spilled over into Q2. The ECB staff is expected to revise higher its inflation forecast, but may its growth forecast later this week. 

On the other hand, sterling was punished in response to the series of economic data that showed a much weaker industrial/manufacturing sector, a smaller than expected rebound in construction output and a trade deficit twice as large as forecast.   The trade deficit jumped to GBP5.28 bln in April.  Economists expected a GBP2.5 bln shortfall and the March deficit was revised to GBP3.2 2 bln from GBP3.1 bln.   Industrial output was forecast to match the 0.1% gain in March but instead fell 0.8%.  Manufacturing output slumped 1.4%, the biggest fall in six years and the third consecutive fall.   

The UK reports employment, inflation and retail sales in the coming days.  The data was expected to firm expectations for an August rate hike. Short-sterling futures are a bit firmer, suggesting that today’s data makes investors a bit cautious.   Tomorrow, the House of Commons begins its two-day debate on the government’s withdrawal bill that was heavily amended by the House of Lords.  Prime Minister May made a compromise last week that was aimed at deterring a rebellion by some backbenchers who could side with the Labour.  Many observers are still concerned about the risk of a political crisis in the UK, leading to May’s ouster in favor of a harder Brexit candidate.  

Sterling briefly traded above the pre-weekend high before the disappointing data brought it toward the pre-weekend low.  A break of $1.3355 would set up an outside day, and a close below there would warn that sterling’s bounce off $1.32 on May 29 is over.  

The euro reached $1.1820 in early European turnover, but the upside fizzled as the morning progressed.  Initial support is seen near $1.1750, though the pre-weekend lows was a little above $1.1725.  There is an 820 mln euro option struck at $1.1750 that will be cut today, and 582 mln euros struck at $1.18 that will also expire today.  

Japanese officials seem not to have been caught up in the drama around the G7 meeting.  The BOJ meets at the end of the week, and while, it may not take any material action, a cut in the this year’s inflation forecast, which is well above market expectations, drives up the point that Japan will lag behind the other major central banks in normalizing policy.  Earlier today, Japan reported a large rise (14.9%) in machine tool imports, and it follows on the heels of a strong (22%) rise in April.  This is seen as favorable for industrial output and exports.  

The yen is the weakest of the majors.  It is off 0.4%; allowing the greenback to straddle the JPY110 area.  Firm equities and slightly higher core yields are seen as supportive to the dollar, which is snapping a two-day decline against the yen.  The greenback has blown through the JPY109.50-JPY109.60, which housed a little more than a billion dollars in options that expire today.  The 200-day moving average is found at JPY110.20.  The dollar spent most of the second half of  May above it, the greenback has struggled here in June to get back above it.  

Over the weekend, the Swiss defeated the Vollgeld referendum that would have imposed much tighter controls on bank lending.  While many observers and investors recognize that the current system of marginal reserves and bank lending creating money is prone to crisis, more than three-quarters of Swiss voters rejected this controversial alternative.   

Turning to the US, the economic calendar is light today ahead of tomorrow’s CPI and Wednesday’s FOMC meeting.  There is a deluge of new Treasury supply today and tomorrow.  The US will raise $193 bln.  Today’s sales include $90 bln of three- and six-month bills, and $22 bln of 10-year notes (re-opening a previous issue).  Tomorrow, the Treasury comes back for around $35 bln in four-week bills and $14 bln 30 -year bonds (re-opening previous issue).  Many observers, including some Fed officials, see the flood of bills as distorting the short-end of the US curve, which is why the Fed will hike the Fed funds target range by 25 bp later this week, but hike the interest rate paid on reserves (all reserves not just excess reserves) by only 20 bp.  


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