The Half Of Growth
Ashraf Laidi | Jul 01, 2022 03:19AM ET
The final week of the month and the quarter is delivering its share of negative US economic surprise, to the extent of moving growth worries nearer to inflation fears—at least in the eyes of the bond market. Fed officials reiterated how inflation remains the top priority, while attaching the ubiquitous disclaimer on the difficulty of avoiding recession.
The key points are:
1. The divergence between the declining US-JPN 10yr spread and the rising USD/JPY, opened the door for an all too likely catch-down in USD/JPY to a preliminary target of 134.70s.
2. As the yield on the 10-year Japanese govt bond pulls away from the Bank of Japan's tolerable cap of 0.25%, the central bank is under less pressure to buy JGBs, thereby no downside pressure on JPY, which would help drag down USD/JPY and the rest of currencies against JPY.
3. The 3-week decline in US gasoline prices, coupled with falling US crude oil (partly helped by anticipation of OPEC output hike) is helping to guide inflation expectations lower.
4. An intensification of the downward trend of inflation expectations may temporarily weigh on metals, but start to serve temporary support for equity indices.
I tweeted yesterday about the considerable drop in the 3-month/10-year spread and its importance in joining the other three popular measures of US yield curve steepening/inversions (2-10s, 2-5s and 3-5s). The crucial aspect with 3-mth/10-yr spread is that by the time it has inverted (10 yr yield below 3 month yield), each of the other three measures would have already inverted. As the 3m-10y drops below the 1st support of 133, the next target stands near 114. Such prolonged declines, would be accompanied with sharp selloffs in the 10-year yield, with which additional declines in USD/JPY and rerating of growth and earnings estimates would be inevitable.
We turn our focus to Friday's release of June services ISM, expected at 54.5 from 56.1. Bond bulls will have a field day in the event of a sub-52 print, or/and a drop in the price paid component below 75. We're not sure about the extent of any rebound in equities due to the challenging earnings season starting next week. Gold, however, should start gaining despite the recession threat to industrial metals.
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