Will The Fed Talk The Talk?

With the outcome of the FOMC meeting awaited, the dollar was narrowly mixed in quiet turnover. The Scandis were the weakest (~-0.3%) among the majors, while the Antipodeans were the strongest (~+0.25%). JP Morgan's Emerging Market Currency Index was snapping a three-day decline.

Equity markets were mixed, with the MSCI Asia Pacific Index succumbing to profit-taking after a four-day rally. Europe's Dow Jones Stoxx 600 was edging higher for the ninth consecutive session, setting new record highs along the way. US futures indices were little changed.

The US 10-year yield was hovering just below 1.50%, and European yields were slightly softer.

Gold was straddling the $1860 area while trading inside yesterday's range, which was within Monday's range.

A large drawdown of US inventories (~8.5 mln barrels) kept oil prices firm today. The July WTI contract was mostly trading between $72.20 and $72.80 a barrel. Industrial commodities were trading heavily, though the price of lumber rose yesterday for only the second time since May 21.

h2 Asia Pacific/h2

Copper prices slumped by over 4% yesterday and were trying to steady today after falling to new two-month lows. Reports that China will tap its strategic reserves for copper, aluminum, and zinc, may have contributed to the sell-off. Reports also suggested weakness in the physical market in China.

Import premiums paid have fallen. LME copper inventories in Asia are near the highest in a year. Speculators have cut their gross long copper position in the US futures market for the past five weeks through last Tuesday. Officials have ordered state-owned companies to report their overseas futures exposures. 

China's May economic reports missed expectations, but the data can hardly be called weak. Retail sales rose 12.4% year-over-year. The median forecast was for a 14% gain. Industrial output rose 8.8%, missing the 9.2% projection. Fixed investment rose 15.4% in the first five months of the year compared with the same period in 2020.

The one report that did improve from April, and beat forecasts, was the unemployment rate, which slipped to 5% from 5.1%. The data were reported after mainland markets closed, but there didn't appear to be any strong policy implications. The recovery remains intact.

As the seasonal pattern suggested, the Japanese trade balance deteriorated in May but will likely rebound in June, as it has consistently for 19 of the past 20 years. Japan reported its first trade deficit (~JPY187 bln) for the first time since January. It was more than twice as large as economists projected.

Exports accelerated to 49.6% year-over-year from 38% in April, just missing expectations (~51%). Imports beat expectations with a nearly 28% increase from the depressed year-ago rate, more than doubling from the 12.8% increase reported in April.

Separately, Japan's core machine orders disappointed with a 0.6% increase, about a quarter of what had been anticipated.

The BOJ's two-day meeting begins tomorrow. New economic projections will be provided, but no fresh initiatives are expected. Unlike nearly every other country, Japan is still experiencing deflation.

The May CPI reading will be released before the outcome of the BOJ meeting. The headline is expected to be -0.2% after -0.4% in April. The core rate, which excludes fresh food, is projected to be at zero to snap a nine-month run of negative prints.

The dollar peaked a little shy of JPY110.20 yesterday and came back slightly offered today, especially during early European activity. Support is seen in the JPY109.80-JPY109.90 area. There is an option for $625 mln at JPY109.70 that expires today.

The Australian dollar was confined to around a 10-tick range on either side of $0.7695. It has recorded lower highs so far this week. Yesterday's high was a little above $0.7715, and Monday's high was about $0.7725. Tomorrow, Australia reports May employment data. It is expected to have recouped the 30k jobs lost in April.

The Chinese yuan rose for the first time in four sessions today and was slightly firmer than it finished last week. The PBOC set the dollar's reference rate at CNY6.4078, close to what was anticipated by the median in Bloomberg's survey (CNY6.4071). Recall that the dollar bottomed on May 31 around CNY6.3570. It has only traded once so far this month above CNY6.4100. Chinese officials seem content with this broad sideways movement.

h2 Europe/h2

The UK's May inflation readings were slightly higher than expected but are unlikely to signal a change in the stance of the BOE, which meets next week. The preferred measure of CPI that includes owner-occupied costs rose to 2.1%, the most in two years. It was at 1.6% in April, and the median forecast in Bloomberg's survey was for a 1.9% pace.

The monthly gain of 0.6% matched the April rise but was twice the median expectation. While higher fuel prices were evident, the jump in core prices (2.0% vs. 1.3%) showed a wider increase in prices, including restaurant meals, clothing, and recreation goods.

Economists' forecasts got closer to the PPI increase. Input prices rose 1.1% in May (1.0% expected) for a 10.7% year-over-year increase. Output prices rose by 0.5% (0.4% expected) for a 4.6% year-over-year rate, up from 4% in April.

There was strong demand for yesterday's first EU bond sale for the "Next Generation" recovery fund. The debt managers were tempted by the strong demand (~142 bln euros) to double the size of the 10-year offering to 20 bln euros. It is estimated that it will raise around 80 bln euros this year. Several large banks from the US and Europe were denied a role in the syndication because of past wrongdoings.

The ECB will reportedly extend its capital ratio relief until the end of March 2022. Deposits held at central banks will continue to be excluded from the leverage ratio. A final decision by the ECB's Governing Council is expected shortly. The current exemption is set to expect at the end of the month (June 27).

The Federal Reserve (and the Swiss National Bank) had allowed their leverage ratio exemptions to expire this year. The cap on bank dividends is set to expire in September, and this will likely be debated next month but looks set to be lifted.

The euro was confined to a narrow range of less than a fifth of a cent below $1.2135 through the European morning. There are 1.1 bln euros in expiring options struck between $1.2115 and $1.2120. The euro has recorded higher lows this week and held above $1.21 yesterday and so far today, after slipping below it at the end of last week and on Monday.

Sterling fell to about $1.4035 yesterday, its lowest level since May 13, but recovered to settle slightly above $1.4080 and today firmed to almost $1.4125. A move above $1.4150 would lift the tone, but despite repeated intraday penetration of $1.4200 over the past month, it has rarely closed above it and not for two successive sessions.

h2 America/h2

The market is focused on three elements at the outcome of the FOMC meeting. First, is there a confirmation that officials have begun talking about the pace of bond purchases?  Second, does the median official forecast now anticipate a rate hike in 2023?  At the March meeting, 11 of 17 officials had it after 2023. Third, will the Fed make a technical adjustment to the interest it pays on reserves or on reverse repos to prevent the Fed funds rate from approaching the zero bound and blunt some of the pressure on other short-term rates? 

Although there has been some high profile push back against the Fed's claim that its working hypothesis is that the elevated price pressures will prove transitory, surveys suggest most agree with it. For another glimpse into the market's mind, consider that Bloomberg's survey shows a median economist view that the pace of both growth and inflation peaking around now.

By comparison, Europe lags behind the US, and economists look for its growth and price pressures to peak in H2. Also, the implied yield of the December 2022 Eurodollar futures contract was just below 40 bp. This is consistent with a 25 bp rate hike by the end of next year.

Yesterday's May retail sales and industrial production reports were difficult to read because of the back month revision. Retail sales, for example, fell by 1.3% compared with expectations for a 0.8% drop. However, April was revised to show a 0.9% gain instead of being unchanged. Similarly, core retail sales fell by 0.7%, a little more than anticipated, but the April series was revised to show only a 0.4% decline, not the 1.5% drop initially reported.

Industrial output looked strong with a 0.8% gain in May, but the April increase was slashed to 0.1% from 0.7%, and the 0.4% gain in April manufacturing was revised away to show a 0.1% decline.

Ahead of the FOMC meeting, the US reports May housing starts and permit. Housing starts tumbled by 9.5% in April and are expected to have steadied (~+4%) in May. Permits may have slipped a little after falling a revised 1.3% in April. Higher material and labor costs have led to delays and postponements.

The US also reports May import and export price indices. Although they do not typically move the market, the takeaway is that the US has experienced modestly positive terms of trade shock as export prices have risen faster than import prices.

Biden and Putin meet shortly. There will not be a joint press conference, but each side is expected to make a statement. It is more about politics than economics.

Canada reports May CPI figures today. The year-over-year pace is expected to tick up to 3.5% from 3.4%. A 0.4% increase on the month would be the smallest of the year. The year-over-year pace is likely to ease next month, when the June 2020 increase of 0.8% drops out of the 12-month comparison. The underlying core measures are expected to be little changed.

The key to the Bank of Canada's decision next month whether to proceed with the tapering seems more tied to the next employment report rather than today's CPI. 

After repeatedly trying in vain to push the US dollar below CAD1.20, the market has given up (for the time being) and the position squaring lifted the greenback above CAD1.22 yesterday for the first time since May 13. The US dollar remained firm today but below yesterday's highs. A convincing move above CAD1.2200 targets the CAD1.2250 area, the (38.2%) retracement objective since the Apr. 21 hawkish Bank of Canada meeting.

News that Pemex would miss a bonus payment weighed on the Mexican peso yesterday. The dollar briefly poked above MXN20.19 for the first time since June 6. It was offered in the European morning below MXN20.00. Support was seen around MXN19.90.

Brazil's central bank meets today, and the third 75 bp hike in the Selic rate this year is widely expected. The Selic rate began the year at 2%.

Mexico's overnight target rate was set at 4.25%. Mexico delivered a 25 bp cut in February. With today's hike, Brazil's Selic rate will be above Mexico's target rate.

The Brazilian real has appreciated 3% this year, while the peso was off a little more than 0.25%.

Written By: Marc Chandler