Many people are watching the stock market nowadays as the S&P 500 index breaks through to a new record highs. However, the really astonishing action has been in the bond markets. Bond yields have been collapsing around the world.

Yields have come down so far, most of the major countries now have 10-year yields at or below their official policy rates! In fact, yesterday 10-year German Bund yields even fell below the ECB’s deposit rate (-0.40%) for the first time. This portends either a wave of official rate cuts, or chaos in the bond market if and when people change their mind.

The rally hasn’t been confined to the major markets. The peripheral European markets too have benefited greatly. Greek bond yields for example have hit record low yields. Two-year Italian bond yields are negative!

There are now a record $13.4tn in negative-yielding bonds outstanding globally. Ten-year yields are negative in at least ten countries, including Japan, Sweden, Switzerland and a host of EUR countries, such as Germany, France, Netherlands, Austria, Finland, Belgium, and Denmark.

Swiss bond yields this morning hit the lowest level of any bond in recorded history, with the three year around -0.93%.

The driving force behind the rally has been the decline in inflation expectations. You can see how in most markets, inflation expectations were rising until April. But then inflation expectations started to come down – sharply.

Oddly enough, this wasn’t due to any big fall in actual inflation rates, which have been little changed overall:  up in some countries, down in others. Nonetheless, six of the ten countries shown have inflation below 2%, which is the target for most of the industrial countries.

Nonetheless, investors are so confident about the outlook for inflation, for central bank policy, or just bonds in general that have pushed the term premium – the extra return (risk premium) that they demand to compensate them for the risk associated with a long-term bond – to a record low.

The decline may have been due of the fall in the price of oil, which occurred at the same time. Falling oil prices suggests falling inflation in the future, as lower oil prices feed through to the real economy.

Then again, both oil prices and bond yields may have been driven by the same thing -– expectations of slower growth. The slowdown in growth isn’t just a fear – it’s actually happening. Global trade has started to contract, and industrial production is hardly growing at all. This is the problem that confronts the financial markets and the central banks of the world. This is the main issue driving financial markets.

Schedule for the coming week:  Powell testimony, China inflation, UK short-term indicators, Bank of Canada

As usual, the second week of the month is relatively quiet without that many important indicators.

The main theme for the week will be further clarification of the Fed’s stance. The main focus will be Fed Chair Powell’s twice-yearly testimony to Congress, to the House on Wednesday and the Senate on Thursday. On Wednesday we also get the minutes of the June 19th FOMC meeting. So we should get more clarity on the Fed’s position.

Powell will no doubt be asked about the weak employment data; the change in consumer sentiment with regards to jobs; the falling PMIs; low inflation expectations…there’s plenty he could mention as to why the Fed might need to take some action to “sustain the expansion,” as he put it. On the other hand, with PCE inflation steady and the unemployment rate still exceptionally low, perhaps he will stress “patience” again? The Fed doesn’t like to surprise the markets and so three weeks before the FOMC meets again, I would expect him to give a fairly obvious hint about what he thinks is likely to happen.

At the beginning of the year, the market thought rates would almost certainly be either unchanged or higher by the end of the year. Now that’s seen as having zero chance; the question is only how many cuts there will be. Right now a Fed funds rate of 1.75%, i.e. three more cuts, is seen as the most likely scenario. In that case they better get started soon, because there are only four more FOMC meetings this year! But that’s considered only slightly more likely than two more cuts. In short, the market doesn’t really know what to expect. That’s what they’ll be looking for some guidance about.

I expect Powell to confirm that they will ease policy. That could be negative for the dollar, even if the market is already 100% expecting it. However, how he expresses it will be crucial. Will he make a case for a series of rate hikes, or one protective “insurance” cut? That’s what people will want to know. I expect he will make the case for only one rate cut and will stress that the Fed will be “data dependent” after that. Such comments could dampen speculation about three or more cuts and thereby be positive for the dollar. 

The morning of Powell’s second day of testimony, the US CPI for June will be released. While that’s not the inflation target that the Fed uses, it plays that role in the public imagination and therefore is closely watched. While the rate of headline inflation is expected to slow, core inflation – excluding food and energy – is forecast to be unchanged at exactly the Fed’s target level (although as I said, this measure isn’t the target). Stable core inflation would give no reason to cut rates and therefore would be positive for the dollar.

Other US indicators out during the week include the Job Offers and Labor Turnover Survey (JOLTS) report, which will give us an indication of how many jobs are still on offer. That number is important so that we can determine why the number of people getting jobs each month has slowed down; is it because there are fewer jobs out there, or is it because there are fewer people available to take the jobs?

Also there will be two Commitments of Traders reports (Monday and Friday), because the one tonight has been delayed owing to the Independence Day holiday.

China will also announce its inflation data on Wednesday. That’s expected to show no change in consumer price inflation and some further deceleration in producer price inflation. Both are bad news for the markets. Consumer price isn’t accelerating that much yet, but if it continues to rise, it could force the authorities to put the brakes on – thereby further damaging global growth prospects. Meanwhile, it’s the producer price index (PPI) that matters for overseas economies, and central banks that are looking to see if there’s inflation on the horizon are likely to be disappointed.

Britain has its short-term indicator day on Wednesday. That’s the day they announce the monthly GDP figures, manufacturing and industrial production, and the trade balance (as well as construction output, which isn’t significant for the FX market).

The GDP is the most important of the three. The mom rate is expected to bounce back slightly after two consecutive months of decline. Still, it’s not expected to bounce back that significantly. The 3m/3m change will continue to decelerate, further proof that the economy is stalling.

Of course, that should come as no surprise to anyone who tracks the UK PMIs. The composite indicator fell into negative territory in June, indicating that output as a whole is contracting. It would be no surprise if the GDP figures reflected that too – after all, that’s why the PMIs were invented to begin with. Nonetheless, confirming this fact from the official figures is likely to be negative for sterling.

Finally, the Bank of Canada is the only major central bank to meet during the week (Wednesday). The market has had a hard time this year trying to figure out what the Bank would do. Early on people expected them to hike this year, and twice people thought it was likely they’d cut, but now it seems most people are settling on the idea that they’ll be unchanged.

The forward guidance at their last meeting was that “the degree of accommodation being provided by the current policy interest rate remains appropriate. That was somewhat less dovish – neutral, really – when compared with the previous comment, which said “Governing Council judges that an accommodative policy interest rate continues to be warranted. They said, as most central banks do nowadays, that they would remain “data dependent,” and added that they would be “especially attentive to developments in household spending, oil markets and the global trade environment.” Since then, household spending (as shown by retail sales) have slowed, oil prices have fallen and the global trade environment remains as chaotic as before. So no reason to switch to a tightening bias, that’s for sure. But neither are the declines bad enough to justify returning to a loosening bias, either. In particular the Canada business outlook survey, which Bank of Canada Gov. Poloz seems to put a lot of weight on, has turned up noticeably. The sharp rise in “future sales growth” indicates business confidence in household spending – so no need to change course. I expect a relatively unchanged statement from the Bank of Canada that will have little impact on the currency.

 

Daily comment: Currencies little changed; payrolls coming up!

Rates as of 07:15 GMT

Market recap: 

Not much point spending a lot of time discussing the movements in the FX market. Currencies moved very little. It looks from the chart like NZD collapsed, but that’s only because of the scale.

Today’s market

We’re all waiting for today’s US nonfarm payrolls.  The big question now is, after 104 consecutive months of expansion, will we have the first decline in payrolls? Or was May just a fluke and we’re back to the races again? (Sep 2017 was initially -33k, but later was revised up to +18k.)

The market is expecting some mean reversion but not back to the six-month moving average of 195k. Expectations currently are for 160k, which is still quite healthy. A figure like that would probably quell any thoughts that the employment picture is turning and would therefore reduce the need for a preemptory “insurance” cut in interest rates by the Fed. It would therefore be positive for the dollar.

Note though that the Bloomberg “whisper” number is a much lower 133k. That means a lot of market participants are expecting a much lower number, probably because of the disappointing ADP report on Wednesday (102k vs 140k expected). Economists can’t necessary revise down their forecasts for the Bloomberg poll, so the “whisper” number can be a more accurate assessment of what the market is expecting.

Other numbers coming out are expected to corroborate the optimistic picture. The unemployment rate is expected to remain at the extraordinarily low level of 3.6%, while average hourly earnings are expected to rise by 3.2% yoy, accelerating slightly from 3.1% yoy in the previous month.

All told I think figures like what the market consensus is expecting would give no reason to think that the US labor market is softening. In that respect they should be positive for the dollar.

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Marshall Gittler

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