Rates as of 05:30 GMT


Market Recap

A relatively quiet day in the FX market, especially compared with the dramatic moves in rates (more about that later).

GBP was the best performing currency on the report that I mentioned yesterday about UK MPs manuevering to prevent a no-deal Brexit. But the risk reversals show that the market doesn’t have that much confidence; even the one-month risk reversal has just kept coming down. 

The relatively small gains in the safe-haven JPY and CHF were noticeable against the background of quite large falls in the stock markets and big moves in the bond markets. The weekly Swiss deposit data suggests that the Swiss National Bank (SNB) has ramped up its intervention noticeably. As mentioned yesterday, I take that to be an indication of the upward pressure on CHF and would see that as a reason to sell EUR/CHF (i.e., to buy CHF against the euro).

The main action yesterday was in the bond market though, especially US Treasuries. Ten-year yields rallied around 10 bps to within 30 bps of their record lows set in 2016. Thirty-year bonds rallied even more, almost 13 bps, to within 3 bps of their all-time lows. Short rates fell as well. Fed futures are now pricing in two rates cuts this year and maybe a 50-50 chance of a third cut.

With long rates falling so much, yield curves have been flattening, with the 2/10year curve hitting a new low for this economic cycle. As this curve too nears inversion, the signal from the bond market becomes unmistakable:  recession is coming.

One of the main reasons for the depressed tone in the market was yesterday’s China weak credit data.  New loans rose by CNY 1.06tn, well below consensus estimates of CNY 1.28tn. M2 growth fell to 8.1% yoy (8.4% yoy expected), near its all-time low of 8.0%, and M1 grew only 3.1% yoy (4.4% expected). Credit growth is one of the main leading indicators for growth in China, so the slowdown heightened concerns over global growth.


Today’s market

The European day starts with British employment data.

The unemployment rate is expected to stay the same, while the change in employment, although expected to rise from the previous two months, is expected to remain below trend. In other words, the labor market seems to be cooling. 

Wage growth on the other hand is expected to accelerate further. The rates of growth in both base wages and total wages are expected to reach post-financial crisis highs. It’s hard to see this lasting however as Brexit approaches and uncertainty increases. Companies have been reporting a drop in pay plans in the future, so I doubt if this report will raise any alarms about future inflation with the Bank of England. GBP neutral

In Germany, the ZEW survey of analysts and economists  is expected to show that reality and expectations are both getting worse, but at about the same pace. The two were almost in line in April, indicating that people thought the situation was about as bad as it was going to get, but since then they’ve both deteriorated. Today’s figure is expected to show a further drop, meaning people are turning increasingly bearish on Germany – and hence the euro probably too. EUR negative

The National Federation of Independent Businesses (NFIB) small business optimism survey is expected to show a small increase. This would be in line with the major consumer confidence indices, which both rose in the latest month, believe it or not. The change in the NFIB survey is particularly closely related to the change in the Conference Board consumer sentiment survey, which was up sharply in the month, so that suggests it will improve. Also the NFIB “hiring plans” sub-index, which is already out, rose to 21 from 19. Although the rise in the index is expected to be small, any improvement should be taken as a positive for the US economy. USD positive

Next we come to the major indicator of the day:  the US consumer price index (CPI). The CPI isn’t the inflation gauge that the Fed actually targets –that’s the personal consumption expenditure (PCE) deflator, or more accurately, the core PCE deflator – but the market pays attention to it almost as if it were -- the correlation between the headline CPI and the movement of EUR/USD 30 minutes after is about 0.32, compared with 0.42 for core PCE deflator. Surprisingly, the market pays more attention to the headline CPI figure than to the core figure, whereas with the PCE deflator the attention is definitely on the core figure.

In any case, the figures are expected to show that the Fed had no real reason to cut rates recently – the headline figure is forecast to creep up a bit closer to their 2% target, while the core measure is forecast to remain a bit above it. Nothing that screams for four more rate cuts, as the market is currently forecasting, that’s for sure.

Apparently no one cares about the current inflation rate, or at least it’s not seen as the major determinant of Fed policy, because if it were, no one would be looking for more rate cuts. Probably they’re more concerned with inflation expectations, which have been coming down rapidly, especially since the last FOMC meeting. So while in theory the CPI figures should be positive for the dollar, my guess is that the market reaction, if any, won’t last very long.

Then the calendar goes quiet until overnight Japan announces its core machinery orders. This rather erratic indicator is starting to show a distinct negative trend. JPY negative

This indicator is important not only for Japan, but globally, as Japan supplies much of the capital equipment that the world uses, particularly in the semiconductor area. Sluggish foreign demand is an indication of a global slowdown in investment, although that seems to be lessening recently.

Australia’s wage price index is expected to show an increase more or less in line with the recent trend. The qoq rate of growth is expected to be just fractionally below that of the previous two quarters (you’d have to look at the 2nd decimal place to find any difference) while the yoy rate of change is forecast to be unchanged. That’s probably not a good sign for the AUD. The Reserve Bank of Australia wants to see unemployment falling further so that inflation can pick up, presumably based on the idea of the Philips Curve – that as unemployment falls, companies start bidding up the price of labor and then pass along their higher costs in the form of higher prices. With the Australian economy showing no signs of this phenomenon at present (something that it shares with virtually all other advanced economies nowadays), it’s going to have to cut rates further and faster in the hopeless pursuit of trying to start this sequence of events happening. AUD negative

China announces its usual trio of fixed asset investment, retail sales and industrial production. They’re expected to show a small slowdown in production and a more marked slowdown in retail sales, although with the latter, the question is why sales jumped so much in the previous month not why they should slow this month. (There was a big jump in auto sales in the previous month owing to heavy discounting.) Excluding that one-month leap, the figures for this month are expected to show basically sideways movement within the recent range. You certainly would not be able to pick out the date of a trade war just by looking at the figures. Data showing a fairly stable Chinese economy – if you believe it -- should be good for risk assets, such as AUD and NZD.

Finally, as the sun in Europe kisses with golden face the meadows green and gilds pale streams with heavenly alchemy, Germany releases the first estimate of German Q2 GDP, followed a few hours later by the second estimate of EU-wide Q2 GDP. The EU-wide figure is rarely revised, so the focus will be on Germany. It’s expected to show a modest contraction in output from the previous quarter, which is likely to be EUR negative. The next question then is whether a fall in output will help to tip the debate over running a budget deficit in order to finance measures to combat climate change.


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Marshall Gittler

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