Rates as of 05:30 GMT

Market Recap

Some really surprising moves overnight. First off, I’m amazed at the sudden appreciation of JPY. It goes far beyond what “safe haven” buying might account for, seeing as Tokyo stocks are down only 0.70%, not a huge move. I think it could be related to yield differentials – the Bank of Japan fiddled with the amount of bonds that it purchased in three maturity buckets in an effort to steepen the Japanese yield curve, while in the US, yields were down 2.5 bps to 5 bps across the curve, thereby widening the yield spread between the two countries.

At the other end of the scale, sterling had a bad day. First the UK construction PMI fell to its lowest level since April 2009, and we all remember what was happening in the world in April 2009 – we were staring into the abyss of global depression.

Then Bank of England Gov. Carney delivered a speech entitled “Sea Change.” No prizes for guessing which direction he thinks the sea is changing in. “A sea change is a profound transformation In recent months, there has been a sea change in financial markets driven by growing concerns over the global economic outlook.” He said the latest tariff hikes by the US administration “raise the possibility that trade tensions could be far more pervasive, persistent and damaging than previously expected.” “The intensification of trade tensions has increased the downside risks to global and UK growth,” he observed, and said it was “unsurprising” that markets were pricing in a cut in UK rates. I got the impression that the Bank is likely to revise down its forecasts when the next Inflation Report is released on August 1st , or at least focus more on the risks, and perhaps drop its tightening bias. Gilts yields declined by up to 10 bps on the remarks. His increasingly negative view is definitely negative for sterling.

There’s big news on the central bank personnel front. The EU nominated IMF Managing Director Christine Lagarde to succeed Mario Draghi as the President of the ECB. The implication of her nomination can best be seen by looking at who her main competitor was for the post:  Bundesbank President and uber-hawk Jens Weidmann. Clearly the authorities have gone for the dove, as her tenure at the IMF has shown. Net net this is negative for the euro.

Not to be outdone however, Trump nominated two people for Fed governors. One, Christopher Waller, is a somewhat conventional choice in that he is director of research for the St. Louis Fed. Note though that St. Louis Fed President James Bullard is perhaps the most dovish person on the FOMC right now (certainly the most dovish voter) and so it’s clear why Trump would pick his head of research. The other person, Judy Shelton, is a little bizarre. Back in May she told Bloomberg News that she was “highly skeptical” of the Fed’s mandate -- the pursuit of maximum employment, stable prices and moderate long-term interest rates. “Those are such nebulous goals,” she said. In fact, she seemed to question the Fed’s use of monetary policy at all. “A Fed that is too eager to artificially put in an interest rate that isn’t close to what the market would be suggesting is not so good,” she said. “I would try to be the voice saying, are you sure you know better than the markets?

While Lagarde may be a negative for the euro, these two would also be negative for the dollar. The main difference though is that the ECB president seems to have a lot of sway over the ECB board, whereas individual governors have only one vote on the FOMC.

Oil plunged as OPEC+ struggled to specify exactly what they had agreed on. They’ve agreed to cut output, but the Saudi and Russian oil ministers yesterday gave different views on how to calculate the cuts. While it’s just a technicality, the difference in opinion between the two is worth an estimated 670k b/d, which is quite substantial.

Today’s market

Today we get the service sector purchasing managers’ indices (PMIs), once again the final ones for the major economies and the first and only versions for all the other countries. People don’t pay much attention to these however because they tend to be less cyclical than the manufacturing PMIs. You can put off buying a new iPhone if times are bad, but you’ll keep paying your internet bill as long as you can afford it.

The main one of interest is the UK service sector PMI. After the disappointing manufacturing PMI and the disastrous construction PMI, the market is looking forward to an unchanged service-sector PMI. Since the bulk of the UK economy is services, that would be encouraging – but seems doubtful to me. In any case, if it does come in as expected I think that would be positive for sterling.

Later in the day, the US Institute of Supply Management (ISM) version of this indicator will be of interest, as it’s more closely followed in the US than the Markit version of these indicators. It’s expected to show a small decline, but remaining well in expansionary territory. That would be similar to the ISM’s manufacturing PMI, which also declined slightly. Nonetheless, a decline is a decline and the market is likely to take it as such. USD negative

But before then, we’ll get the highlight of the day, namely the ADP employment report. Automated Data Processing Inc. (ADP) is an outsourcing company that handles about one-fifth of the private payrolls in the US, so its client base is a pretty sizeable sample of the US labor market as a whole. One point to note:  its figures are adjusted to match the final estimate of the nonfarm payolls (NFP), not the initial estimate that we get this Friday. So while they are one of the best guides to the NFP that we have, they aren’t perfect by any means – in fact, neither is the NFP figure itself, since it’s always revised.

The market is assuming that last month’s unusually low figure was just a one-off and we will see a return to more normal levels. However, it’s noticeable that economists are not predicting a return to the mean – the average for the last six months has been around 200k, and the forecast for this month is a much-lower 140k. The range of estimates on Bloomberg is 57k-190k, meaning that almost no one is looking for a return to the mean, let alone any pay-back after last month’s lower-than-normal figure. They apparently sense that something is up with the labor market and we are at a turning point, as the Conference Board’s jobs plentiful/hard-to-get DI indicated (I showed that graph twice last week, so I’m not going to bore you with it again).

Note that the Bloomberg “whisper” is only at 103k. This suggests some people in the market are bracing for an even lower figure (admittedly, this figure is compiled from a mere 22 people who took the trouble to input their guess into the Bloomberg system, and who knows if they’re just talking their own book, vs the 29 deeply, deeply serious economists who duly filed their well-thought-out predictions to Bloomberg). This suggests that the risk is for a positive surprise – that is, a positive surprise would probably elicit a stronger reaction from the market than a negative surprise.

A figure like what the market consensus expects could be the start of a shift down to a lower quantum level of growth in jobs – although to be fair, the working-age population in the US is actually falling by around 11,000 people a month, according to the OECD’s data, so it shouldn’t take much of an increase in jobs every month to keep the unemployment rate falling.

After last week’s US advance goods trade balance unexpectedly surprised on the downside at -$74.55 (market consensus: -$71.8bn), economists have been busy downgrading their forecasts for today’s overall US trade balance, which includes trades in services – a less volatile category than merchandise. Note that the Trump administration is basically tearing up the world’s trade system and destroying decades of alliances in order to rectify this balance, and the result? Not much. That may mean more pressure on the US’ allies, which if recent history is any guide, is likely to be negative for the dollar.

Note that several of the Democratic Party candidates have focused on the trade issue as well, and are looking at weakening the dollar as a way to address this issue. While I think virtually everything Donald Trump has done, is doing and will do in the future is wrong, wrong and wrong again, he has focused attention on this issue (disregarding whether that’s right or wrong) and I’m not sure it will go away even after the blessed day that he does. This isn’t an issue for today, but it’s something you should be aware of as the US elections approach and the market starts to focus on what the new Democratic administration will do after they sweep the House, Senate and the Presidency, throwing the Republicans out onto the dustheap of history where they belong.

OK, stop fantasizing and back to work. Canada’s trade figures come out at the same time. The trade deficit there blew up back in December and has been narrowing ever since. This month it’s expected to widen out a bit for the first time this year. The main reason is a likely increase in imports, which have been growing only sluggishly recently. A wider deficit is likely to be CAD-negative initially, but could prove CAD-positive after further reflection. At the May Bank of Canada meeting, the Governing Council said they would be “especially attentive to developments in household spending, oil markets and the global trade environment.” Although the April retail sales figures were disappointing, a rise in imports due to higher consumer demand in May could actually encourage the Bank of Canada when it meets next Wednesday. That’s why I think the news could ultimately be CAD-positive, depending on just why the deficit widens.

TD looks for the goods trade deficit to widen to $1.30bn in May from $0.97bn. Stronger imports will serve as the main driver behind the wider deficit, although we also expect a modest increase in exports. The latter reflects a rebound in auto exports after temporary production shutdowns weighed heavily last month, which will be countered by a pullback in nominal crude exports. WTI prices (in CAD) fell by 4.1% in May although stronger rail shipments could provide an offsetting increase in volumes; even after the recent recovery, total crude exports by rail remain 35% below levels from December 2018.

US factory orders are largely a derivative of the durable goods figures released a few days ago, so they don’t attract that much attention. The durable goods figures were messy – the headline figure plunged more than expected as orders for the ill-fated Boeing 737 MAX dried up, but the figure ex-transportation equipment beat expectations. So the headline factory orders figure may show yet another decline, but the ex-transportation figure – which isn’t forecast – could be better. As a result, I would expect the market to ignore this one.

Overnight we get two indicators from Australia. One, Australian job vacancies, doesn’t have any forecast. I usually don’t cover indicators that are too unimportant for economists to bother forecasting, but with employment now the main focus at the Reserve Bank of Australia (RBA), this series is likely to get more air play than it usually does. The news isn’t good. There’s clearly been a shift down in the job market starting in Q3 last year. If vacancies fail to improve, then the RBA will probably have to lower rates even further to reach its new, lower estimate of the non-inflationary level of unemployment. On the other hand, a significant rise in vacancies would allow them to be a bit more “patient” than they currently are indicating.

The Australian retail sales figures usually attract more attention, but this time around they’re expected to be simply in line with the recent trend, so a figure in line with the consensus won’t tell us much about any change in the environment. AUD neutral

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Marshall Gittler

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