Rates as of 07:30 GMT

 

Market Recap

A big “risk-on” day after Trump and China President Xi agreed to restart their negotiations, Trump visited his pal Kim Jong Un, and OPEC+ basically reached an agreement before their meeting even started. The commodity currencies were up and the safe-haven CHF and JPY were down, down, down. Gold fell the most it’s fallen in a year. Stocks were up across the board in Asia, with the exception of Hong Kong (down slightly).

I wouldn’t get too excited at this point however. In an interview on Fox News, White House National Economic Council director Larry Kudlow said that there are no firm promises and no timetable for completion of a potential sweeping trade agreement, and that China still needs to address the issues that the US has said caused the discussions to fall apart in early May, according to Bloomberg News. He repeated that the US and China are 90% done on a trade deal but that the final 10% will be the hardest. So what we really have is Trump’s usual habit of caving once he’s in front of the guy he’s negotiating with and doing what he can to proclaim a win, while actually making little or no progress. I expect to see some not-so-happy headlines in the not-so-distant future that will lead to a reversal of the enthusiasm.

The market’s joy was damped by a worse-than-expected China manufacturing PMI.  The official PMI was unchanged at 49.4 (market expectation: 49.5), while the Caixin/Markit manufacturing PMI fell sharply to 49.4 from 50.2 (expectations: 50.1). So into contractionary territory! The two often give different readings. This can be attributed to the different coverage:  the Caixin survey not only covers fewer companies, but most of them are smaller, privately owned firms, while the official survey includes many more of the large state-owned enterprises. Furthermore, the companies Caixin surveys are concentrated on the booming East coast, while the official survey has a much more even national coverage.

Japan’s tankan was also generally worse than expected, but that didn’t stop the Tokyo stock market from rising 2.2%, which may be why JPY weakened.

The two-day OPEC+ meeting between OPEC members, Russia and several other oil producing countries seems to be over before it even begins. Russia’s President Putin said that his country and Saudi Arabia have agreed to extend their agreement to restrain output by 1.2mn b/d for six to nine months. Saudi energy minister al-Falih said the deal would most likely be extended by nine months. He said in answer to a question that probably no further reductions in output were needed. So now the delegates have two days to sit around eating dates and discussing the market before they go home tomorrow afternoon. “Who needs an OPEC meeting?,” one delegate was quoted as saying Sunday. There’s a possibility Iran might object, but I doubt if they can sway the group.

Oil jumped on the news. I’d expect it to keep firming, although at some point there could be a “buy the rumor, sell the fact” response if enough market participants anticipated this result. 

The big mystery to me is why GBP is up today. I couldn’t find any particular reason. Over the weekend, the two guys competing to become the next UK Prime Minister - Jeremy Hunt and Boris Johnson --  reiterated their willingness to take Britain out of the EU without a deal if necessary. I think this is fast becoming the most likely conclusion to this three-year debacle. Furthermore, both outlined their proposals for tax cuts and spending increases. How they will fund this as foreigners flee the gilts market is beyond me. Hunt is making a more detailed speech today, although the details have already been leaked: spend more, tax less. Who wouldn’t be happy with that? As I’ve said before, I remain negative on GBP until further notice.

COT report:  long gold & silver, short GBP

The Commitments of Traders (COT) report showed speculators increasing their gold longs and more than doubling their silver longs. Still, positions in neither are anywhere near extreme, so if the rally in precious metals stops – which it certainly did this morning – it’s not necessarily because of over-extended positioning.

GBP shorts increased. There too, they’ve got much further to run before anyone will be troubled by the size of the position.

AUD shorts are a bit stretched, but that might not be the whole story – see the section on positioning below in my discussion of tonight’s RBA move.

Speculators cut their CAD shorts significantly – good move as oil prices moved up and “risk on” took hold. Positioning in CAD is still bearish but not extremely so. Still, I think given the fundamentals for CAD and the expected agreement out of OPEC+, we could see further closing of these CAD shorts ahead of next week’s Bank of Canada meeting.

 

Today’s market

Lots on the schedule today!

The big events will be the start of a two-day OPEC meeting, the manufacturing PMIs, and the Reserve Bank of Australia (RBA) meeting overnight.

As mentioned above, the OPEC+ meeting is virtually over before it began, so not much further to discuss there.

During the US and European day, the main event will be the release of the final manufacturing purchasing managers’ indices (PMIs) for June. The preliminary PMIs for the three major industrial economies (Japan, Eurozone, US) were released about a week ago; those are often slightly revised, but the revisions are usually not enough to be market-affecting. So the focus is generally on the UK manufacturing PMI and also the overall tone from the rest – is activity globally expanding or contracting?

The latest data shows that activity in the developed countries is contracting at a slightly accelerating pace. As you can see, this is mostly because of the Eurozone in general and Germany in particular. US activity is still expanding, although the there’s some difference between how rapidly it’s expanding according to the Institute of Supply Managers (ISM – modestly at 52.1) or Markit (barely at 50.5 – although this is the May figure, the preliminary June figure was even worse at 50.1). The UK figure is also a standout globally for the speed with which it’s collapsed.

The official China PMIs are already out, as discussed above.

The UK manufacturing PMI is expected to be little changed, still below the 50 “boom or bust” line, as worries about Brexit depress activity in Britain. There was a big surge in activity as companies stocked up ahead of what everyone thought was going to be the March 31st Brexit deadline (see graph), but since then, activity has plummeted.

The construction PMI (due out tomorrow) is expected to improve slightly, but also to remain in contraction, while the service PMI (Wednesday) is forecast to remain unchanged. All told, the three PMIs are expected to show a poor outlook for the UK economy that ay well prove negative for the pound.

Later in the day, the US ISM manufacturing PMI is expected to fall considerably, although not quite to the level that its equivalent from Markit is at, according to the preliminary figure. Still, this is not encouraging. The ISM manufacturing price paid index is also expected to fall notably. Slowing activity and falling inflationary pressures…a background that might encourage some FOMC members to go for an “insurance cut” in rates. USD negative

Before that then, there are a number of other indicators out.

German unemployment is expected to be unchanged in June – no change in the number of unemployed, no change in the unemployment rate. This follows May’s surprising 60k surge in the number of unemployed.

 

Last month’s surprising surge in the number of unemployed – analysts had expected a decline of 8k – was in part a statistical fluke. The Federal Labor Agency said about two-thirds of the increase was due to reclassification of some people in the statistics, although it also cited the “first signs of a weakening economy on unemployment.” Today’s figures will be crucial to see if the number of unemployed and the unemployment rate rise further. One month might be a statistical fluke – two months is a trend. An unchanged figure would be positive for EUR or at least not negative, but signs of further slack in the German labor market would be quite negative.

The EU money supply figures are no longer a big item for the ECB. However, the bank lending data is important insofar as it shows whether the ECB’s monetary stance is being transmitted to the economy. Low interest rates are of no use if no one is borrowing. Total lending was up 2.4% yoy in April, a low rate of increase but nonetheless equal to the fastest pace of growth in recent months. I’m not sure what this means though. If it falls back, perhaps they see more of a need to ease policy quickly = EUR-negative. If it accelerates further, maybe they take it to mean that they don’t need to ease so quickly. But on the other hand, they could take it to mean that a further cut now would be quite effective, because it would be transmitted rapidly to the private sector.

ECB President Draghi noted recently that “…although we have seen the successful transmission of monetary policy to financing conditions, and from financing conditions to GDP and employment, the final legs of the transmission process to wages and inflation have been slower than we expected.” He added that “In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.”

Speaking of money supply data, the Bank of England releases its money supply data too, including the official UK mortgage lending figures. No surprises expected here; the market looks for a 1.1% fall in mortgages, in line with the -1.2% drop that the UK Finance figures showed a few days ago. GBP neutral

Finally, overnight the Reserve Bank of Australia (RBA) meets. At their last meeting on June 4th they cut the cash rate by 25 bps to 1.25%, the first change in rates since August 2016. The market expects them to cut again at Tuesday’s meeting (75% probability) and then at least one more time this year as the RBA “continues to monitor the labour market closely.”

RBA Gov. Lowe last month explained that the RBA has changed its mind about how low unemployment can get before inflation starts rising. Apparently they had thought that the nonaccelerating inflation rate of unemployment (NAIRU) was around 5%, but now they think it’s even lower. With unemployment currently at 5.2%, that means they’ll have to get the unemployment rate down much further if they want to see inflation back in their target range.  That makes the unemployment figures key for AUD. The next ones are coming out on July 18th.

For today, I think a cut is pretty much baked in and wouldn’t cause AUD to weaken. Investors will be looking at the forward guidance to gauge how many more cuts are likely in the future. We could have a “sell the rumor, buy the fact” response, except of course that AUD has been strengthening recently, so clearly no one has been selling the rumor to begin with. According to the Commitments of Traders report, speculators have kept their short AUD positions pretty stable for the last seven weeks. On the other hand, Citibank’s “FX Pain” positioning index, which infers the positioning of active currency traders from relationships between exchange rates and currency managers' returns, postulates that they’re long AUD and have been getting increasingly long. That suggests there could indeed be some selling if the RBA does confirm that there are more rate cuts to come, as I suspect that they will do.

 

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Marshall Gittler

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