It’s been a confusing week in the financial markets. The currency markets seem to be reflecting a “risk on” mood, with the commodity currencies coming out on top and the risk-averse Japanese yen weakening (although the safe-haven Swiss Franc was higher). NZD was the best performing currency of the week even though the Reserve Bank of New Zealand turned even more dovish and virtually promised to cut rates. Gold is up but silver is down. It’s hard to find a one-size-fits-all theme to explain all of this.

A lot of the market’s movement this week had to do with rumors and leaks concerning this weekend’s G20 meeting in Japan. Normally these meetings are the very definition of “anodyne,” while the communique that comes out afterwards is the very definition of “bromide.” It’s hard enough to get two world leaders to agree on anything, but 20? Talk about a lowest-common-denominator settlement. We’re talking here about the lowest-common-denominator for 20 prime numbers. The communique is usually something like in the movie “Animal House,” where the college motto was “knowledge is good,” if I remember correctly. Rarely does it move markets.

However, Trump has upset the comfortable pattern by rejecting what used to be considered acceptable boilerplate by everyone. This time, the focus is going to be on his bilateral meetings, particularly his meeting with Chinese President Xi. It’s expected to take place on Saturday at 1130 local time (0230 GMT) and scheduled to run for 90 minutes.

There’s some optimism that the meeting may result in a temporary truce in the trade war between the two countries. A truce but not a settlement. The Washington Post reported that Peter Navarro, a senior advisor to Trump and the top China critic, is also going to attend the G20 meeting. He was a last-minute addition to the team, which includes US Trade Representative Lighthizer, Treasury Secretary Mnuchin and Commerce Secretary Ross. The addition of Navarro, a staunch critic of China, reduces the likelihood of reaching an agreement, although that was never that likely anyway. Both sides have been trying to play down expectations of what’s likely to be achieved.

But even a truce – holding tariffs where they are and not escalating further – would probably improve sentiment for the dollar and for the “risk on” currencies. Buying AUD/JPY or NZD JPY would be the way to play that one.

What’s the market’s view? Compared to the same time ahead of last year’s G20 summit in Buenos Aires (Nov. 30-Dec 1), the market seems quite concerned about the result of the summit. The USD/CNY one month risk reversal, a measure of the relative expense of USD/CNY calls vs puts, is noticeably higher than it was back then. China has shown it’s willing to let its currency weaken to offset the impact of any tariffs. USD/CNY is not much different than it was before the Buenos Aires summit, but the market perceives the risk of USD/CNY moving higher, i.e. CNY weakening, as much higher, indicating that it sees a higher possibility of failure at this meeting than at the previous one. Or perhaps just less room for success. US Treasury Secretary Mnuchin said on CNBC this week that they “were about 90% of the way there with a deal.” That sounds good, but what it also means is that the last 10% may require concessions that neither side is willing to make.

China isn’t the only trade issue, however. Trump is also threatening to impose tariffs on car imports from Europe. If talks at the G20 meeting and afterwards don’t manage to kill that idea, then Europe is threatening to “hit the president where it hurts,” wherever that is. So probably we’ll never hear the end of this.

 

Main events during the week: tankan, NFP, RBA meeting

After the G20 meeting over the weekend, the week starts out with Monday’s Bank of Japan short-term survey of economic conditions, known by its Japanese acronym, the tankan. This is probably the only Japanese indicator that matters nowadays – most others don’t seem to move the market that much.

The market expects the diffusion indices (DIs) for both the large manufacturers and large non-manufacturers to decline. The tankan also includes a forecast for what they think the DIs will be in the next quarter – and those are expected to decline, too.

The problem with the tankan is, you never know how it will affect the yen. The impact seems quite inconsistent.

It has a more consistent impact on the Tokyo stock market. The reaction of the yen then may well be a knock-on effect:  the FX market takes its cue from the stock market. That could move the currency in a counter-intuitive direction. For example, if the tankan causes people to downgrade expectations for the Japanese economy, as seems likely, the stock market may fall and USD/JPY may well fall too, i.e. the yen strengthen, on a “risk-off” mood.

Probably there are so many variables to watch here –the DIs, the outlook DIs and the very important capital spending expectations figures – that you can’t make a simple judgement from one number, but rather have to evaluate the entire set.

After that, the major indicator out in the coming week will be the redoubtable US nonfarm payrolls on Friday and its harbinger, the ADP report on Wednesday. This indicator, once the main focus of excitement every month, had become rather routine until suddenly last month it shocked everyone by coming in far below expectations at only 75k.  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 165k, 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.

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 3.1% yoy again, showing no acceleration but then again no further slowing, either.

The payroll figures are always closely watched, but this month is likely to come under even more scrutiny than usual because of Tuesday’s Conference Board consumer confidence figures. Those figures include includes data on the percent of people who think jobs are “plentiful” and the percent who think they are “hard to get.” Subtracting the latter from the former gives us a “jobs diffusion index,” which is watched as a fairly reliable indicator of turning points in the labor market. This month it fell the most it’s fallen in a decade as the percent saying jobs are “plentiful” fell and “hard to get” rose. It’s still positive, but not as positive as it was in May. An early warning sign of a turn in the US labor market – and the dollar -- perhaps?

There’s only one central bank meeting during the week: the Reserve Bank of Australia (RBA). 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 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.

Other important indicators out during the week include the purchasing managers’ indices for most countries, including the final ones for June for the Eurozone and the US.

Finally, Thursday is a national holiday in the US (Independence Day) and so all markets will be closed. Many people are likely to take Friday off as well, so US markets may be thin and volatile as a result. The weekly Commitment of Traders report will come out the following Monday, not on Friday. 

 

Today’s market:  USD lower, CHF up on risk aversion; US PCE

Seeing as the G20 meeting and Monday’s tankan are important issues for today’s daily, I thought I would wrap it all into one report today.

Rates as of 06:30 GMT

 

Market Recap

It’s definitely a risk-off day today as virtually all Asian stock markets are lower. The questions then are why is CAD beating JPY, and why are all the commodity currencies up anyway? Looking at the trade-weighted indices, the only down currencies this morning are GBP (naturally) and USD. And looking just at movements against the dollar, NZD is leading the pack again. I assume this is all end-of-month rebalancing – that investors want to get dollars off their books and hold currencies for the end of the month, and so were simply selling everything vs USD.

But still, why NZD would perform so well in a “risk off” environment continues to be a mystery to me. Yesterday’s ANZ business activity outlook failed to show any recovery in confidence or activity, instead it was consistent with the Reserve Bank of New Zealand’s recent message of the risk of “ongoing subdued domestic growth.” Today’s consumer ANZ consumer confidence index was a bit higher, but nothing dramatic. More rate cuts are in store here (a 70% probability of a cut at the August meeting).

 

Today’s events

To keep it brief, I’m mostly going to discuss the major indicator out today, namely the US personal consumption expenditure (PCE) deflators, which are released every month as part of the personal income and spending data. The FOMC stated back in January 2012 that the PCE deflator was “most consistent over the longer run with the Federal Reserve's statutory mandate.” In other words, this is the Fed’s preferred inflation gauged and therefore crucial for its rate decision. They didn’t spell out that they focus on the core PCE deflator, but it’s widely assumed. The core deflator is therefore more important, but as it doesn’t change very much, the market usually gets it right. In that case, attention will focus on the headline measure and any deviation from expectations there.

The key point is that according to last week’s “dot plot,” half the members of the FOMC are expecting a rate cut at some point this year. But when? Will they cut pre-emptively as “insurance” or only once they see a definite need to? They noted in the statement that inflation is “running below 2 percent.” If the PCE deflators continue to run below their 2% target and show no sign of turning upwards, then the Committee may feel a rate cut is justified in order to get inflation back up towards target. Thus the consensus forecast of an unchanged headline rate of inflation and a 10 bps drop in the core rate, the more important of the two, is probably negative for the dollar.

The EU-wide CPI is expected to remain at the same yoy pace as in the previous month, both at the headline level and core. After yesterday’s German CPI stayed unchanged at 1.3% yoy, that shouldn’t be a surprise. EUR neutral.

 

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Marshall Gittler

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