Fragile turn around Tuesday

Overview: Calmer markets are prevailing today, but an unease remains, and market moves continue to be sharp even if less dramatic. Still, it is in these somewhat less volatile conditions that the US dollar is doing better. It is firmer against all the G10 currencies today. The yen and sterling are the weakest, nursing 0.4%-0.5% losses, while the Norwegian krone and the Canadian dollar are faring the best, off 0.05%-0.15%. Emerging market currencies are also mostly lower, except a couple of East Asian currencies. 

Large Asia Pacific equity markets recovered, with the Nikkei up 10.2%, and South Korea and Taiwan equities rising by more than 3%. However, Europe is struggling and the Stoxx 600 is off for the fourth consecutive session. US index futures have pared early gains though are still slightly firmer. The 10-year JGB yield jumped 11 bp to almost 0.89%. European benchmark 10-year yields are mostly 2-4 bp lower, though the UK, Sweden and Swiss yields are 1-2 bp firmer. The 10-year US Treasury yield is up five basis points to 3.84%, and the two-year yield is up 2.5 bp to almost 3.95%. Gold is straddling the $2400 level in quiet turnover. September WTI is flattish near $72.30 after having tested the $74.50 area earlier, slightly above yesterday's high. 

Asia Pacific

The financial markets themselves are the news, having overwhelmed macroeconomic data. Still, there are two macro highlights in the Asia Pacific region today. First, Japanese labor nominal earnings are rising and rose when adjusted for inflation. However, household consumption remains poor. Labor cash earnings rose 4.5% year-over-year in June, which is the most since 1997, more than twice May's rise (2.0%) and well above expectations (2.4%). It is the third consecutive month that the year-over-year rate increased. Moreover, when adjusted for inflation, real cash earnings rose 1.1%, the first increase since March 2022. Household spending fell by 1.4% (-0.8% expected), and outside of the fluke in April, has been negative since February 2023. If the weak yen contributed to the inflation pressure in Japan, its dramatic recovery would contribute to the disinflationary forces already evident. Before the weekend, the swaps market was anticipating at least another 10 bp hike by the BOJ toward the end of the year. It has been trimmed to about six basis points. Second, the Reserve Bank of Australia left policy unchanged, and pushed back against speculation that it would cut rates shortly. The futures market had nearly a 2/3 chance of a cut next month discounted and fully priced in a cut at the following meeting in November. Governor Bullock still that sounded hawkish, playing up the risk that inflation would take too long to return to target. She said it was too early to talk about rate cuts. The central bank formally raised its forecast for economic growth and core inflation. 

The dollar bottomed Asia Pacific turnover yesterday near JPY141.70, which was about three standard deviations below the 20-day moving average. It recovered to almost JPY144.50 in the North American session. The pre-weekend low, after the disappointing US employment report was about JPY146.40. The dollar nearly reached that in early Asia Pacific turnover today (~JPY146.35) before pulling back to finding support near JPY144.30-50. The intraday momentum indicator is oversold in the European morning, suggesting the upside potential in North America. The Australian dollar set new 2024 lows in the Asia Pacific session yesterday near $0.6350 and recovered to about $0.6510 in the North American morning. Since the high was reached, the Aussie held above $0.6470. The hawkish hold by the RBA saw the Australian dollar rise to $0.6540 but was greeted with new sellers, which pushed the Aussie back below $0.65000. It is slightly lower on the day in Europe. A move and ideally a close above $0.6550 would lift the tone. The momentum indicators appear to be bottoming, but more work may be needed. The US dollar recovered from almost CNH7.0840 to almost CNH7.15. It settled near three standard deviations below the 20-day moving average (CNH7.1365). Nearby resistance is seen near CNH7.17 and then CNH7.20. It is consolidating in a CNH7.1335-CNH7.1530 range today. The PBOC set the dollar's reference range at CNY7.1318 (CNY7.1345 yesterday). Chinese state banks reportedly sold government bonds yesterday after the 10-year yield slipped below 2.10% for the first time. Reports suggest sales of 10- and 30-year bonds yesterday. Although the PBOC indicated recently that they were prepared to sell bonds, which they would borrow from the market, it is not clear that they acted on the PBOC's behalf. 

Europe

June eurozone retail sales, which declined by 0.3%, are a side issue, as is the unexpected jump in German factory orders (3.9% vs. 0.5% expectations), the first rise this year. The financial instability has encouraged the market to look for more aggressive easing by the European Central Bank. The swaps market is pricing in a quarter-cut next month. The calmed markets today have seen the amount of cuts this year scaled back to about 73 bp from 85 bp yesterday. Last Tuesday, the market did not quite have a 25 bp cut discounted for September and had 57 bp of cuts in the remainder of the year. Similarly, the UK's July construction PMI (55.3 vs. 52.2) is not the focus. The weekend riots stemmed from the murder of three girls in Stockport by a British suspect, but a rumor spread on social media invention, some attribute to Russian disinformation, and fed by local anti-immigrant "influencers" attributing the ghastly crime to a Muslim immigrant and is the Labor government's first non-economic challenge. The swaps market is now pricing in about a 47% chance of another cut in September, down from about 65% at the peak yesterday. It is now pricing in 47 bp of cuts this year and almost 60 bp in H1 25.

As capital markets stabilized, the euro pulled back to around $1.0945. It settled near its upper Bollinger Band (two standard deviations from the 20-day moving average), around $.10955. The daily momentum indicators are turning up but given the 2 1/4-cent rally in the past two sessions, some near-term consolidation is likely. It is in about a half cent range today above $1.0910. The US two-year premium over Germany collapsed to about 147 bp yesterday, the least since May 2023, but recovered as the US two-year yield bounced from 3.65% to almost 3.95%, where it stalled. The two-year premium settled near 157 bp and is a little firmer today. Sterling spent yesterday's volatile session inside the range set on Friday (~$1.2710-$1.2840). It was in a narrow range in North America, mostly $1.2740-$1.2790. It was turned back from $1.28 today and is near $1.27 in late European morning turnover. A break could spur a move toward $1.2655. Unlike the euro, sterling's momentum indicators have not turned up yet. While the euro's five-day moving average looks to soon cross above the 20-day moving average, sterling's moving averages are further from crossing than the euro's. The euro has shot up from GBP0.8420 last Wednesday and Thursday to nearly GBP0.8620 yesterday, its best level since mid-May and just beyond four standard deviations above the 20-day moving average (~GBP0.8610). It settled beyond three standard deviations (~GBP0.8565). It is enjoying a firm bias today (range: GBP0.8560-GBP0.8590).

America

With Q2 GDP already reported, the June US trade balance was unlikely to be a mover in any event, even if will impact revisions. With instability in the financial markets, it is doubly true. There continues to speculation of an emergency Fed rate cut, but at this juncture, it does not appear to be the most likely scenario. Note that even with the steep losses seen in recent days, the major US indices are still higher for the year. Moreover, Fed Chair Powell has tried to playdown the "Fed put," which, since at least Greenspan has been understood to address the threats to financial instability and is linked in the popular imagination to dramatic losses in the stock market. Canada reports its June merchandise trade balance today. Given market developments, it is unlikely have much impact. Still, the takeaway is that in the first five months of the year, Canada has reported a C$3.5 bln merchandise trade deficit. In the first five months of 2023, Canada recorded about a C$700 mln merchandise surplus. The swaps market has about 80 bp of cuts discounted over the last three Bank of Canada meetings in the remainder of this year. Mexico reports auto production and exports figures. It is striking that amid the talk of excess capacity, Mexico exported about 85% of its auto production in H1 24. Mexico reports July CPI later this week. The recent pattern looks to be intact, whereby the headline has stopped falling but the core rate continues to gradually ease. The peso dramatic weakness (~12% in mi-July) adds to the inflation risk. Still, the swaps market has about 45 bp of cuts discounted in the next three months and nearly 100 bp in the next six months.

The US dollar posted a potentially powerful downside reversal pattern against the Canadian dollar. The possible key reversal was created when the greenback initially rose to new highs since October 2022 near CAD1.3945 and settled below the pre-weekend low (~CAD1.3835). However, follow-through activity today was limited, and the brief and shallow dip below CAD1.38 was snapped up and the greenback pushed through CAD1.3850 in the European morning. Note that as of July 30, which is the latest Commitment of Traders report, speculators in the CME futures had a record short Canadian dollar position. Amid the frantic position adjustment, the Canadian dollar seemed to benefit from short covering. Yesterday, it outperformed the Antipodeans, Scandis, and sterling. The US dollar soared to MXN20.2180 yesterday in Asia Pacific trading, its best level since October 2022. The greenback's gains were gradually pared, and it recorded a low in North America slightly below MXN19.21. The US dollar surpassed the three standard deviation mark from the 20-day moving average (~MXN19.8150) and settled above the upper Bollinger Band (~MXN19.2950). Participants remain on edge: Not only are market developments worrisome, but the reaction to Iran's pending strike on Israel could also inject volatility. The peso is used by some market participants as a liquid proxy for other emerging market currencies and for expressions of risk off. The US dollar is approaching MXN19.50 in Europe as it recovers from session low near MXN19.14.