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US equities dropped yesterday, with some analysts/commentators citing concerns about inflation following a much hotter than expected US CPI report for the month of June, though in fairness, the fall in the major US equity indices was not much, with the S&P 500 and Dow only losing about 0.3% and the Nasdaq 100 actually finishing the session flat. For reference, headline US CPI rose 0.9% MoM (much higher than expected) and at a YoY rate of 5.4%, a surprise rise from last month’s 5.0% YoY reading. Meanwhile, core CPI also posted a larger than expected MoM and YoY rise. The reaction in bond markets to the data was much more telling; 10-year yields barely budged and even fell a little in wake of the data, suggesting that the market’s belief in the “transitory inflation” narrative remains strong (to be fair, much of the price rises in yesterday’s CPI was in “pandemic affected” sectors, with another big rise in used car prices). Yields were then boosted later in the session by a weak 30-year bond auction. 10-year yields currently trade just under 1.40%, a decent recovery from lows earlier in the month around 1.25%. Much of this rise in nominal yields has been driven by a rise in inflation expectations; 10-year break-evens are up in the mid-2.30s% again, up from earlier monthly lows under 2.25%. The rise in inflation expectations has simultaneously kept the pressure on real yields, which continue to consolidate close to recent lows (10-year TIPS yields are just above -1.0%). 10-year break-even inflation expectations remain well below recent highs about 2.50%, however, but this is something to watch and could be a sign that the market’s “reflation trade” might be coming back to life (this is a trade that tends to push nominal bond yields and commodity prices higher). In terms of what is going on this morning; US equities are a little higher, with news that Apple is set to increase iPhone production in 2021 seemingly giving sentiment a bit of a boost (E-mini S&P 500 futures are up about 0.1%) in otherwise quiet trading conditions. Markets are broadly in wait-and-see mode ahead of the main event of the day and arguably weekly, the first day of Fed Chair Jerome Powell’s two-day semi-annual testimony before the US Congress where he is quizzed on the Fed’s current monetary policy stance by elected officials in the Senate Financial Services and Banking committees.
Separately, one of the major news developments of the past 24 hours has been the news that Senate Democrats in the US have reached a deal on a new $3.5T budget deal. One Democrat Senator said the deal would be fully paid for (i.e. funded by tax hikes rather than borrowing), something which seems to be a condition for support from some more centrist Democrat Senators like Manchin. Needless to say, it is likely that Republican Senators will object. But if the new spending bill is passed via the budget reconciliation process in the Senate, then none of there votes will be needed. The market has not shown much of a reaction to the news as of yet; given the talk is that there will be no new borrowing to fund the spending, the fiscal impulse will likely be neutral for the economy (borrowing tends to boost short-term economic activity) and this spending ought not be considered as “stimulus”. This is likely why we haven’t seen equity markets cheer this news as they have past fiscal “stimulus” plans (like the $1.9T implemented earlier in the year), which were mostly funded with borrowing.
Turning now to FX markets, the New Zealand dollar is far and away the best performing G10 currency this morning after last night’s more hawkish than expect RBNZ meeting and is currently up around 1.0% on the session, sending NZDUSD to the north of the 0.7000 level again. The bank opted to hold its main interest rate (the OCR) at 0.25% as expected, but unexpectedly announced that it would cease its asset purchase programme by the end of July (by which time the bank would have only used less than 60% of its original NZD 100B remit). Meanwhile, important changes were made in the language in the bank’s statement on monetary policy; the reference to the need for “considerable time and patience” for the bank to achieve its monetary policy objectives was dropped. The bank also shifted from a stance where it deems the maintenance of stimulus as necessary to meet its policy objectives, to a stance where “the level of monetary stimulus could be reduced to minimise the risk of not meeting its mandate”. This is hawkish stuff and is essentially the RBNZ saying that it no longer sees ultra-accommodative monetary policy as appropriate. Where banks and analysts had previously been expecting the first hike to come in November, many are now calling for the first-rate hike to come in August (though Westpac fears that this might be a policy mistake). That might put the RBNZ at the front of the G10 central bank monetary policy tightening queue, now ahead of the Norges Bank. FX strategists suspect that NZDUSD might continue to struggle if the positive USD conditions remain but suspect that NZD will be an outperformer in the weeks/months ahead versus other G10 currencies. Some have recommended short AUDNZD, given the growing policy divergence between the RBNZ (who seem set to hike this year) and RBA (who still say no hikes into 2024 – though most analysts agree this stance is going to gradually become more hawkish in the months ahead).
Elsewhere in FX markets, GBP is the second best performing G10 currency so far on the session, currently up roughly 0.4% on the day versus the US dollar, with GBPUSD having bounced from around 1.3800 to above 1.3850. Sterling is deriving a boost from hotter than expected CPI in the UK which seems to be being interpreted as having modestly hawkish implications for the BoE’s coming monetary policy tightening cycle. Price action in other G10 currencies in much more subdued and indicative of a tentative risk tone. The dollar bulls who had had their foot on the gas in wake of yesterday’s stronger than expected US CPI data seem to be taking a breather and the DXY is consolidating above 92.50 this morning after just missing out on setting fresh multi-month highs yesterday in the 92.80s. Consolidative/tentative trade conditions are too surprising given the main risk event of the week looms in Fed Chair Powell’s two day testimony before Congressional Committees on Financial Services (today) and Banking (tomorrow). In the meantime, EURUSD is pretty much bang on the 1.1800 level, USDJPY is close to 110.50, USDCAD is around 1.2500 with traders also awaiting today’s BoC rate decision and USDCHF just under 0.9200. Slightly softer than expected EU industrial production for the month of May has not ruffled any feathers.
The Day Ahead
First up, we have US PPI (June) at 1330BST. Will it come in hotter than expected like CPI did yesterday? If so, further “inflation concerns” might be triggered. The Bank of Canada (BoC) releases the result of its latest rate decision at 1500BST, and it is expected to be a hawkish affair, with the bank again reducing the pace of monthly asset purchases. Loonie traders will closely eye the bank’s guidance on interest rates (markets currently expect the hiking cycle to begin by the mid-point of next year). Canadian Manufacturing Sales out at 1330BST is also worth watching for CAD traders. Oil traders will then be watching official US inventory data from the EIA at 1530BST. The main event of the day is at 1700BST when Powell’s testimony begins. This should massively overshadow the release of the Fed’s Beige Book at 1900BST, though it will be interesting to hear what businesses across the US are saying about economic conditions right now, nonetheless. Elsewhere, BoE member Ramsden will also speak today at 1800BST, and may refer to this morning’s hotter-than-expected UK CPI.
