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After yesterday’s distinctly risk off session, during which global equity markets and global bond yields saw a decent sized drop, markets are seeing a decent technical correction on the final trading day of the week. For the most part, global equities are higher; E-mini S&P 500 futures are 0.4% higher following yesterday’s 0.9% loss – the 4300 level is providing solid support for the time being and the index is only about 0.6% from record levels set earlier in the week. European stocks are seeing even more impressive gains, with the Stoxx 600 index up nearly 1.0%, though this comes in wake of yesterday’s sharp 1.7% decline. That leaves the index about 1.0% below record levels set back in mid-June. Meanwhile, US bond yields are sharply higher on the day; 10-year yields are trading around 1.35%, up about 5bps on the session, a decent recovery from multi-month lows set yesterday around the 1.25% mark. 30-year yields are up about 7bps but have not quite been able to break back above the 2.0% mark. US yields remain substantially lower still on the week however, with 10-year yields down about 9bps (having started the week close to 1.45%) and 30-year yields down about 8bps (having started the week around 2.05%).
In terms of what this week’s moves signify; the move lower in bond yields is being taken as the most meaningful market signal by analysts, a signal that markets are tilting more heavily in terms of their expectations towards forecasting a return to the pre-pandemic deflationary environment (i.e. lower long-term inflation) rather than inflation remaining higher than pre-pandemic levels for the foreseeable future. Hence, bond yields moving lower in anticipation that central bank interest rates will be lower in the long-term. Meanwhile, though most major global equity indices are off highs, stock market sentiment continues to look strong, as evidenced by the apparent appetite to buy-the-dip (which has been a winning strategy since the March crash last year). Indeed, if bond markets are right that the global economy will return to a regime of low inflation (and likely slower growth), then that means more accommodative central banks, which (based on the last decade’s worth of stock market price action) is typically a good thing for stocks.
So, while stock markets don’t seem to be sending to strong a signal of any major downturn in risk appetite, the signal from FX markets is distinctly more risk off; on the week, JPY is the best performing G10 currency, up about 1.0% versus the USD, while fellow safe-haven low yielder CHF is up more for 0.5% on the week versus the buck. Analysts have explained that outperformance in these two currencies has been driven this week by an unwind in pro-risk carry trades (i.e. where you borrow in a currency in a low interest rate country such as Japan or Switzerland and lend in a higher interest rate country like an EM country, or somewhere like Australia or indeed the US). This explains in part why EUR is roughly flat on the week versus the buck; the euro is another one of the market’s favourite carry trade funding currencies given low Eurozone interest rates, and so the unwind of these trades has helped the euro hold ground versus its traditionally more “safe-haven” counterpart the US dollar. Most other G10 currencies have not had such luck against the safe haven dollar; NOK and CAD are both down about 1.5% versus the dollar on the week and are the worst performing G10 currencies (in part thanks to the sharp drop from highs in crude prices given ongoing OPEC+ angst) while risk-sensitive AUD and NZD are both down about 1.0% on the week versus the buck. Thus, perhaps the strongest signal that risk appetite may be about to take a turn for the worse has come from FX markets this week; aside from the gaining of traction in the peak growth narrative seen this week, analysts have also cited Covid-19 delta variant spread concerns as a reason for caution, as well as OPEC+ concerns and China crackdown concerns.
Do note, however, that on the day, FX markets are seeing a bit of a technical correction as is also the case in bond and equity markets; risk-sensitive currencies (led by the NOK) are performing well and the US dollar and yen lag. The DXY remains well supported not too far from recent highs, however, trading around the 92.30 mark, down only about 0.1% on the session. In terms of a quick US economic update; yesterday’s US data wasn’t great. Weekly initial jobless claims posted a surprise increase to 373K from an upwardly revised 371K the week before, above expectations for a drop to 350K. The US labour market recovery remains “choppy” analysts observed, though most maintain their positive outlook for the US jobs market in the near-term. Thus, yesterday’s labour market data hasn’t had any notable impact on risk appetite or on USD. Elsewhere, GBP did not ay real negative reaction to this morning’s softer than expected UK activity data; GDP saw a slower than expected pace of growth in the month of May of 0.8% MoM versus consensus forecasts for a monthly growth rate of 1.5%. According to Capital Economics, GDP is now likely to return to its pre-Covid-19 level by October rather than previous forecasts for this recovery to have been completed by June. The economic consultancy remains positive on the UK’s recovery, stating 1) “that the recovery so far has been faster than most imagined possible six or 12 months ago” and 2) “the economy may yet surprise most forecasters again by emerging from the pandemic without much scarring”. Meanwhile, pound sterling is yet to show signs of concern, but it is worth monitoring a developing story involving a growing split between the UK and EU over the “Brexit divorce bill” (the UK says its £35-40B, but the EU is reportedly claiming that it is over £40B). We also had Chinese inflation data out last night; PPI remains stubbornly high up 8.8% YoY, but CPI fell short of expectations, coming in at 1.1% versus consensus forecasts for a reading of 1.3%. Meanwhile, Chinese lending data was a little stronger than expected, though this has not been enough to change the narrative of credit expansion in the Chinese economy having peaked (a lead indicator of slower growth in the months to come), which forms part of the basis for the rationale for the aforementioned 50bps cut to the PBoC’s RRR and announcement of CNY 1T in additional long-term liquidity. CNY nor AUD or NZD have seen any meaningful reaction to the most recent China updates, but note that all will be vulnerable to losses versus the US dollar if sentiment about Chinese economic growth continues to deteriorate.
The Day Ahead
The main event of the day for FX markets is the Canadian jobs report, which is expected to be strong in June, a reflection of an easing of the harsh Covid-19 restrictions implemented earlier in the year. Consensus expectations are for the economy to have added roughly 200K jobs on the month (a lot for a country of under 40M people). The Loonie will likely be choppy. Aside from that, there will also be the release of a Fed Monetary Policy report at 1600BST which comes in advance of Fed Chair Powell’s semi-annual testimony to the Senate which might garner some attention. Most analysts would agree that in wake of last month’s FOMC meeting (and confirmed by the FOMC minutes released earlier in the week), it remains too soon for Fed Chair Powell to announce the bank’s move towards tapering is asset purchase programme.
