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Overview:  The drama in Russia captured the imaginations but failed to have much impact on the capital markets. Conventional wisdom sees it as a sign of Putin's weakness, but he has been underestimated, including by many Ukrainians who did not think Russia was going to invade despite America's repeated warnings. It may take some time for the implications for the two main protagonists, Wagner head Prigozhin and Defense Minister Shoigu. The war in Ukraine is likely unaffected, and Kyiv's counter-offense thus far seems rather muted. The risk is that the war escalates if Kyiv resorts to medium- and long-range missiles to hit Russian assets in Crimea, and possibly in Russia proper. Meanwhile, the record from the Bank of Japan's recent meeting showed at least a couple of members were moving toward a change in stance. One wanted to discuss revisions to the yield curve control "at an early stage" and another warned of while inflation may moderate later this year, it may not fall back under 2%. These comments, coupled with the Vice Finance Minister for International Affairs warning that officials will respond if moves were excessive. 

The sell-off in equities continues. The MSCI Asia Pacific fell for the sixth consecutive session, and so has Europe's Stoxx 600. US equity futures are also trading with a softer profile. Benchmark 10-year yields are mostly 2-4 bp lower in Europe and the US (putting the 10-year US Treasury yield slightly below 3.70%). The yen leads the G10 currencies higher with about a 0.35% gain. The Swedish krona (central bank meets later this week) and the Australian dollar are the chief laggards today. Emerging market currencies are mixed. We note that the Chinese yuan and Russian rouble are trading lower, and the Turkish lira has been tagged for another 2.5%. Lower rates and a softer dollar have given gold a small lift. It traded near $1910 before the weekend, a three-month low, and is near $1930 late in the European morning. August WTI began higher near $70 before easing to almost $68.70. It has steadied near $69.50.
 

Asia Pacific

Chinese markets re-opened after being closed for the holiday on Thursday and Friday last week. The MSCI Asia Pacific equity index fell every day last week, the first time since last June, and lost about 2% while China's mainland markets were closed. Investors continue to look for new stimulative measures from Beijing. The CSI 300 fell by 1.4%, as it played a little catch-up. Yet, the Chinese economy still seems to be on pace to achieve the GDP target this year of around 5%. The Politburo's semi-annual conference at the end of next month seems to be a possible forum that new economic initiatives. Separately, we note that the Shanghai Clearing House announced it was launching a new initiative using the digital yuan for clearing and settlement services for bulk commodities.

Japan's economic diary is light in the first half of the week, but reports May retail sales, employment, and industrial production in the second half. And ahead of the week, Tokyo's June CPI will be reported. It offers useful insight into the national figure, which is reported with a few weeks' lags. Meanwhile, with the dollar climbing to above JPY144, there is more talk of intervention. Although speculators in the futures have amassed a larger short yen position than they had last September and October when the BOJ intervened, the sell-off is driven by policy divergence. The move seems more about yen weakness than dollar strength. Still, the correlation between changes in the exchange rate and US interest rates remains high. Over the past 30 sessions, the correlation with the US 10-year yield is near 0.82. It was near 0.95 earlier this month. The correlation between changes in the exchange rate and the US two-year yield is near 0.73. The correlation set a four-year high near 0.86 earlier this month.

Softer US yields and some ideas that BOJ may be closer to a policy adjustment helped steady the yen after it fell to new lows for the year ahead of the weekend. The dollar is inside Friday's range (~JPY142.70-JPY143.85). A break, and ideally a close below JPY142.65 is needed to suggest more than a flatting consolidation. The Australian dollar is pinned near the pre-weekend low (~$0.6665) and has held below $0.6695 in quiet turnover, which is about where the 200-day moving average is found. The $0.6680 area corresponds to the (50%) retracement of the Aussie's gains this month. The next retracement (61.8%) is near $0.6625. Note that the Australian dollar is approaching the measuring objective of the double top against the New Zealand dollar (~NZD1.0820), which we have been tracking. A break of NZD1.08 can see NZD1.0750 near term. The PBOC set the dollar's reference rate much lower than expected, but this did not stop the greenback from rallying to new seven-month highs. The fix was set at CNY7.2056 compared with the median forecast in Bloomberg's survey of CNY7.2133. The dollar rose to CNY7.2372. 
 

Europe

Germany's June IFO survey showed a troubling deterioration in sentiment. The current assessment fell to 93.7 from 94.8. It was the third consecutive decline and is now below the 94.2 seen at the end of last year. The expectations component tumbled for the second month to 83.6 from 88.3. It finished last year at 83.3. The overall business climate softened to 88.5 from 91.5. The German economy contracted by 0.5% in Q4 22 and by 0.3% in Q1 23. The median forecast in Bloomberg's survey conducted earlier this month (44 economists) is anticipate 0.1% growth in Q2 and 0.2% in each quarter in H2. 

Ahead of the eurozone's preliminary June CPI at the end of the week, it is interesting to review where the 10-year breakeven, a measure of inflation expectations is the difference between the yield of the inflation-linked instrument and the conventional yield. Germany's 10-year breakeven is near the middle of the 2.20%-2.40% range that has dominated here in Q2. Italy's 10-year breakeven is also near the middle of its 2.10%-2.30% Q2 range. Separately, we note that the UK's 10-year breakeven is a little below 3.80%. Last week, it spiked to nearly 3.94%, the high for the year. It finished last week below 3.77%, the 20-day moving average for the first time since May 22. By way of comparison, the US 10-year breakeven has mostly been between 2.15% and about 2.30% this quarter and finished last week near 2.21%. 

The euro is trading quietly and has been confined to slightly more than 10 tick on either side of $1.09. It had traded down to $1.0845 at the end of last week in response to the disappointing flash PMI. This met the (38.2%) retracement of this month's advance. The (50%) retracement is found near $1.0825 and the 20-day moving average is a little lower at $1.0820. On Thursday, 2.35 bln options at $1.08 expire. Sterling is trading quietly in a half-of-a-cent range above $1.2700. The latest CFTC data, which runs through the week ending June 20 appears to have seen a record rise in speculative net long sterling futures position (~39.9k contracts). In that reporting week, the sterling average about $1.2765. It set a marginal new low for the week on Friday slightly below $1.2690.
 

America

The gap between the market and the Fed's Summary of Economic Projections remains stark. The futures market has a little more than 70% of a hike next month discounted. On June 13, the day before the FOMC meeting concluded the market had a slightly higher chance of a July hike. Net-net, it was unchanged last week despite the flurry of Fed officials that seem to endorse the need to hike more but Atlanta Fed's Bostic, who does not vote this year. The January Fed funds futures imply a year-end effective rate of 5.24%. The current effective rate, which is what the contract settles is around 5.07%-5.08%. Assuming the Fed delivers two more quarter-point hikes this year, as it indicated, fair value is 5.57%-5.58%. Today's Dallas Fed's June manufacturing survey is of little consequence for policy expectations. Last week, roughly half of the Fed officials spoke, and this did not persuade the market, what will? We suspect that the PCE deflator at the end of the week could spur a market response. While the headline deflator will likely slip below 4%, the core rate is problematic. The risk is that the year-over-year rate move higher for the second consecutive month. The median forecast in Bloomberg's survey is for a 0.4% increase. As we noted, this would mean that an annualized pace, core PCE would be rising at a 4.8% clip compared with 4.6% in the first five months of last year.

Canada reports May CPI tomorrow. A 0.4% rise would bring the annualized rate this year to 6%, which is less than half the annualized pace in the Jan-May period last year. The underlying measures, which the Bank of Canada cited in the decision to end its conditional pause earlier this month, are proving more resilient. Consider that the weighted core median averaged 4.6% this year through April. In the first four months of 2022, it averaged 4.1%. The trimmed core mean has risen at an average year-over-year rate of 4.6%, unchanged from the same year-ago period. The swaps market is discounting about a 67% chance of a hike at the July 12 Bank of Canada meeting and is fully discounted by the September 6 meeting.

The US dollar may be carving out a small shelf against the Canadian dollar. Last Thursday, it set a nine-month low near CAD1.3140 and the pre-weekend low was slightly above it, and today's low matches Thursday's low. The greenback settles near CAD1.3185 ahead of the weekend and has not trading much above it so far today. The CAD1.3200-20 area offers nearby resistance. There are options for around $935 mln that expire Thursday at CAD1.3150. The dollar spent last week consolidating against the Mexican peso. It set the multiyear low on June 16 near MXN17.0250. The week's high was set on Friday by MXN17.2650. A move above MXN17.30 would suggest a proper correction may be at hand rather than the broadly sideways consolidation. There are options for about $535 mln struck there that expire Wednesday. 

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