After falling in April and May, the US dollar rebounded in June, gaining against all the major currencies. The move appeared to begin as a technical adjustment to positions after the two-month slide left the greenback over-extended. However, it morphed into a powerful short squeeze after the Federal Reserve moved into a more hawkish direction. At the March FOMC meeting, the median view was for no hike until after 2023. The June forecasts showed the median projection anticipates two hikes in 2023, and seven of the 18 officials think a hike next year will be appropriate.

The US 10-year yield spiked to a three-month low near 1.35% a few days after the FOMC meeting concluded but averaged around 1.50%, which is still the lower end of the range since the end of February. The shorter end of the curve was not as stable. The December 2022 Eurodollar futures contract (three-month deposit rates) rose from around 33 bp in the first half of the month to 55 bp before the end of June. The cash market set a record low, a touch less than a dozen basis points in mid-June. The futures market implies that a full quarter-point hike is discounted by the end of next year and around 60% of a second hike.

In June, US 10-year yields fell more than in Europe and Asia. Australia, which has ordered a lockdown covering areas that contain around 80% of its population, was the sole exception. Its 10-year yield fell 18 bp compared with the 14 bp decline in the US. The short end of the curve was a different matter. The US 2-year yield doubled to 28 bp, its highest level since April 2020. The premium over Germany rose 10 bp to a new high for the year near 93bp. The premium over Japan rose about the same, and at 37 bp, the premium is the most since early Q2 20. The US two-year premium over the UK rose toward 20 bp late last month, a five-month high. 

Do not get the wrong idea. The US is not in the front of the queue for adjusting monetary policy. Among the high-income countries, Norway fine-tuned its forward guidance and has signaled a rate hike is likely in September. Judging by the participation rate and the number of jobs created in recent months, Australia’s labor market fully recovered from the pandemic. The Reserve Bank of Australia meets on July 6. It is likely to stop its yield-curve control efforts to cap the April 2024 yield at 10 bp, the same as the cash rate. This would entail not extending the target to the November 2024 bond. It seems less clear what the RBA will do with its asset purchases, but it appears likely to slow the purchases from the current A$100 bln six-month pace.

The Bank of Canada is also in the queue. It has begun to slow its bond purchases, and additional tapering could be announced at its July 14 meeting. It is a close call after employment fell in April and May. A strong jobs report on July 9 could help solidify expectations for additional tapering. The market appears to be pricing in a hike in H1 23. New Zealand and the UK are also likely candidates to be in the first group of high-income countries to adjust monetary policy. 

The European Central Bank, the Bank of Japan and the Swiss National Bank are expected to lag behind the US. However, the ECB’s acceleration of its emergency bond-buying is up for review in September. It will meet a little before the Federal Reserve, which is widely expected to formally announce slowing its purchases in the fourth quarter, perhaps initially focusing on the Agency mortgage-backed securities. The ECB will face an accelerating economy as the vaccine has made possible the uneven lifting of social restrictions and significant doses of fiscal stimulus. Price pressures also will remain elevated as the base effect peaks. 

Time is not a luxury that an increasing number of emerging market central banks experience. Mexico, Hungary, the Czech Republic raised rates, and the markets are pricing in the start of a tightening cycle. Chile, Poland, and South Africa are likely candidates. South Korea has signaled it will likely raise interest rates before the end of the year. Taiwan and the Philippines are probably not far behind. Russia and Brazil are already a few steps into their policy adjustment, and additional moves are likely July and August, respectively. 

As the rotating head, Italy will host the G20 meeting on July 9-10 in Venice. There could be an opportunity for the US and China leaders to meet one-on-one. However, there cannot be a rapprochement with a significant change in behavior from China, in Xinjiang and Hong Kong, its trade harassment of Australia, aerial harassment of Taiwan, and its other provocative actions in the region. This is not particularly likely. President Biden has also made some vague threats if Beijing blocks an independent inquiry into the origins of the covid virus. The G20, which includes more emerging market countries, may push back against the minimum corporate tax proposed and the carbon tax, which is thought to fall disproportionately on them.

Biden appears to have grounded his “America is Back” campaign on forging a coalition to check China. Of course, Taiwan, Japan, and South Korea are keenly interested, though apparently not sufficient for Tokyo and Seoul to bury their historical grievances. Europe’s concerns are much more regionalized and seem to only be galvanized in extremis. It resisted US efforts to widen the mission of the North Atlantic Treaty Organization. Some opposition seemed to be based on political realism and commercial benefits, while others wanted nothing to dilute the efforts to contain Russia. Indeed, the fear of Russia in eastern and central Europe was sufficient to prevent a Merkel-Macron initiative to move the EU-Russian relationship beyond the post-Crimea stalemate.

China took three initiatives in June, and they all appeared to yield at least partial success. First, the reserve requirement on foreign currency deposits was lifted as part of the nuanced attempt to steady the yuan without resorting to overt intervention. The official efforts were aided by a general recovery in the dollar for most of June. Second, officials have spoken out against the rise in commodity prices. Many of the industrial metal prices seemed to respond more to the threat than the actual specific official plans to auction some metals from the state’s strategic reserves, some of which had been bought previously to support prices. The government is also cracking down on unlicensed producers. Third, China reiterated its ban on crypto financing, trading, and mining. This was one of the factors that appear to have sparked a significant drop in crypto prices. 

China is woefully behind in meeting the objectives of the two-year trade deal with the US. Although it was negotiated by the previous administration, it will be up to Biden’s team how the US will respond. Reports suggest China has largely rebuilt its swineherd, and this may also dampen some US exports (e.g., live hogs) while keeping grain shipments firm. Grain prices have become more sensitive to the drought in the western part of North America and in Brazil.

The CRB Index of commodities rose by 3.75% and finished June at its highest level in six years. Lumber prices fell by more than a third in June, leaving them about a quarter higher since the end of last year. On the other hand, early reports suggest that the wholesale market for used vehicles may have peaked, with retail prices expected to follow with a lag. The shortage of semiconductor chips also is reportedly become less acute.

The imbalance of the supply and demand for oil has sent crude prices soaring. US and China have been drawing down their reserves. The price of WTI has risen by more than 50% this year and has doubled since the vaccine was announced. Although OPEC+ is set to boost output, there is talk of $100 a barrel of oil again. We recall that the last few business downturns were proceeded by a sharp rise in oil prices. Although it is not yet the baseline view, the risks that the combination of the end of the fiscal stimulus, the exhaustion of the pent-up consumer demand, the excesses associated with the surging economy coupled with the dramatic rise in oil prices could spur a downturn late next year seem to be increasing. 

The Bannockburn World Currency Index, our GDP-weighted currency basket fell in June to snap a two-month advance. Most of the currencies fell against the dollar. There were three exceptions, the Brazilian real (~5.0%), Russian ruble (~0.4%), and the Mexican peso (~0.1%). However, together they account for 7% of the BWCI. The euro and Chinese yuan’s combined share is 40%, and they fell by around 3.0% and 1.4% respectively. The weightings will be adjusted next month based on the World Bank’s new 2020 GDP estimates.

Dollar: The dollar corrected higher in June, helped by higher short-term rates and the more hawkish tilt by the Federal Reserve projections showing seven of eighteen now think a hike next year will be appropriate, and the median sees not one but two hikes in 2023. In March, seven officials saw a hike in 2023. Now 13 do. The 2-year yield doubled to 28 bp June. Over the course of the month, the US 10-year premium fell, and the 2-year premium widened. Surveys have suggested that most expect an announcement about tapering not until late August or the September 22 FOMC meeting. It is hard to say that any FOMC meeting is a non-event, but the meeting in late July may be close. The Earned Income Tax Credit and the Child Tax Credit begins payments in the middle of July. The downside pressures on short-term rates may be alleviated when the debt ceiling is either waived or extended. The current waiver expires at the end of July. We suspect the pace of growth is near a cyclical peak, and the base effect that has helped lift measured inflation is also peaking.

Euro: The ECB will not review its decision to maintain an elevated level of bond-buying under its emergency program until the September meeting. Issuance and liquidity tend to suffer in August and ECB purchases may be partly front-loaded. Growth appears to be accelerating as the vaccine rollout is allowing the relaxation of some social restrictions. Extensive fiscal support is still being provided, and EU funds (mostly grants) under the Next Generation (Recovery Fund) initiative are expected to begin being distributed. The pullback since peaking in late May near $1.2265 appears to have largely run its course. although a marginal new low (below $1.1825) cannot be ruled out. Two significant foreign policy initiatives backed by Germany's Merkel, the EU investment agreement with China and the new initiative for a rapprochement with Russia, have faltered. The former will not complete the ratification process because of Beijing's clumsy statecraft the sanctioning some members of the European Parliament before they endorsed the agreement. The attempt to get past Russia's annexation of Crimea (2014) was rebuffed by eastern and central European countries, suggestive of a deeper divergence within the EU, and also lends itself to a sense of the beginning of the post-Merkel era.

(June 30, indicative closing prices, previous in parentheses)

Spot: $1.1860 ($1.2190)

Median Bloomberg One-month Forecast $1.1950 ($1.2100) 

One-month forward $1.1865 ($1.2200) One-month implied vol 5.6% (5.7%)

Japanese Yen: The dollar edged over JPY111.00 for the first time since last March. Rising oil prices and commodities prices, more generally, are a negative shock for the terms of trade. The extended states of emergency and the continued social restrictions leave Japan as the only major economy that likely contracted in Q2. A strong second-half recovery seems likely as the vaccination program accelerates. Strong foreign demand is providing important support. Prime Minister Suga standing in the poll is low, and he will likely face a leadership challenge in September. The exchange rate remains sensitive to US interest rates, and higher US rates could see the dollar rise further against the yen. The 2019-2020 highs were in the JPY112.20-JPY112.40 area offer the next important targets. 

Spot: JPY111.10 (JPY109.85)

Median Bloomberg One-month Forecast JPY110.70 (JPY109.00)

One-month forward JPY111.05 (JPY110.00) One-month implied vol 5.4% (5.5%)

British Pound: Sterling reversed lower after recording a three-year high on June 1 near $1.4250 and did not look back. It dipped briefly below $1.38 for the first time since mid-April on the back of the hawkish Fed on June 16. A convincing move back above $1.40 would confirm a low is in place and a resumption of the bull move, for which we target $1.4350-$1.4375 in Q4. The postponement of the economy-wide re-opening until the middle of July, and a central bank looking past the uptick in CPI above the 2% medium-term target weighed on sentiment. The central bank will update its economic forecasts in August, and both growth and inflation projections likely will be raised. The furlough program ends in September, and it may take a few months for a clear picture of the labor market to emerge. Nevertheless, the market has begun pricing in a rate hike for H1 22.

 Spot: $1.3830 ($1.4190)

Median Bloomberg One-month Forecast $1.3930 ($1.4000) 

One-month forward $1.3835 ($1.4200) One-month implied vol 6.5% (6.7%)

Canadian Dollar: The US dollar's sell-off accelerated after the Bank of Canada announced it would slow its bond-buying operations and brought forward its projection of when the economic slack will be absorbed to the middle of next year. The greenback set a six-year low just above CAD1.20 on June 1 and was already moving above CAD1.22 when the FOMC meeting concluded. It peaked a little below CAD1.2500. Although the social restriction still weighed on the economy in Q2, growth is expected to accelerate in Q3. Canada's labor market disappointed, shedding almost 145k full-time positions in April and May combined. A snapback n June (reported July 9) is seen as the key for the Bank of Canada's forward guidance and pace of tapering to be announced at the July 14 meeting. Rising equities (risk appetites) and commodity prices (terms of trade) typically help underpin the Canadian dollar. Another factor for the exchange rate's two-year interest rate differential edged a couple basis points (to 20) in Canada's favor.

Spot: CAD1.2400 (CAD 1.2075) 

Median Bloomberg One-month Forecast CAD1.2325 (CAD1.2300)

One-month forward CAD1.2405 (CAD1.2080) One-month implied vol 6.5% (6.6%) 

Australian Dollar: The Australian dollar fell by about 3.1% against the US dollar in June, offsetting the April and May gains in full. New lows for the year (~$0.7475) were set a few days after the Fed's seemingly hawkish turn saw the US 2-year premium over Australia widen to more than 20 bp, the most since March 2020. The Australian and New Zealand dollars were among the worst-performing major currencies in June. The slow rollout of the vaccine, the least among the OCED, has left Australia vulnerable to the Delta mutation. As the month drew to a close, roughly 80% of the population is facing lockdown orders, the most since the pandemic first struck. The Reserve Bank of Australia meets on July 6, and it is will likely drawback from its yield curve control effort, which sought to cap the April 2024 bond at the cash rate target of 10 bp. At issue is whether it will extend it to the November 2024 bond. At the same time, it seems likely to extend its bond-buying program for another six months at a reduced pace. There is risk that the Australian dollar will weaken further in July. The next target is the $0.7380-$0.7400 area.

Spot: $0.7495 ($0.7710)

Median Bloomberg One-Month Forecast $0.7610 ($0.7750)

One-month forward $0.7500 ($0.7715) One-month implied vol 8.5 (8.5%)

Mexican Peso: The dollar fell to five-month lows against the peso (~MXN19.60) shortly after Mexico's June 6 legislative elections that did not give AMLO's coalition a super-majority needed to enact significant reforms. The firmer dollar tone and signals that AMLO was going to press on with his structural changes, while Brazil was engaged in an aggressive tightening cycle and the hawkish Fed saw the dollar soar to three-month highs of almost MXN20.75. The central bank surprised with a rate 25 bp rate hike on June 24. The dollar quickly fell back to the MXN19.70 area. The central bank meets next on August 12. The market may be at risk of over-correcting and has discounted a 25 bp hike a quarter through the middle of next year when Banxico now projects inflation will peak.

Spot: MXN19.95 (MXN19.9380)

Median Bloomberg One-Month Forecast MXN19.97 (MXN20.2250)

One-month forward MXN20.02 (MXN20.01) One-month implied vol 10.7% (11.6%)

Chinese Yuan: The dollar fell to three-year lows near CNY6.37 at the end of May. The yuan had appreciated by about 2.5% against the dollar through the first five months of the year and was near five-year highs against a trade-weighted basket (CFETS). On June 1, the PBOC hiked the reserve requirement for foreign currency deposits to 7% from 5%. It had been steady since 2007. It aims at reducing onshore foreign currency liquidity, making it more expensive to sell it and buy yuan. At the end of May, Chinese banks reportedly had accumulated more than a trillion dollars of foreign currency deposits due to the large trade surplus and portfolio investment inflows. As part of its broad-based gains, the dollar rose to CNY6.49, a two-month high on June 23. The greenback drifted lower into the month-end, perhaps encouraged by the PBOC's dollar fixings which seemed neutral.

Spot: CNY6.4570 (CNY6.3685)

Median Bloomberg One-month Forecast CNY6.4360 (CNY6.4650) 

One-month forward CNY6.4815 (CNY6.3760) One-month implied vol 4.7% (5.0%)