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Overview: A surprise cut in China's seven-day repo and a stronger-than-expected UK employment report are the session's highlights ahead of the US CPI. The base effect alone suggests a sharp fall in the year-over-year rate, while the median forecast in Bloomberg's survey has been shaved to a 0.1% month-over-month gain. The dollar is under pressure and is weaker against nearly all the G10 currencies. It is mixed against the emerging market currencies. The dollar gapped higher against the Chinese yuan for the second consecutive session and is higher against the South African rand, Mexican peso, and Turkish lira, among a few others. 

It is a risk-on day, with equities advancing. Tokyo and Taiwan gained by more than 1%, while nearly all the large bourses in the Asia Pacific region advanced. Europe's Stoxx 600 is edging higher for the second consecutive session and US equity futures are firm. Benchmark 10-year bond yields are mostly a little lower, except for UK Gilts, where the strong employment and wage growth are lifting the 10-year yield by a handful of basis points to nearly 4.40%. Gold is consolidating in a narrow range of around $1960. After falling 4.3% yesterday, following a 3.2% drop in the last two sessions of last week, July WTI is stabilizing today (~$67.15-$68.15).
 

Asia Pacific

The PBOC unexpectedly cut the seven-day repo rate by 10 bp to 1.90%. It is the first such cut since last August and elevated speculation of a cut in the one-year medium-term lending facility later this week and a reduction in the loan prime rates next week. There is also scope for a cut in reserve requirements though the reduction in interest rates may push it into Q3. Reports suggest officials are considering a broader package of stimulative measures, including more support for the property market. Separately, but perhaps not unrelated, China reported a smaller than expected rise in new bank loans (CNY1.36 trillion, while nearly double the April lending, below the CNY1.55 trillion expected). The lending figures also indicate that shadow bank lending slowed to about CNY200 bln from about CNY500 bln in April.

US exemptions on South Korean and Taiwanese existing semiconductor fabrication in China are set to expire at the end of Q3, but the US has signaled an extension. It is not clear the length of the extension, but reports suggest that Estevez, the US Undersecretary of Commerce for Industry and security, indicated last week the extension would be for the foreseeable future. The US leverage over South Korean and Taiwanese chipmakers (as well as Japanese and Dutch chip companies) does not derive from the role of US Treasuries, the dollar, or the US military might. Rather it arises out of the fact that their technology and equipment were developed or manufactured by the US. Reports note that Samsung has indicated that it has reduced some of its operations in China, and in any event, was not producing its most advanced chips there. Just like the US modified its rhetoric from de-coupling to de-risking to help ensure that Europe and its other allies would stay the course, the extension of the exemptions may help ensure cooperation from South Korea.

Reports indicate that Pakistan made its first government-to-government payment for Russian crude oil in Chinese yuan. It does not appear to have been acknowledged yet, but we suspect Pakistan tapped its swap line with the PBOC. According to Chinese data released yesterday, the outstanding fx swaps totaled CNY109 bln (~$15.6 bln) at the end of Q1 23, a record. Even though China has negotiated a few dozen swaps lines, the use has been extremely limited. Argentina alone may account for 2/3 of the swap usage. Pakistan, like Argentina, are not turning the yuan to protest the hegemonic role of the dollar or US deficit, but out of sheet necessity given their dire financial straits. Some have suggested that these swap lines are the way the yuan will be internationalized, but the scale is not there. Most countries do not have a natural yuan revenue stream and those that have used the swaps lines pose credit risk. This is a far cry from invoicing in yuan or the use of the yuan as a reserve currency.

The dollar is consolidating against the yen within yesterday's narrow range (~JPY139.05-JPY139.75). This pennant or triangle formation tends to be seen as a continuation pattern. The downtrend off the highs comes in near JPY140 and the uptrend off the lows is found near JPY138.75. That said, the five-day moving average (~JPY139.50) looks poised to cross below the 20-day moving average (~JPY139.35) in the next day or two for the first time in two months. The Australian dollar's advance is stretching into the fourth consecutive session. It is the ninth session of the month, and the Aussie has only fallen once (June 7). It is nearly $0.6800 the upper end of the trading range that goes back to late February. It has traded above the $0.6800 cap three times here in Q2 but has not closed above it once. A convincing move above it would suggest potential toward $0.6900. For the second consecutive session, the dollar gapped higher against the Chinese yuan. It reached CNY7.1670 before steadying. Still, it remains above yesterday's high (~CNY7.1480). The PBOC is not expressing concern about the yuan's weakness through the setting of the dollar's reference rate. It was set at CNY7.1498, a bit above the median in Bloomberg's survey for CNY7.1469. 
 

Europe

There is practically no doubt in the market's mind that the ECB will hike rates by 25 bp on Thursday. Moreover, the swaps market is pricing in about a 70% chance of another move at the next meeting in July (27th). The meeting is the week's highlight. Today's ZEW survey was mixed. The assessment of the current situation weakened to -56.5 from -34.8. It was weaker than expected and has not been positive since November 2021. On the other hand, the expectations component improved to -8.5 from -10.7. It is the first improvement in four months. Recall that the German economy contracted in Q4 22 and Q1 23 (0.5% and 0.3%, respectively). The median forecast in Bloomberg's survey projects a 0.1% expansion in Q3 and 0. 2% in Q4.

The UK reported April/May jobs report. Wage growth accelerated and the unemployment rate unexpectedly fell. The takeaway is that the risks of a 50 bp move at next week's Bank of England meeting have increased. The unemployment rate fell to 3.8% in the three months through April. The market had expected a rise to 4.0% from 3.9%. It was 3.7% in the last three months of 2022. Recall that the UK unemployment rate was 3.8% in the last few months of 2019. Wage growth accelerated in April, following the 9.7% increase in the national living wage. Average weekly earnings, excluding bonuses accelerated to 7.2% from 6.8%. The Financial Times reported last week that according to the Indeed, job search website, the median wage in the UK jobs postings was 7.2% higher in May from a year ago. The number of employees on payrolls rose by 23k in May, and April's loss of 136k jobs was revised to a gain of 7k. Vacancies are falling. Tomorrow, the UK reports April GDP figures, and details. In March, the UK economy unexpectedly contracted by 0.3%. It is seen recovering and growing 0.2% in April. The swaps market is pricing about a 25% chance of a 50 bp hike next week. A month ago, a quarter-point hike was not fully discounted. The year-end rate is seen near 5.65%, up almost 15 bp today and 30 bp this month.

The euro has been bid through $1.08 for the first time since May 23 and the five-day moving average is crossing above the 20-day moving average for the first time since May 14. Some buying may be related to the nearly 815 bln euros in options at $1.0790 that expires today. A move above $1.0810 targets the $1.0860 area. Still, the intrasession momentum indicators are stretched, which leaves the single currency vulnerable to a firm US CPI report. Initial support is seen near $1.0780. Sterling has not experienced follow-through selling after yesterday outside down day. It has come back the bid, rising to almost $1.2580. Yesterday's high was nearly $1.2600. Here, too, the intraday momentum indicators are stretched. A setback in North America may find initial support near $1.2540.
 

America

The US reports May CPI figures today. The median forecast in Bloomberg's survey calls for a 0.2% increase in the month. That would bring the year-to-date pace, at an annualized rate of a little more than 3.8%. Due to the 0.9% increase in May 2022 dropping out of the 12-month comparison, the year-over-year rate could fall to 4.1%-4.2%, which would the slowest pace in two years. The core rate is proving to be more resilient. It is expected to rise by 0. 4%, which is the average monthly increase for the past six months. That will translate into slightly more than a 5% annual rate through May. In the first five months of 2022, the annualized pace of core CPI was closer to 5.8%. Last May, core CPI rose by 0.6%, as this drops out of the 12-month comparison, the year-over-year rate may ease to 5.2%-5.3%. That would be the lowest since late 2021. Moreover, as we have noted (here), another significant decline in headline CPI should be expected when the June CPI is reported on July 12. In June 2022, the US headline CPI jumped by 1.2%. This will drop out. A conservative projection suggests it will be replaced by a 0.3% increase. That would bring the year-over-year rate to 3.2%-3.3%. The core rate may ease to 5%. 

For the fourth consecutive session, the greenback is consolidating between CAD1.33 and CAD1.34. There are nearly $700 mln of options at CAD1.3330 that expire today but were likely neutralized in recent sessions. The US dollar found support in early European turnover near CAD1.3340. We suspect it can retest yesterday's high around CAD1.3385. The mayor of Mexico City and the foreign minister announced their resignations yesterday to prepare presidential contest within the Morena Party. Two other officials (a senator and another cabinet minister) are expected to resign shortly. Friday is the deadline to declare candidacy and officials cannot hold a public office during the campaign. A series of polls, in which non-party members can participate will be held in late summer and a candidate selected in late August/early September. This did not stop the peso from grinding to a new multi-year high yesterday. The dollar reached MXN17.2415. It is consolidating in quiet turnover now. A move above MXN17.32 could see MXN17.40, but from a larger perspective, we see little to prevent a move toward MXN17.00.

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