Overview:  Chinese markets were the notable exception amid sharp losses in many of the large markets in the Asia Pacific.  A rebound in the Japanese yen, spurred by official comments about the pace of its losses, saw Japanese shares tumble.  South Korea, Australia, and India markets were off more than 1%.  Europe’s Stoxx 600 is also off more than 1% as it the benchmark records the fourth consecutive decline.  US futures are steady to a little higher. 

Meanwhile, the US 10-year year yield is hovering around 3.03%.  In Europe, the peripheral bonds are under pressure and the premium over Germany is widening after the ECB did not unveil a new tool to combat “fragmentation.” The dollar is mixed against the major currencies.  The Antipodeans join the yen in modest gains (~0.3%-0.5%) today while sterling and the Canadian dollar lead the decliners (~0.3%).  Emerging market currencies are mostly lower, but the Turkish lira is the top performer with about a 0.25% gain (the central bank doubled to 20% the required reserves on lira loans). 

Gold is trading quietly between $1842 and $1848.  July WTI is firm above $122.  US natgas is slightly firmer after rising 3% yesterday.  Europe’s natgas benchmark is off almost 1.5% to pare yesterday’s nearly 10% surge.  Iron ore is pressured for the second day after fresh Covid-related restriction were announced in Shanghai. With these losses, iron ore prices fell on the week (~2.2%). July copper is extending yesterday’s losses.  July wheat continues to unwind the 5.1% rally seen at the start of the week.

Asia Pacific

Verbal intervention by Japanese officials saw the yen trade modestly higher.  Coming into today, the yen had fallen in eight of the past nine sessions.  In late April, with the US dollar probing JPY131, Japanese officials warned about the sharp moves, which arguably helped help the yen stabilize.  If intervention is best thought of as an escalation ladder, another small step was taken today.  After Ministry of Finance, Bank of Japan, and Financial Services officials met, a statement was issued expressing concern about the pace of the yen's decline, and threatened to "act appropriately, if needed.".  The yen was trading near seven-year lows against the euro and Australian dollar and 20-year lows against the greenback.  The dollar was around JPY134.50 before the statement and pulled back to almost JPY133.35.  The G7/G20 statements about foreign exchange say that while the markets should determine rates, excessive volatility should be avoided.  The yen's weakness is driven by fundamental considerations (e.g., divergence of monetary policy, terms-of-trade shock).  Perhaps, verbal intervention may be more effective than actual material intervention in dampening volatility.  

China report inflation and lending figures today.  The CPI was unchanged at 2.1% year-over-year.  It declined (0.2%) month-over-month for the first time this year.  Food and transportation gains were not demand driven, and the core rate, which excludes food and energy, was steady at 0.9%.  Pork prices were 21.1% lower than a year ago and shaved 0.34 percentage points from CPI.  On the other hand, fresh vegetable prices were up 11% and fresh fruit prices rose 19%.  Together they added 0.58 percentage points to CPI.  The price of gasoline a little more than 27% year-over-year.  Producer prices fell for the seventh consecutive month.  After peaking last October at 13.5% year-over-year, China's PPI has slowed to more than half, to 6.4% in May.  This was in-line with expectations.  The medium-term lending facility rate will be set next week.  Most do not look for a reduction.  Inflation does not stand in the way, but it hasn't, and Beijing shows a preference to use fiscal levers, while interest rate adjustments have been meager thus far.  Separately, Chinese lending figures showed a larger than expected recovery from depressed April levels.  Overall aggregate financing rose CNY2.79 trillion, which was around 30% more than expected and a three-fold increase from April's CNY910 bln. 

The verbal intervention by Japanese officials steadied the dollar-yen after probing near JPY134.50 in early turnover today.  However, yesterday's low near JPY133.20 was unchallenged.  In order there to be sustained impact, officials need to spur a short squeeze, which is challenging as one is paid to be short the yen, given the rate differentials. Some position adjustments today have also been encouraged by the expiration of options for $570 mln at JPY134 that expire shortly.  The North American session may be skeptical that the verbal intervention can be backed by material intervention as the FOMC is set to deliver a 50 bp hike next week and will likely to continue at that pace in July, and likely September.  The Australian dollar losses were extended to $0.7085 today, a new low for the month, but recovered to $0.7140 in late Asian turnover.  However, it found fresh offers in the European morning. We suspect a durable low is not in place.  The next technical target may be the $0.7055 area.  Only a move above $0.7160 would negate this bearish outlook.  The US dollar is firm against the Chinese yuan but confined to yesterday's range (~CNY6.6650-CNY6.7000). It is up about 0.6% this week, recovering from a loss of a similar magnitude last week.  The PBOC set the dollar's reference rate at CNY6.6994, slightly lower than the expected (CNY6.7017, according to the Bloomberg survey).

Europe 

One might not know it from downside reversal in the euro that many banks that the market heard a hawkish message from the ECB. The swaps market for the year-end jumped 15 bp to almost 150 bp. There are four meeting left this year. That implies expectations for not one by two 50 bp hikes this year. Many banks concur. That said, ECB President Lagarde was clear about the July move being only 25 bp. The possibility that the pace quickens in September was conditional about prices not stabilizing or deteriorating.

The case for skepticism may begin with an appreciation that interest rates are not waiting for the ECB to move official rates. Consider that since early March, the two-year German yield has surged by more than 160 bp to a little more than 0.8%, its highest level in 11 years. The US two-year yield has risen by less, and this has resulted in the US premium has fallen below 2.0% from over 2.50% as recently as mid-May. It has retraced half of this year increase in the past three weeks. The relationship between the exchange rate and the interest differential seems cyclical with the dollar rising as rates more against it a late-cycle phenomenon.

After a big outside down day yesterday, follow through selling of the euro took the single curerncy below the $1.06 level for the first time since May 23. The next target is $1.0570 and then $1.0520. Still, the decline has stretched intra-day mometnum readings, but the $1.0650 area may cap the bounce. The big outside up day sterling enjoyed on Tuesday did not generate any follow through buying and the $1.26 cap held. It has been gradually unwinding the gains in the subsequent sessions and today's low near $1.2450 is a three-day low. A break of $1.24 would be ominous and suggest at least another two-decline. 

America

Another month-over-month rise in consumer prices boosts the risk that the year-over-year pace could tick up. Last May, the headline CPI rose by 0.7% and the core rate by 0.6%. The continued rise in gasoline, retail food prices, and shelter costs warns that of sticky prices. However, at the end of the day, the CPI is unlikely to alter views of investors or policymakers. Put simply, the Fed seems to have committed to a 50 bp hike next week and another in July. Officials have been a bit cagey as a whole about September, but the markets are not waiting for them. The Fed funds futures has more than a 90% chance of a 50 bp hike in September too. The first look at June's consumer confidence from the University of Michigan is also due. Sentiment has fallen in four of the past five months, and at 58.4, it is the lowest since 2011. While confidence has deteriorated, inflation expectations have stabilized. The one-year expectation was at 5.4% in March and April and eased to 5.3% in May. The 5-10-year expectation has been at 3.0% since beginning the year at 3.1%.

The May budget statement may be under-appreciated in the current context where monetary policy is center stage. The point is that the Fed could engineer the proverbial soft-landing if it were operating in a policy vacuum, but fiscal policy is also contracting dramatically. As we have noted, the budget deficit is expected to fall from 10.5% of GDP last year to less than 5% this year. In terms of dollar, it means that the budget has been in surplus by an average of $4.4 bln a month in the January-April period. Last year, it recorded an average monthly deficit of $340 bln. In 2019, the average deficit was $53 bln a month.

Canada reports May employment figures. Job growth is expected to have accelerated to 27.5k from 15.3k in April. In the first four months of the year, Canada has created 227k jobs compared with 142k in the same period last year. The unemployment rate fell to a new low of 5.2% in April. Before the pandemic it was 5.8%. At 65.3%, the participation rate slightly below where it was at the end of 2019. The takeaway is the Canadian jobs market is strong and the Bank of Canada will continue to hike rates. The swaps market has 50 bp hikes discounted in the next three meetings this year. There is about a 1-in-3 chance seen of a 75 bp hike in July. With so much already in the market, the Canadian dollar continues to appear sensitive to the general risk appetite, for which we use the S&P 500 as a proxy. That said, yesterday's sharp greenback advance (~1.1%, the biggest this year) coincided with a dramatic narrowing of the Canadian premium over the US on two-year money. The nearly eight basis point narrowing snapped a six-day widening move, but simply brought it back to almost where it settled last week (25 bp). 

The US dollar rallied strongly against the Canadian dollar yesterday. In fact, the 1.1% gain was the most in a session this year. The greenback's gains have been extended to CAD1.2730 today. It finished last week, slightly below CAD1.2600. There are $820 mln in CAD1.2750 options that expire today. With today's upticks, the US dollar is testing the (38.2%) retracement objective of the slide since May 12 high (~CAD1.3075). The next retracement objective (50%) is near CAD1.2800. Mexico's May CPI was a little firmer than expected, and although speculation of a 75 bp hike later this month remains intact, lost ground amid the risk-off mood. The US dollar is making new highs for the week today, near MXN19.75. The high for the month is near MXN19.77. A move above MXN19.82 could spur further dollar gains toward MXN19.95-MXN20.00. Note that Brazil's CPI was a little softer than expected and but the real also soften. It has fallen every session this week coming into today. The four-day streak is the longest decline in nearly three months. The next big technical target is BRL5.0.