Corrective Forces Grip Markets

The light news stream is spurring position squaring by short-term momentum traders and the dollar’s firmer tone suggests confidence that the Fed will indeed raise rates.  We also discuss the minutes from the recent BOJ and RBA meetings and what to expect from the latest survey on Brazil’s government approval ratings.

  • The light news stream has spurred some position squaring by short-term momentum traders
  • The general narrative of the dollar’s firmer tone is that the market feels more confident that the Fed will raise rates this year is not yet fully priced in
  • We discuss the minutes from the recent Bank of Japan and Reserve Bank of Australia meetings
  • At 10:30am local time, a polling institute in Brazil will release the results of its latest survey on the government’s approval rating – it’s likely to be grim

Price action:  The dollar is mostly softer against the majors, with Kiwi outperforming for the second straight day.  The Scandies and sterling are underperforming.  The euro is little changed, trading right around $1.0850 after earlier making a new marginal low for the cycle.  Sterling is trading softer at around $1.5550, while dollar/yen is stuck near 124.30.  EM currencies are mostly firmer, with the CEE currencies outperforming.  KRW and TWD are underperforming.  MSCI Asia Pacific rose 0.5%, as Japan markets reopened and the Nikkei rose nearly 1%.  The Shanghai Composite posted a 0.6% gain, while the Shenzhen Composite rose 1.6%.  Nearly 20% of Chinese stocks are still not trading.  The Greek stock market still remains closed despite banks re-opening.  MSCI EM is up 0.4%.  Euro Stoxx 600 is down 0.1% near midday, while S&P futures are pointing to a lower open.  The US 10-year yield is flat at 2.37%, while European bond markets are mostly firmer.  Gold is stabilizing just above support 1100, but further losses seem likely.  WTI oil is down 0.3%, falling for the fifth straight day.

  • The light news stream has spurred some position squaring by short-term momentum traders.  This is giving the dollar a somewhat heavier tone, and there have been some losses in equity markets.  European bonds and Treasuries are little changed, though slightly firmer.
  • The general narrative of the dollar’s firmer tone is that the market feels more confident that the Fed will raise rates this year.  We have sketched out a similar view, yet it is important to recognize that this is not fully reflected in market pricing.  Specifically, the healthy June employment report in early July coupled with Yellen’s remarks have produced a net 1.5 bp increase in the implied yield of the September Fed funds contract since the end of June.  It now implies an 18 bp effective Fed funds rate in September.  That is a 5 bp increase from the current average of 13 bp.
  • The FOMC dot plot shows a slight majority of members saw scope for two hikes this year, which seems to imply a September hike.  The recent Wall Street Survey found over 80% of economists expected a hike then.  Yesterday, the Fed’s Bullard suggested a 50/50 chance of a September hike.  The pricing in the futures market suggests the market is still not convinced.
  • Next week’s FOMC statement may show the economy is evolving in line with Fed expectations.  The first look at Q2 GDP will also confirm a modest recovery after the stagnation in the first quarter.  There are still two employment reports the FOMC will see before making the decision in September.
  • Minutes from the recent Bank of Japan and Reserve Bank of Australia meetings were released.  There is an important take-away from each.  From the BOJ, the key point is that officials are still voicing confidence that inflation is trending in the right direction.  This, especially in the context of the recent downward revision in the central bank’s multi-year inflation forecasts, suggests that there is no urgency about easing further.  Many economists expect the low inflation to prompt the BOJ into expanding its asset purchases.  These expectations, originally for mid-2015, have been pushed into the second half of the fiscal year (beginning in October).  But even this seems somewhat less likely.
  • The RBA’s minutes were slightly dovish.  It did not rule out a further rate cut but did not signal that investors should expect it next month.  It did recognize that growth in Q2 likely slowed sequentially.  The RBA underscored the importance of the upcoming data.  Tomorrow, Australia reports Q2 CPI and RBA Governor Stevens speaks.
  • The Reserve Bank of New Zealand is expected to cut the official cash rate 25 bp to 3.0%.  It is expected to signal scope for additional rate cuts.  After talking the Kiwi lower, recent comments have noted the speed of its decline.  That, and the suggestion that milk prices will rebound, have helped spur a bounce in the currency.  It is nearly 2% off the lows seen yesterday to trade near $0.6620.  We suspect that that as it nears $0.6700, sellers will re-emerge.
  • Asian equities followed the US advance.  The MSCI Asia-Pacific Index gained about 0.5%.  The Nikkei’s advance stretched into its eighth consecutive session.  Chinese stocks were higher, with the Shanghai Composite up 0.6% and the Shenzhen Composite up 1.6%.  It is the fourth session that the Shanghai market has advanced.  It closed above the 4000 level for the first time since July 1.  Companies continue to re-open trading in their shares.  Some 543 companies were still suspended, about 5% fewer than yesterday.  This represents about 19% of all listings.
  • European shares are narrowly mixed.  What is at stake is the nine-session advancing streak in the France’s CAC.  This appears to be among the largest advancing streaks in its history.  It has risen almost 13% over this period to test a two-month high.  Over the same period, the German DAX is up 10.6%.
  • The corrective pressures in the foreign exchange market can persist a bit longer.  Above yesterday’s $1.0870 euro high lies the $1.0900-10 cap.  If this is not sufficient to check the short-covering rally, there is technical scope for another half cent or so advance.  While the Nikkei has been rallying, the dollar has been recording higher highs against the yen.  Today is the eighth consecutive session to see this.  The greenback edged higher to almost JPY124.50 and remains poised to retest it.  Sterling is in less than half a cent range inside yesterday’s price action.  A break of $1.5540 could see slippage toward $1.55 were better bids likely lurk.
  • At 10:30am local time, a polling institute in Brazil will release the results of its latest survey on the government’s approval rating.  This will obviously be another blow to the government which is already struggling.  Aside from the ailing economy, the ruling coalition is fracturing and the PT is seeing its most important figure, former president Lula, dragged into the corruption scandal.  To top it off, the recent fall in oil prices has knocked the price of the Bovespa’s most important company, Petrobras, down 22% since the June high (looking at the US ADR price).  USD/BRL is trending higher, but still some distance away from the 3.3148 high in March.  And comparatively, BRL has been holding up well compared with COP and MXN, both of which underperformed over the last month and are making new highs.
  • Hungary central bank meets and is expected to cut rates 10 bp to 1.40%.  A small handful of analysts look for a 15 bp cut to 1.35%.  Central bank minutes from the June meeting showed a 8-0 vote to cut rates 15 bp to 1.50%, but one MPC member wanted to end the easing cycle right then.  All 8 also voted to change the forward guidance to further “slight” easing.  We think after this meeting, there will be a pause.  The real sector data have been quite robust, so the need for more cuts is limited.  CPI rose 0.6% y/y in June, the highest rate since November 2013.  Low base effects should see the y/y rate explode in H2, and it could approach the 3% target.