Dollar Mixed Ahead of US Inflation Data

  • US rates markets continue to reflect lower recession odds
  • President Trump threatened tariffs on China if President Xi did not meet with him at G20
  • China eased restrictions on how local governments can spend money; PBOC fixed CNY firmer than expected
  • During the North American session, the US reports May PPI
  • UK reported mixed labor market data; Norway reported lower than expected May CPI
  • South Africa April manufacturing production is expected at 1.3% y/y; political risk is rising in Brazil; Mexico April IP is expected at -2.2% y/y

The dollar is mixed against the majors ahead of US PPI data. Sterling and Nokkie are outperforming, while Kiwi and yen are underperforming. EM currencies are mostly firmer. PHP and ZAR are outperforming, while TRY and HUF are underperforming. MSCI Asia Pacific was up 0.7%, with the Nikkei rising 0.3%. MSCI EM is up 0.6% so far today, with the Shanghai Composite rising 2.6%. Euro Stoxx 600 is up 0.9% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 2 bp at 2.17%, while the 3-month to 10-year spread rose 5 bp and stands at -8 bp. Commodity prices are mixed, with Brent oil up 0.1%, copper up 0.8%, and gold down 0.4%.

US rates markets continue to reflect lower recession odds. The 3-month to 10-year curve is now at -8 bp, the least negative since May 28 and less than a third of the peak -25 bp inversion on June 3. The 10-year yield of 2.17% is the highest since May 31. US inflation data will be key in determining if the inversion continues to ebb. We remain constructive on the US economy, and this underpins are bullish equity and dollar calls as well as our bearish bond call.

Yesterday, President Trump threatened tariffs on China if President Xi did not meet with him at this month’s G20 meeting in Osaka. This comes even as details of the US-Mexico deal remain murky, supporting our view that trade tensions are unlikely to disappear. Japan and Europe remain in the US cross-hairs later this year with the auto tariff deadline in November. This backdrop remains very negative for EM.

China eased restrictions on how local governments can spend money raised by issuing so-called special bonds. The Ministry of Finance said it would allow a portion of those funds to be used as capital for qualified major infrastructure projects. The special bond quota was raised this year to a record CNY2.15 trln ($311 bln), and so the moves suggest a growing reliance on infrastructure spending to offset the headwinds from the trade war.

Elsewhere, PBOC fixed CNY firmer than expected. It also announced a bill sale in Hong Kong this month that would mop up some offshore liquidity and lend support to CNH. While policymakers will lend the yuan support, we do not see a full-throated defense of the 7 level like others claim. The yuan will mostly trade along with wider EM FX, with some days of outperformance due to official measures of support.

During the North American session, the US reports May PPI. Headline inflation is expected at 2.0% y/y and core at 2.3% y/y. May CPI will be reported Wednesday, with headline expected a tick lower at 1.9% y/y and core steady at 2.1% y/y. With the media embargo in effect ahead of the June 19 FOMC, there are no Fed speakers until Powell’s post-decision press conference.

UK reported mixed labor market data. Average weekly earnings came in a tick higher than expected at 3.1% y/y in April, while employment rose 32k vs. 4k expected. However, May jobless claims rose 23.2k. Yesterday, April GDP, IP, trade, and construction output all came in weak. Last week’s PMI readings for May confirmed our view that the UK economy will continue to weaken into the October 1 Brexit deadline.

Sterling is seeing a small bounce today. We remain negative on sterling and expect it to soon retest the May 31 low near $1.2560 on the way to the January low near $1.2440. EUR/GBP is leading this move, making new highs this month and on track to test the January high near .91085.

Norway reported lower than expected May CPI. Headline inflation was 2.5% y/y vs. 2.9% and the lowest since May 2018, while underlying inflation was 2.3% y/y s. 2.6% expected. Norges Bank next meets June 20. It last hiked 25 bp to 1.0% back in March. It signaled that a June hike was likely, as well as another hike before year-end. However, the CPI data makes a hike this month difficult and we think it’s a very close call. Lower oil prices this past month may be the deciding factor and lead to no hike next week. Next meeting after this one is August 15.

South Africa April manufacturing production is expected to rise 1.3% y/y vs. 1.2% in March. April retail sales will be reported Wednesday, which are expected to rise 1.2% y/y vs. 0.2% in March. The economy remains weak and we think the central bank is moving towards a rate cut in H2. Next policy meeting is July 18 and a 25 bp cut is possible then. Much will depend on how the rand is trading then.

Political risk is rising in Brazil. Leaked messages from the Car Wash investigation have led to growing calls for Justice Minister Moro to step down. Opposition lawmaker said they would not vote on pension reforms until the Moro matter has been resolved. Even the government-allied head of the special lower house committee discussing pension reform said Moro should step down. So far, President Bolsonaro has not commented on the matter.

Mexico April IP is expected to contract -2.2% y/y vs. -0.1% in March. While the tariff risk has ended (for now), the economy had already been slowing and a recession remains a distinct possibility. Yet Banco de Mexico cannot cut rates anytime soon due to the vulnerable peso. Next policy meeting is June 27, no change is expected then.