Firm US Rates Underpin Greenback

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  • The Five Star Movement and the League are getting closer to forming a government
  • There are three noteworthy economic reports from Europe today: French wages, German GDP, and UK jobs
  • The US reports April retail sales and May Empire State Manufacturing Survey; Canada reports April existing home sales
  • Several Federal Reserve speakers are also in focus
  • Israel April CPI is expected to rise 0.4% y/y
  • Argentina April CPI is expected to remain steady around 25.4% y/y; it will try to roll over $29 bln in notes under less-than-ideal conditions

The dollar is mostly firmer against the majors as US rates continue to rise. Swissie and Kiwi are outperforming, while the yen and Stockie are underperforming. EM currencies are broadly weaker. RON and SGD are outperforming, while ZAR and INR are underperforming. MSCI Asia Pacific was down 0.8%, with the Nikkei falling 0.2%. MSCI EM is down 1.1% so far today, with the Shanghai Composite rising 0.6%. Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open. The 10-year US yield is up 1 bp at 3.01%. Commodity prices are mixed, with Brent oil up 0.8%, copper down 0.4%, and gold down 0.3%.

US 10-year rates are again probing the air above 3%, and this is encouraging a push back toward JPY110, with the euro slipping towards $1.19. Asian equities fell, with the MSCI Asia Pacific shedding 0.8%, the most in nearly a month. It snapped a three-day advance.

China and India were able to buck the regional move. China’s economic data was mostly softer than expected and is consistent with a gradual turn in the cycle as the Lunar New effect fades. Retail sales rose 9.4% y/y, matching the slowest past since 2004. Urban fixed investment also slowed more than expected. The 7% y/y pace is down from 7.5% in March and is the slowest pace since 2000. Industrial output did surprise to the upside, rising 7% y/y and up from 6.0% in March.

For its part, India reported higher than expected April inflation yesterday. Wholesale prices rose 3.18% y/y, up from 2.47% in March. A rise to 2.90% had been expected. CPI rose 4.58% y/y from 4.28%.

Turing to Europe, the Five Star Movement and the League are getting closer to forming a government. The combination of a flat 15% and 20% tax rate coupled with new benefits for the poor (unemployment insurance or what is dubbed a universal basic income for unemployed/poor) could challenge the EU fiscal rules, but there is little impact on Italian assets. The 10-year bond yield is off a basis point today and is the strongest bond market among the high-income countries today. The two-year yield is off a basis point as well. The premium over Germany has narrowed. And the signal from the equity market is similar. Italian equities are up about 0.3% near midday in Milan. The Dow Jones Stoxx 600 is off fractionally after slipping yesterday too.

There are three noteworthy economic reports from Europe today. First, French wages growth accelerated in Q1 to 0.7% from 0.2% in Q4 17. It is the strongest pace since 2013. It follows on the heels of the settlement of the construction sector negotiations in Germany, which also saw an above-inflation settlement like the public sector and metal workers. This will encourage the ECB to look past the near-term softness in the regional CPI.

The second development was disappointment from Germany. The initial estimate for Q1 GDP was revised to 0.3% from 0.4%. The economy grew 0.6% in Q4 17. Of note, government spending fell for the first time in five years. A critical issue is whether the slowdown is a mid-cycle pause or the cyclical peak. We tend to favor the latter, but recognize that the weakness in Q1 was exaggerated. Investors will be watching the incoming data with this issue in mind.

Today’s ZEW survey suggests little improvement is being seen in Q2. The assessment of the current situation slipped to 87.4 from 87.9. The pullback was not as large as expected, but the direction is clear. It has fallen every month since January, but it remains at elevated levels. Consider that last year’s average was 84.1, and the average in Q4 was 88.4 and in Q1 18 the average was 92.7. However, perhaps more to the point, the expectations component remained at -8.2, the weakest expectations in six years.

The third economic important economic data point was the UK jobs report. The claimant count rose 31.2k while the March rise was upgraded to 15.7k from 11.6k. This was a bit more than expected. However, the 3m/3m employment change (through March) was stronger than expected at 197k, up from 55k. The ILO unemployment rate was steady at 4.2%. Weekly earnings growth matched expectations. The overall measure slowed to 2.6% from 2.8%, while excluding bonus payments, the underlying measure edged up to 2.9 from 2.8%. The fact that tightness of the labor market is boosting earnings growth above the pace of inflation will likely keep a rate hike on the table even if it is pushed out into H2 18.

The North American session is also busy. The US reports April retail sales and the May Empire State Manufacturing Survey. Headline retail sales are expected to be halved from the 0.6% m/m pace in March. That, however, may be a misleading optic. The details should be healthier, and the components used for GDP calculations is expected to remain at a firm 0.4%. We suspect the risk is to the downside. The Empire State Survey is one of the first metrics for May, and a modest slowing is expected (15.0 vs. 15.8). After softening in January and February, the survey snapped back in March but eased back to Jan-Feb levels in April.

Several Federal Reserve speakers are also in focus. Kaplan speaks for the market open, and the soon-to-be NY Fed President William speaks shortly after midday. The testimony of Fed nominees Clarida and Bowen continue before the Senate. Note that Bernanke and Fischer formally endorsed Clarida.

Canada reports April existing home sales. Sales declined sharply in January and February (-14.5% and -6.5% respectively). The stabilized in March, rising 1.3%, but may have slowed in April.

Option expiry may also impact activity in the North American morning. This includes nearly two billion euros in options struck between $1.1940-1.1950, and another 1.3 bln euros struck between $1.1990-1.2000. There is an option at JPY110 for almost $900 mln and between JPY109.50-JPY109.55 for another $620 mln. An option struck at $1.35 is good for almost GBP450 mln. The Australian dollar options struck at $0.7500 continue to expire. Today there is A$1.7 bln that will be cut. The Aussie remains pinned just above there after the RBA minutes failed to excite.

Israel April CPI is expected to rise 0.4% y/y vs. 0.2% in March. If so, inflation would be the highest since December, though still well below the 1-3% target range. Next Bank of Israel policy meeting is May 28, no change is expected then. Israel reports Q1 GDP Wednesday, which is expected to grow 3.8% SAAR vs. 4.1% in Q4. Yet politics is likely to trump economics near-term, as deadly protests over the opening of the US embassy in Jerusalem are likely to continue.

Argentina April CPI is expected to remain steady around 25.4% y/y. If so, inflation remains well above the 12-17% target range. The central bank was wrong to cut rates in January, which is one of the major reasons that investor sentiment soured on Argentina. The bank was forced to reverse course and hike rates in recent weeks to the current 40%. These are not the ideal conditions to roll over $29 bln in notes, but that is what will happen today. The central bank has been buying local debt this week to prevent a huge spike in rates, but we suspect rates will still rise sharply at the auction.

The rise in USD/ARS yesterday was halted at 25, which is where the central bank reportedly offered to buy $5 bln worth of pesos. The bank reportedly sold $408 mln Monday. Once that $5 bln is exhausted, we assume that the pair will resume its rise towards the next line in the sand. The plunging peso warns of a spike in May inflation, and so the bank will likely need to hike rates again. We still regard an IMF standby agreement as a necessary but not sufficient condition to stabilizing Argentine markets. Talks are progressing, but Argentina does not have the luxury of time.