Fragile Stability

new conflict

  • The day began with equity losses in Asia before a sharp recovery, perhaps initiated in China
  • The ECB confab in Portugal draws interest today as the headline speakers include Draghi, Powell, Kuroda, and Lowe
  • The chief drama of the day is in the UK
  • Thailand central bank stood pat while Philippines hiked; no change expected from Brazil

The dollar is mostly firmer against the majors.  Aussie and Stockie are outperforming while the euro and Swissie are underperforming.  EM currencies are mixed.  ZAR and RUB are outperforming, while HUF and TRY are underperforming.  MSCI Asia Pacific was up 0.6%, with the Nikkei rising 1.2%.  MSCI EM is up 0.7% so far today, with the Shanghai Composite up 0.3%.  Euro Stoxx 600 is up 0.8% near midday, while US futures are pointing to a higher open.  The 10-year US yield is up 1 bp at 2.90%.  Commodity prices are mixed, with Brent oil up 0.6%, copper down 0.2%, and gold down 0.2%.

The day began with equity losses in Asia before a sharp recovery, perhaps initiated in China.  The MSCI Asia Pacific Index was up a little more than 0.5%.  The Shanghai Composite fell more than 1% before closing 0.25% better.  Market talk suggests retail accounts followed the so-called national team of the large state-owned banks, following comments by PBOC Governor Yi Gang that some took as a hint that another cut in reserves requirement could be forthcoming shortly.

Foreign investors returned to Korea for the first time in seven sessions.  Foreigners bought almost $241 mln of Korean shares today, after selling $1.43 bln since the start of last week.   The KOSPI was up 1% while the KOSDAQ was up 3%.  Foreign investors were not so keen about Taiwanese shares.  They were net sellers for the sixth session.  Over this period, they sold $1.88 bln.

The positive tone carried into Europe, and the Dow Jones Stoxx 500 has recouped yesterday’s loss, rising 0.7% in the morning, led by materials and consumer staples.  All industry sectors were moving higher.  The news stream is light.  The market is digesting Merkel and Macron’s proposals ahead of next week’s EU Summit.  While details are of course light at this stage, the general sense is that it provides for an evolutionary step toward greater integration, but falls short of the bold initiatives that Macron has previously presented.

At the same time, it is clear that Merkel needs something from Europe to help defend her from a domestic challenge on asylum seekers.  Merkel needs to take a tougher position on refugees and a more cooperative arrangement with Europe is essential.  The challenge is that under EU rules the first country that registers an asylum seeker is responsible for their welfare.  Geography dictates it is southern Europe–like Greece, Italy, and Malta, among the least that can afford it.

The ECB confab in Portugal draws interest today as the headline speakers include Draghi, Powell, Kuroda, and Lowe.  Some think Draghi broke new ground last week and are especially attentive for a fresh tell.  We suspect Draghi was as surprised by any by last week’s market reaction.  Draghi just laid out the ECB course and pre-committed to not raising interest rates for another year.  His caution, tempered by optimism in May, gave way to an optimism tempered by caution over the extended soft path.

The chief drama of the day is in the UK.  Around the time of the US equity open, the House of Common is expected to begin voting on the Withdrawal Bill again.  The key is the latest amendment by the House of Lords that gives parliament a “meaningful” vote on Brexit.  This issue is partly over the terms of Brexit and partly a constitutional issue about the power of parliament.  Even if May loses, it is not clear that the hardliners in the cabinet will challenge her.  A palace coup would not resolve anything and could delay negotiations further.

After the summit, the next one is not until October, when ostensibly an agreement is necessary so it can go through the approval channels.  Time is of the essence.  The EC continues to complain that the UK is ill-prepared.  Given the lack of substantial progress, the EC may urge members to step-up their contingency planning for a hard exit (no agreement).

The US economic calendar is light.  It features Q1 current account and existing home sales.  Existing home sales are expected to have recovered after the 2.5% fall in April.  The current account deficit is expected to be little changed from the $128 bln deficit recorded in Q418.  We share two observations.  First, the TIC data shows the portfolio investment inflows of almost $131 bln covered the current account deficit.  Second, the US current account deficit, driven by the trade balance, is most likely going to deteriorate.  The fiscal stimulus runs counter to the more aggressive trade position of the Trump Administration.

Turning to the US stock market, there has been an interesting pattern in the S&P 500.  For the past three sessions, the S&P 500 closed lower on the day but above the open.  This leads to bullish candlestick formations.  Yesterday the benchmark slipped below 2747.7, the 38.2% retracement of this month’s rally, but closed above it and on its highs.  A gap higher opening is possible today, setting the stage for another attempt on 2800.

The dollar itself is little changed.  The Australian dollar is the strongest of the majors, up a little less than 0.15% and the New Zealand dollar is the weakest, off 0.2%.  The euro is consolidating in the lower half of yesterday’s range.  So far it is the first session that the euro has not traded above $1.16.  There are very large options expiring tomorrow:  $1.1500-1.1525 houses 2.5 bln euro options.  $1.1550-1.1600 holds another 2.5 bln euro, and at $1.1625 there are an additional 2 bln euros.  The dollar continues to straddle the JPY110 level.  There is a $540 mln option struck there that expires today and $600 mln at JPY110.45.

Sterling is lower for the third session.  Today it has not been able to poke back through $1.32.   On the other hand, it has only marginally penetrated $1.3150.  Lastly, we note that the Canadian dollar is slipping to new lows for the year, with its fifth successive decline.  The odds of a rate hike next month have eased, but remain the odds on the most likely scenario.

Malaysia May CPI rose 1.8% y/y, as expected and up from 1.4% in April.  Bank Negara does not have an explicit inflation target.  However, low price pressures should allow it to remain on hold this year.  Next policy meeting is July 11, rates are likely to remain steady at 3.25%.

Bank of Thailand kept rates steady at 1.5%, as expected.  It raised the growth forecasts to 4.4% from 4.1% for 2018 and to 4.2% from 4.1% for 2019.  BOT also raised its 2018 inflation forecast to 1.1% from 1.0%.  CPI rose 1.5% y/y in May, the highest since January 2017 but still near the bottom of the 1-4% target range.  One senior bank official said it is more focused on local factors than on external ones such as the Fed.  Showing no urgency to tighten, we see steady rates this year.

South Africa May CPI rose 4.4% y/y vs. 4.6% expected and down from 4.5% in April.  Inflation has moved back into the bottom half of the 3-6% target range.  Next policy meeting is July 19, rates are likely to remain steady at 6.5%.  Q1 current account data will be reported Thursday, and the deficit is expected to widen to -4.0% of GDP from -2.9% in Q4.

Philippine central bank hiked rates 25 bp to 3.5%, as expected.  It also cuts its 2018 and 2019 inflation forecasts both by a tick to 4.5% and 3.3%, respectively.  CPI rose 4.6% y/y in May, well above the 2-4% target range.  The bank started the tightening cycle with a 25 bp hike last month, and so this is the second move.  Governor Espenilla said the bank is prepared to take further action, and we expect it to continue tightening in H2.

Brazil COPOM is expected to keep rates steady at 6.5%.  We are shocked to find that of the 48 analysts polled by Bloomberg, only 1 sees a 50 bp hike in Brazil to 7.0% with the rest seeing no hike.  The central bank’s massive FX swaps intervention needs to be backed up with higher rates, or else BCB is just throwing good money after bad.  We believe no rate hike would be a disaster for Brazil assets.