Sterling Pounded Ahead of BOE Decision

  • The second wave infection narrative is gaining ground; the dollar has gotten some traction from building risks
  • Fed Chair Powell broke no new ground on his second day of testimony before Congress
  • Regional Fed manufacturing surveys for June will continue to roll out; weekly jobless claims will be reported; Brazil cut rates 75 bp last night, as expected
  • ECB allotted EUR1.31 trln in its latest TLTRO operation; BOE is expected to increase its asset purchases by GBP100 bln
  • SNB and Norges Bank kept rates steady, as expected; however, Norway delivered a hawkish hold
  • Antipodean data disappointed overnight; Indonesia cut rates 25 bp, as expected

Please see our new table at the end of this piece for a snapshot of the biggest movers of the day across asset classes.

The second wave infection narrative is gaining ground. Rising infection numbers in Beijing, increased hospitalizations in the US, and meatpacking workers contamination in Germany are all part of the negative virus news stream. Beijing’s case count has now increased to 150, leading authorities to restrict travel after having already shut schools. In the US, hospitalization rates have picked up notably in Texas, and we are getting some headlines of hospitals reaching capacity again. Europe is seeing the same slaughterhouse infections surge that took place in the US, with hundreds of workers confirmed to have been contaminated in Germany. However, the infection rate there continues to drop.

The dollar has gotten some traction from building risks. DXY had risen two straight days but is flat today just above 97. Whilst likely to gain from periodic bouts of risk-off sentiment, we believe it will be hard for the dollar to mount a significant comeback while the Fed is operating in dovish mode. The euro has steadied above the $1.12 area, while sterling is selling off ahead of the BOE decision and is trading at its lowest level since June 15 near $1.2480. USD/JPY traded at its lowest level since June 12 near 106.70 on risk-off sentiment but has since recovered back above 107.

AMERICAS

Fed Chair Powell broke no new ground on his second day of testimony before Congress. He said negative rates aren’t appropriate for the US, adding that Yield Curve Control is still being studied. He warned that Congressional support is critical at this time, and that the recovery will be delayed if state and local government layoffs continue. This is a clear signal to Congress to pass the next stimulus package aimed at supporting state and local governments. Mester and Daly speak today. Yesterday, Mester said the Fed needs more study on Yield Curve Control and she too stressed the need for more fiscal aid to states and municipalities. For now, Fed officials are singing from the same song sheet.

The regional Fed manufacturing surveys for June will continue to roll out. The Philly Fed survey is expected at -22.7 vs. -43.1 in May. Earlier this week, the Empire survey came in at -0.2 vs. -29.6 expected and -48.5 in May. These are the first snapshots for June and obviously welcome news. That said, recent China data underscore the man problem with reopening. That is, the factories may be up and running but consumers are not returning to normal spending patterns as long as the risk of infection remains. Still, the trend is positive here. May leading index (2.4% m/m expected) will also be reported.

Weekly jobless claims will be reported. Initial claims for the survey week containing the 12th of the month are expected at 1.29 mln vs. 1.542 mln last week. Continuing claims are expected at 19.85 bln vs. 20.929 last week. It seems continuing claims are giving a better picture of the labor market than the initial claims. Continuing claims fell -4.1 mln during last month’s survey week, which suggested that markets were being too pessimistic about May jobs data. Because continuing claims are reported with a one-week lag, we will have to wait until next week for the survey week containing the 12th of the month.

It’s early still but Bloomberg consensus sees a gain of 3 mln jobs in June, up from 2.509 mln in May. Unemployment is expected to fall to 12.3% from 13.3% in May, but the data have been rife with errors the past two months. Data will be reported July 2 and we will get more claims data before then to round out the picture. Still, markets would do well to remember Powell’s sobering outlook for the US labor market.

Brazil’s central bank cut rates 75 bp to a record low of 2.25%, as expected. It also left the door open for a final adjustment. By keeping the reference about inflation is “running below the level compatible with” its target over the forecast period, the BCB gave itself the degrees of freedom to enact a residual cut. We don’t have a clear call on whether this will materialize yet; it will depend on a host of variables from the fiscal outlook to the shape of the contagion curve in Brazil. As discussed in our Brazil Update, the local yield curve remains very steep, implying the risk of rate hikes early next year. We doubt this will happen, but we respect the risk premium given the lack of a solid fiscal anchor for the country. Local rates fell as much as 16 bp and the real appreciated slightly yesterday, the first day of gains after five consecutive sessions of heavy depreciation.

EUROPE/MIDDLE EAST/AFRICA

The ECB allotted EUR1.31 trln in its latest TLTRO operation. This amount was within expectations, with 742 banks taking part after the terms were sweetened in April. ECB official Schnabel noted that the operation added EUR548.5 bln of net new liquidity after repayment of earlier TLTROs were accounted for. The banks are being paid up to 100 bp to take up 3-year funding and boost loans to the real sector. We expect the ECB to increase its QE again this fall and is likely to offer more PELTROs and TLROs as needed.

Bank of England is expected to increase its asset purchases by GBP100 bln. Given how bad the data came in last week, we see risk of a dovish upside surprise. However, even if the BOE sticks to consensus, another top up is likely by the fall as the government will be issuing copious amounts of debt in the coming months. We do not see negative rates announced today or for the foreseeable future, while Yield Curve Control may be possible in H2 if yields start to rise. Please see our BOE Preview.

Swiss National Bank kept rates unchanged at -0.75%, as expected. The bank warned that it will intervene in the FX market “more strongly” as Governor Jordan again called the Swiss franc “highly valued.” New economic forecasts were issued, with the economy expected to contract -6% this year and deflation expected to persist through next year. Whilst Jordan said the bank is always looking for further policy steps if needed, we do not think the bank will go more negative and expect policymakers to continue focusing on the exchange rate with its ongoing intervention program.

The Norges Bank kept rates unchanged at 0.0%, as expected, but set a modestly hawkish tone. The statement made it clear that they do “not envisage making further policy rate cuts.” It also noted that “activity has picked up faster than expected,” substantiating their new expected policy rate path of rate hikes starting in 2022, earlier than the previous end-2023 guidance. The bank’s 2020 GDP forecast was revised to -3.5% from -5.2%. The krone is up 0.7% against the dollar, outpacing the mostly flat G7 FX landscape for the day.

ASIA

Antipodean data disappointed overnight. First, Australia reported weak May jobs data. Jobs fell -227.7k vs. -78.8k and a revised -607.4k (was -594.3k) in April. The unemployment rate rose to 7.1% vs. 6.9% expected and a revised 6.4% (was 6.2%) in April. As bad as these readings were, they would have been even worse if not for the government’s JobKeeper initiative that kept workers attached to their employers during the pandemic shutdown. Preliminary May retail sales will be reported Friday and is likely to come in very weak. Elsewhere, New Zealand reported weaker than expected Q1 GDP data. The economy contracted -1.6% q/q vs. -0.6% expected, driving the y/y down to -0.2% from 1.8% in Q4. Q2 is expected to be even worse, yet both central banks are currently on hold to gauge the impact of past fiscal and monetary stimulus.

Bank Indonesia cut rates by 25 bp to 4.25%, as expected. Governor Warjiyo was also quite explicit about the more easing to come, noting there is “room for lower interest rates in line with low inflationary pressure,” as long as external conditions remain permissive. Note CPI rose 2.2% y/y in May, the lowest since June 2000 and below the 2.5-4.5% target range. Furthermore, BI estimates June inflation will fall to 1.79% y/y. The bank also lowered its growth outlook to 0.9-1.9% this year, but then bouncing back to 5-6% in 2021.The rupiah is flat on the day but has been one of the top performing currencies of late, appreciating 5.5% over the last 30 days.