The Weekly Close Out

Dollar Index (DXY):

With lighter volumes due to the holiday state side, the better risk sentiment in equity futures saw the dollar offered as high beta currencies attracted flows. This theme continued into Tuesday’s morning session with the dollar slipping further. US existing home sales declined by 3.4% less than expected (3.7%). It is still the 4^th consecutive monthly decline. However, this data was recorded prior to the surge in mortgage rates, implying a gloomy outlook as summer approaches. A toxic combination of low inventory and higher borrowing costs is clouding the US housing market. The weakness in the yen dragged the DXY up into Tuesday’s close, however, against other major G10 crosses the dollar was the loser. Continuing with the housing data, mortgage applications declined again from 6.6% to 4.2% as the 30-year mortgage rate moved up to just shy of 6%.

The market was barraged with a cacophony of FOMC speakers on Wednesday. Known hawk Harker, gave us an idea of what a hard landing would be – jobless rates much above 4%. The latest SEP forecast out from the Fed predicts 4.1% in 2024. Powell’s testimony had some interesting content in it. He reiterated the Fed’s strong commitment to returning inflation to 2%. This is where I believe he was hawkish - when asked about a 100bps hike, his reply was ambiguous, stating he’ll never take anything off the table and that market pricing for additional hikes is appropriate (190bps by Dec 2022). However, simultaneously he noted that there’s a possibility their rate rises could cause a recession and that their goal of a soft landing is going to be very challenging.

The only reasons I can think of as to why the dollar was weaker on Wednesday, despite all the talk about recession is that this led to an aggressive repricing of the Fed’s rate path (cuts being priced in) and thoughts of QE being started again. Declining US yields don’t help either. Additionally, the US exceptionalism narrative likely was dented too. Initial jobless claims came in just shy of 230k vs 227k expected. Slight dip on last month’s now higher revised number, but the trend should remain up as layoffs begin to bite. With the US expected to be the cleanest dirty shirt, boy did it disappoint with the PMI numbers released yesterday – misses on expectations and significant declines on previous month’s numbers. Just like Europe, the reopening bounce we saw is reversing rapidly as the cost of living crisis and tighter financial conditions squeeze the consumer. Business confidence has slumped lower to levels associated with recession. The offshoots of this have been much slower growth in payrolls and disinflation. Are we seeing the worst of inflation behind us?

Terminal rates have been adjusting to this new environment of lower breakevens and growth fears. The peak in rates is now at 3.4% by March 2023 vs 4% for June 2023 from last week. 185bps are priced through to December 2022 with four meetings left.

(Source: TradingView - Past performance is not indicative of future performance.)

DXY remains in a tight mini triangle structure. This forewarns of a breakout in either direction. Price is also for the time being above its shorter term moving average (21-day EMA). The RSI is right on the halfway line around the 50 mark. Levels to keep an eye on are – 105 on the upside and 103.160 on the downside (16 June low).

EURUSD:

The void for markets was filled with Central Bank speakers. The ECB’s Kazaks gave some guidance (already priced by the market) stating he would support a 25bps move in July and then 50bps in September. President Lagarde remains optimistic about the eurozone’s economic prospects with a recession not the baseline scenario. She also provided rate guidance, but was more vague about the September meeting to provide flexibility. On the topic of fragmentation risks Lagarde sent a strong message to bond vigilantes not to challenge the ECB as she stated anybody who doubts their determination will be making a big mistake. The ECB’s Villeroy channelled his inner Draghi by informing market participants that the new instrument should be available as much as necessary to make our no-limits commitment to protect the euro very clear. ECB Chief Economist Lane, spoke late on Monday evening and stated that the rate hike increment for September is still undecided. Germany’s largest trade union, IG Metall is gunning for a 7-8% wage rise for its members. This could influence the demands of other unions.

The ECB’s Rehn and Kazimir continued to pepper the market with forward guidance with both saying that it’s likely to see a 50bps hike at the September meeting. The market is already priced for this, so no surprises on that front. News for the eurozone was quiet on Wednesday with the only significant data release being the consumer confidence print, which disappointed with -23.6 vs -20.5 forecasted. Flash PMIs out from Germany and the Eurozone on Thursday painted an ominous economic picture with below expectations prints. The main takeaways were 1) economic growth is slowing as the reopening and pent up demand from the pandemic fades 2) declining business and consumer confidence 3) price pressures remain elevated, however, there are signs of disinflation beginning to creep in as firms struggle to pass on higher costs to consumers (inflation peaking?) 4) lower demand, business confidence and production capacity has led to a reassessment of labour demand required by companies.

This led to a major drop in German 10-year yields (21bps) and 2-year yields were down over 24bps intra-day. These are crazy moves! The BTP-Bund spread widened a smidge on the news that the ECB's PEPP reinvestment flexibility tool isn't yet operational. German Ifo data was disappointing, particularly the expectations segment. 150bps are priced in over the next four meetings through to the end of the year. The terminal rate for the ECB has fallen from 2.6% for September 2023 to 1.8% in July 2023.

(Source: TradingView - Past performance is not indicative of future performance.)

Starting to think we could see a double bottom pattern emerging on EURUSD (bullish). Price remains below the 50-day SMA and 21-day EMA. 1.06 is a key resistance level on the upside with the 50-day SMA just below there. On the downside, there is support around 1.048. The RSI again, similarly to DXY isn’t providing too much information.

GBPUSD:

Hawkish dissenter Catherine Mann was on the wires as the week got underway. The main takeaways from her speech revolved around the impact of imported inflation through a weaker currency. 50bps and bigger rate hikes were tossed around as the remedy to a weakening pound. Additionally, she was in favour of aggressive front loaded hikes to apply downward pressure on inflation and then cuts which would weaken the pound and boost the economy via exports. Tuesday saw the beginning of the most severe rail strikes in 30 years. If this spills over to other industries, UK GDP could take a hit. In more positive news, the survey data from the Confederation of British Industry indicates that companies expectations for selling prices over the next 3-month period dropped to 58% vs 75%. A softening in price pressures will be welcomed with open arms by the BoE. We also had the BoE’s Chief Economist Pill on the wires who reiterated that the bank stands ready to act if there’s persistent evidence of price pressures. Unlike Catherine Mann, Pill, believes using monetary policy to stabilise FX rates in the short-term would distract from goals. Why can’t both be achieved? A stronger pound would lower imported costs of energy, etc. Pill also confirmed his priority remains inflation above growth. He’s also willing to sacrifice growth to bring down inflation.

UK inflation printed the highest since 1982 with headline at 9.1% YoY in line with expectations, however, core both on a YoY and MoM basis came in lower than expected as well as the previous months’ figure. Although the peak will only likely come after the Ofgem price rise in October, this is positive news when viewed in combination with the CBI data above. The broadness of the price pressures also declined. The culprits driving the price rise was food, non-alcoholic beverages, energy and second-hand cars. This led to markets pricing out the 3x50bps hikes by the BoE by November (only a smidge).

The UK flash PMIs bucked the trend with European mainland. Although, manufacturing was similarly weak, services was robust as the Platinum Jubilee saw a bit of a loosening of consumers’ purse strings as well as the recent relief package announced by government. Growth was more resilient, however, business confidence has fallen significantly, which typically signals an imminent recession according to the Chief Economist from S&P Global Market Intelligence. Job creation continues to accelerate and inflation remains elevated, but there are signs of cooling present.

GfK consumer confidence printed at -41, the lowest since records began 50-years ago (lower consumer spending likely result). Retail sales MoM fell less than expected, driven by food store sales, which declined by 1.6%. April’s figure was revised down significantly from 1.4% to 0.4%. On the political front, Johnson, lost the two by-elections as predicted. The shock surprise was the resignation of the party Chairman, Oliver Dowden. A cabinet minister resignation is never a good thing and we’ll have to see if others follow suit such as Chancellor Rishi Sunak. However, there are two factors potentially distorting the results. Both incumbent Tory MPs were involved in scandals and midterm governments also don’t win by-elections.

160bps of hikes are priced through to the end of the year with four meetings remaining. The peak in BoE rates is now sitting at 3% for May 2023 vs 3.6% for August 2023 previously.

(Source: TradingView - Past performance is not indicative of future performance.)

Despite all the negativity, GBPUSD is putting in a decent finish into the weekend. Price is still below the 21-day EMA. The RSI is in no man’s land. Price levels to watch are 1.22 on the downside and 1.24 on the upside.

USDJPY:

USDJPY has cleared 136 and is now back to levels last seen in October 1998. The BOJ now has an ownership of just shy of 50% of JGBs. I think they’ll be forced to change tack as the pressure on the yen causes too much pain. The options at the BOJ’s disposal is to 1) Let’s start with the most basic and bullish for the yen - scrap YCC in its entirety. 2) Widen band around YCC target (currently is -0.25% and 0.25%) 3) Raise actual yield target outright instead of widening of bands 4) Target a different maturity, belly of the curve, say 5-year or 7-year vs the current 10-year yield 5) Sit on their hands and do nothing, hoping FX intervention from the MOF will solve their problems (USDJPY would need to move above 140 at least). Will it be enough though as the bulk of the yen’s move has been down to policy divergence and keeping YCC in place will not change that. Governor Kuroda remains steadfast in his approach to keep policy loose as he sees this as the chance for Japan to finally break out of its deflationary spiral.

The yen is loving the recession, peak rates and inflation narratives swirling around markets on Thursday. Japanese inflation out overnight printed in line with expectations. The metric closely watched by the BOJ printed at 0.8% YoY.

(Source: TradingView - Past performance is not indicative of future performance.)

USDJPY is forming a doji candle as the weekend approaches and after the big bearish candle from yesterday. The RSI is just above 60, providing plenty room for another push higher. 134 on the downside shows some floor for price and for the bulls a push above 135.5 into the former high would be positive.

Gold:

The yellow metal remains unexciting as price trades in a very narrow range around its 200-day SMA, despite a slightly softer dollar and lower real yields. Despite crude really coming off on Wednesday, pulling breakeven rates down with it, yields fell faster allowing real yields to decline. This is gold’s best friend, combined with a softer dollar and talk of recession. A stronger dollar and flat S&P500 sent gold lower yesterday. Price is just below the key $1830 level and the 200-day SMA. The RSI’s position isn’t particularly informative. On the downside $1800 remains important and on the upside $1850.

(Source: TradingView - Past performance is not indicative of future performance.)

Crude Oil:

Risk sentiment fairing better and a weaker dollar has helped the black liquid push higher off its 50-day SMA. There is talk of a price cap being imposed on Russian oil, but the EU don’t seem too keen on this prospect. The demand equation for oil remains strong as China reopens, summer travel moves into full swing and hotter weather requires more energy for cooling. Wednesday was a bloodbath for crude, falling $8 a barrel at one stage. Various narratives are swirling around the market 1) risk-off/recession fears leading to demand destruction 2) deleveraging by CTA and momentum players after price sliced through the 50-day SMA 3) trimming positions before Biden’s announcement around oil. Looks like a positioning flush out took place and longs have been reloaded to claw back some gains. API data showed a significant build in crude inventory, while official figures from the EIA won’t be published this week. Despite the growth fears, crude looks to be closing stronger into the weekend.

(Source: TradingView - Past performance is not indicative of future performance.)

Crude is back in its range between $115 and $100, subdued below its 50-day SMA. The RSI has begun to curl up from just above oversold territory. $105 provides some support for bulls and to the upside $115 and the 50-day SMA will be important levels of resistance.