The Weekly Close Out

Dollar Index (DXY):

Despite a solid start to the week in terms of US economic data – pending home sales beats (slide in mortgage rates in May) as well as durable goods orders outpacing expectations significantly the dollar was dragged lower. USD then flexed its muscles to turn around the direction of the ship, despite worse than expected consumer confidence, however, US CB 1-Year consumer inflation rate expectations for June jumped to record 8.0% from 7.5% in May. This begs the question, which duration of consumer inflation expectations matter more to Jerome Powell? Is it 5-10 years as seen in the UMich survey. So what was behind the strength? Treasury yields were only up a smidge. The sell-off in equities likely provided a boost. Another reason could have been that many flow models from investment banks points to dollar buying into month-end rebalancing.

We also received final Q1 US GDP numbers which were revised down to -1.6%, speaking of GDP on Thursday the Atlanta Fed GDPNOW forecasts Q2 growth of -1%, meaning the US is in a recession as June comes to an end. This and the cooling core PCE led to the US 10-year yield moving sharply lower and below the psychological threshold of 3%. The market is pricing in over 5bps of rate cuts between December 2022 and March 2023 too. Ironically, Jerome Powell on Wednesday during the panel discussion at Sintra said the US economy was in strong shape. The shine of US exceptionalism seems to be wearing off and that combined with expectations of rate cates is likely attracting sellers. Yesterday further saw the peak inflation narrative being fed as the Fed’s preferred inflation metric, core PCE, cooled on previous figures as well as coming in under expectations. Market based inflation expectations (breakevens) have rolled over significantly too, particularly the 5-year tenure. Initial jobless claims printed above expectations at 231k and the previous week’s figure was revised up from 229k to 233k. This trend is worrying for the health of the US economy. ISM manufacturing out later could be the final nail in the coffin as the weekend approaches. As the first half of the year ends here are some interesting stats I came across – 1) S&P 500 first-half plunge of 21%, worst since 1970 2) NASDAQ 100 finishes first half down 30%, most since 2002 3) The Dollar rose by just shy of 10% in H1 2022, best start since 2010.

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

DXY is having a go at the 105 round number after its sell-off yesterday. A breach of that could open up the 15 June high of 105.5. On the downside, the 21-day EMA could provide some support as well as the 103.5 level. The RSI above 60 supports an uptrend bias.

EURUSD:

Berenberg put out a research note on Monday forecasting a recession in the eurozone as Q3 and Q4 GDP growth contracts. They see this occurring as a result of Russia cutting off gas supplies to mainland Europe. EURUSD still had a relatively good Monday despite those fears about energy rationing as a result of a supply cut. We heard from ECB President Lagarde who confirmed she intends to raise rates by 25bps at the July meeting, but caveated this with if price pressures worsen rate increased could be accelerated to provide herself and the ECB flexibility. She further backed up this rationale at the panel discussion where she stated we need to wait for eurozone inflation numbers. Country specific numbers saw Spain with a red hot print of 10% and Germany disappointed with 8.2%, but this was due to lower fuel taxes and discounted public transport costs. Something else she said also caught my attention – unlikely to go back to an environment of low inflation. Now if that’s the case then surely the 2% target is outdated and needs to be adjusted for this structural change? Something to ponder on. Kazaks and other hawks want 50bps option to be left on the table in case of a deterioration in inflation to frontload the hikes.

There was a lot more noise about the PEPP reinvestments and anti-fragmentation tool. The first line of defence will be flexible PEPP reinvestments, which will be deployed from 1 July. The ECB plans to make a list of countries separated into recipients and donors for the reinvestment of PEPP proceeds. The recipients would include Italy, Spain, Portugal and Greece (PIGS) and the donors would comprise Germany, France, Netherlands, etc. good old ECB sources were on the wires again via Reuters. However, the PEPP reinvestments will not be allowed to engage in frontloading of purchases. Essentially, this is a timing issue, so if maturing bonds don’t align with when an intervention is required in peripheral spreads. In my opinion this is a weakness, but it could be as a result of the anti-fragmentation tool filling this gap. Reinvestments of maturing bonds will not be enough given the size of PEPP reinvestments and bond issuance supply.

The plan is to pair the new anti-frag tool with a deposit scheme, enticing banks to park cash at the ECB at more favourable interest rates than the ordinary rate. This would be done in order to keep the money supply constant and absorb excess liquidity (a term called sterilization). This seems to be preferred to selling core bonds to finance the purchases of periphery bonds as those local central banks of core bond nations would incur losses due to forced selling and it could have political implications (seen as quasi fiscal transfers from wealthy to poorer countries). OTM, the previous tool which was developed for fragmentation risk back in 2012 by the ECB was unlimited in size but had strict conditions attached, which would certainly be unpalatable to peripheral countries given the current economic backdrop. I do think a compromise of light touch conditionality could be reached and actually has to happen if the tool is to be free from legal challenges. Sources have told Reuters that this could come from the European Commission (provide fiscal rules/economic recommendations) or the ECB. Lagarde has already acknowledged that sufficient safeguards are required to preserve sound fiscal policy.

The other factors which need to be decided on are the size and duration of the anti-fragmentation tool, which according to sources is something the ECB is deliberating over. This could be dangerous for the ECB, because if the market is disappointed by the size and the time the programme will be operational then spreads could kneejerk higher. Maybe the ECB’s Wunsch is correct in his believe that the tool should be open-ended. Maybe just maybe then the ECB might be able to pull-off their goal by using the trusty tactic of jawboning. If not the market will certainly test their mettle.

German retail sales slightly beat expectations from a MoM perspective, while the unemployment rate ticked up 0.3% points. Many analysts point to this occurring as a result of Ukrainian refugees being absorbed into the labour market. Euro area wide unemployment dropped to 6.6%. Eurozone inflation came in hotter than expected at a headline level – 8.6% vs 8.4% exp, while core (excludes food and energy prices) disappointed at 3.7% vs 3.9% exp and previously 3.9%. The problem is that we have a divergence amongst eurozone nations with the periphery red hot such as Spain and Italy. Wouldn’t want to be the ECB.

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

EURUSD is finding resistance at the 1.048/1.05 level. If it can push above there then the next level to watch would be the 50-day SMA. On the downside, there is decent support at 1.035. The RSI is below 50, which means that a downtrend bias is usually in place.

GBPUSD:

The 2^nd reading of the NI Protocol Bill saw the UK Government win 295 to 221 (majority of 74). This means it now moves to the committee stage, where the bill will be scrutinized line-by-line and amendments will be considered. Additionally, the House of Lords (remainer heavy) will likely slow the passing of the bill down. PM Johnson wants the bill passed by year end. Sturgeon has confirmed the Scottish Lord Advocate will this afternoon refer to the UK Supreme Court to test the legality of the bill. Nicola Sturgeon has another Scottish Independence Referendum in her sights for October 19 2023. The UK supreme court will likely reject the legality of it and Westminster certainly won’t allow it. On Wednesday we did have BoE Governor Bailey speaking at the panel discussion. Bailey reiterated that they would act more forcefully should inflation persist and lead to 2^nd round effects. Wants to keep optionality of 50bps hike given there is still lots that can happen before the next meeting. He also added that one shouldn’t assume it’s the thing on the table. This must be referring to their plans around selling Gilts (QT), which we’ll get more information on at the August meeting.

We also heard from Swati Dhingra - hawkish MPC member Saunders new replacement. From her maiden appearance she seems very dovish. She is of the opinion that there is room for a very gradual approach when it comes to monetary tightening. In a nutshell she believes the UK economy is a basket case. She’s a trade expert and has been a vocal critic of Brexit, so I’m sure any negativity on that front will influence her psyche. Going back to Bailey, when asked on the exchange rate at the panel he replied that the BoE does not target the forex rate. Well maybe they should because although they can’t drill an oil well in Threadneedle Street, commodities are priced in dollars and a weaker sterling will only exacerbate the inflationary problem. The important question however, is whether markets would actually reward GBP for a more hawkish BoE or punish it due to inflaming the already very gloomy economic situation. Final GDP growth for Q1 was in line with expectations, but the current account deficit for Q1 was far higher than expected at £51.7bln vs £39.8bln expected.

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

Cable is getting hit hard as the week comes to an end. Below the 1.21 level and 74 pips from 1.20. The RSI at 37 provides more room for a deeper sell-off and shows a downtrend bias in place. If we see a pop higher and shorts run for cover, there is not much in the way of upside resistance until 1.23.

USDJPY:

The BOJ’s minutes continue to show the desire to maintain easy policy. The 50% threshold was officially crossed on Monday. The BOJ now holds just over 50% of the JGB market. June saw the largest monthly buying of JGBs ever – 14.8 trillion yen. The problem with this is that you begin to crowd out private investors and reduce liquidity. Also, the BOJ is exposed to substantial interest rate risk if rates were to snap higher. An ex BOJ official spoke about how the yield cap may need to be adjusted if inflation overshoots. This could be done with a wider band around the target rate. Japanese retail sales data for May increased by 0.6% MoM and the YoY figure was better than expected at 3.6%. However, consumer confidence fell from the previous month and came in below expectations. BoJ Governor Kuroda believes that inflation is likely to decline to around 1% from next year April. This is why he will keep policy easy. The BOJ are desperate to break the deflationary psychological affect embedded in the Japanese economy.

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

USDJPY is rolling over a bit given the lower yields. However, a lot of those gains have been retraced as we head into the weekend. There is decent support at 134.6 as well as the 21-day EMA, which has acted as a form of dynamic support. The RSI is showing some negative divergence, a potential sign that buyers are losing some steam pushing USDJPY higher.

Gold:

One of the policy decisions to come out of the G7 meeting is to ban the import of Russian gold. This saw the yellow metal pop higher into the open as the week got underway, but the sell-off in nominal rates and softer breakevens meant real rates were stronger and this weighed on gold. It really has been a tough week at the office for the yellow metal. Despite recessionary fears, a weaker dollar and falling real rates gold attracted selling pressure yesterday. The precious metal still trades at a substantial premium to where it should be priced off US 10-year real rates. If this premium was to unwind then look out below.

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

Gold sliced through the $1800 level like butter and the next stop below is $1775. The 50-day SMA looks is inches away from crossing below the 200-day SMA (death cross) and could change the psyche of gold market participants. On the upside, $1830 range resistance would be the area to monitor on any rallies.

Crude Oil:

Crude liked the news of a big push for a price cap on Russian oil and a deteriorating situation in Libya as well as Macron being overheard telling Joe Biden that the UAE and Saudi’s have very little additional spare production capacity. The UAE Energy Minister, later in a tweet admitted this was the case. This is clearly bullish for the oil price. Further easing of restriction in China spurred price to continue pushing higher through range resistance aided by Libya halting exports and issues in Ecuador. Additionally, Iranian Nuclear deal talks looked to have collapsed again with counterparties failing to agree. Late Thursday evening a senior US Official had this to say - prospects to revive 2015 Nuclear Deal ‘getting worse by the day’ and that Iran asked for things unrelated to Nuclear Deal, reopened settled issues. This turned around in the late afternoon session and price slipped below the $115 level as the dollar surged and recessionary fears ramped up. Also, a US envoy made some cryptic comments regarding a moves to step 2 of a supply boost from OPEC+. Official DOE US inventory data showed a drawdown of around 2.76mln in crude stocks, combining last week and this week’s data. Cushing storage levels are close to tank bottoms.

Yesterday, OPEC+ decided to keep the increase for August at 648k bpd. The next OPEC+ meeting is on August 3 where the group makes their decision for September. The group of nations has been pumping much less than their quotas. Macron could be right then about production capacity limits. The Shell CEO said as much this week too. During a speech Biden has said he’ll ask the Gulf alliance to boost their oil production when he travels to the region. I think recessionary fears of a slowdown were weighing on the demand side of the equation for crude on Thursday.

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

Crude is having a nice little bounce as the weekend approaches to push up against the 50-day SMA. The $115 range resistance as well as the 21-day EMA is the next level to navigate. The RSI has turned around and is just below 50. On the downside, $110 would likely see some form of support. A deeper sell-off could see $100 come into play.