Yuan Slump Continues while Hawkish ECB Comments Lift the Euro

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Yuan Slump Continues while Hawkish ECB Comments Lift the Euro

Overview: ECB comments suggesting a rate hike as early as July may be gaining momentum and is helping extend the euro's gains to an eight-day high near $1.0935.  In turn, it is buoying the central European currencies.  The greenback is heavier against most of the major currencies, though after a bout of profit-taking yesterday, it is enjoying a firmer tone against the yen.  The Chinese yuan's drop has extended for a third session.  Chinese President Xi defended the Covid policy seemingly over economic support, and this continued to weigh on Chinese stocks.  The CSI 300 is off for the fifth session and set to drop for the eighth week of the past nine.  The large Asia Pacific markets outside of China, Hong Kong, and Taiwan advanced.  Australian stocks extended their rally for a fifth session to reach record highs.  European shares are extending yesterday's gains, and US futures are around 0.5%-1.2% better.  Ten-year benchmark yields in the US and Europe are 2-5 bp higher, putting the US Treasury at 2.87%.  Gold is inside yesterday's range but continues to trade heavily after being turned back from $2000 at the start of the week.  June WTI held the $100 level yesterday, helped by a large drawdown of US inventories amid strong exports. It is extending its recovery today and is above $103.  US natgas is lower for a third session, while Europe's benchmark is up more than 6% to reach its best level since the middle of last week.  Iron ore fell to give back yesterday's gains, leaving it off nearly 5% this week with one session left.  Copper prices are steadying after falling 3% over the past two sessions.  July wheat is trading lower for the third consecutive session. It had risen nearly 12% over the past two weeks.  

Asia Pacific

The Japanese government upgraded its assessment of the economy for the first time in four months.  It noted that Covid cases have fallen, and social restrictions eased (at the end of last month).  The outlook for consumption and public spending were lifted.  New measures to support the economy and cushion the blow of higher fuel prices are expected before the end of the month.  Meanwhile, the BOJ started its four-day fixed-rate buying of the 10-year JGB, but there wasn't a take-up and it bought JPY225.1 bln yesterday.  Japan's Finance Minister Suzuki warns about the negative impact of a falling yen, foreign exchange was not a major topic at yesterday's G7 meeting.  The head of the IMF's Asia and Pacific Department weighed in and opined that the yen's decline reflects economic fundamentals.  Moreover, the official (Panth) said that the decline has been orderly. He also seemed to play down the negative implications of the yen's weakness, though did note it could impact households.  

The pact between China and the Solomon Islands was reportedly signed earlier this week and some warn that Chinese ships and aircraft could arrive next month.  The US National Security Council's Campbell is going to the Islands apparently to express concern.  However, it is a bit like closing the barn door after the horses bolted.  The US closed its embassy there in 1993.  Strategically, it could be a coup for Beijing. China is Australia's biggest trading partner, but Canberra has aligned with the US. The AUKUS, nuclear submarine deal announced last year seemed to have successfully checked China.  This move does not neutralize AUKUS, but it does give Beijing a presence it did not have before in an area that has proved of great strategic value.  It could have implications for Australia's election next month.  The polls show a close race.  National security was a key plank in Prime Minister Morrison's platform.  Labour's challenger Albanese, who has not run the most inspired campaign, is calling it a "massive foreign policy failure." 

The dollar is trading within yesterday's range (~JPY127.45-JPY129.40) against the yen.  It held above the five-day moving average (~JPY127.65) and has not closed below it since April 1.  A move above JPY128.65 may signal a re-test of the highs.  The Australian dollar is consolidating after yesterday's recovery.  The initial polls suggest Labour challenger Albanese took the first debate with Prime Minister Morrison ahead of next month's election.  The $0.7465 area corresponds to a (38.2%) retracement of the leg lower since the RBA-inspired high on April 5 near $0.7660.  The New Zealand dollar was initially sold in response to the lower-than-expected Q1 CPI (1.8% quarter-over-quarter instead of 2.0%) and fell to almost $0.6765.  It has recovered but is encountering new sales around $0.6800 in the European morning.  The Chinese yuan has fallen by about 0.4% for the third consecutive session.  The greenback traded above CNY6.45 for the first time since last October.  The PBOC set the dollar's reference rate at CNY6.4098 today, slightly above the median projection (Bloomberg survey) for CNY6.4097.  In our weekend note, we suggest a break of CNY6.40 could signal a move into the CNY6.50-CNY6.60 area.  

Europe

If a consensus has been formed at the Fed for an "expeditious" move toward neutrality, a consensus has emerged at the European Central Bank for a hike as early as July.  Several of the hawks, including German, Dutch, Austria, and Belgium appear to have staked out the position, but what is new today is that the ECB's Vice President, who is (nearly) always on message, De Guindos, seemed to endorse it today.  The swaps market has almost a 20 bp move discounted for the July 21 meeting and another 20 bp in September.  There appears to be 30 bp hike priced in for Q4, leaving the year-end rate slightly below 15 bp.  The US 2-year premium over Germany reached nearly 255 bp early this month and has been consolidating over the past couple of weeks and is around 247 bp today.  

Israel announced a major shift in it its reserve strategy.  This would seem to provide evidence for the meme that has emerged based on ideas that the sanctions on  will encourage a move away from dollars and the IMF staff paper suggesting that the shift away from the dollar is toward smaller currencies, not the typical alternatives, like euro, yen, and sterling.  However, the headlines seem misleading.  It is true that the dollar's share of Israel's reserves will be trimmed to 61.5% from 66.5%, which is still above global share, according to the IMF's COFER data as of the end of last year.  However, the bigger move is out of the euro.  Its share will fall to 20% from 30%.  Sterling's share will double to 5%, the same as the yen.  The Aussie and Canada will have a 3.5% allocation each and China will get a 2% share of Israel's reserves.  

The euro's recovery is being extended into the third session today.  It was bid to about $1.0935 in late Asian turnover but has stalled in the European morning.  The intraday momentum indicator was stretched by the rally and has turned lower. Today's gain met the (38.2%) retracement objective of the leg down that begun with the key reversal on March 31.  That retracement target was near $1.0920, which is also where the 20-day moving average is found.  Some euro buying may have been related to the 2.5 bln euro option at $1.09 that expires today. The snap polls found that Macron won the debate with Le Pen yesterday.  It is the only debate ahead of this weekend's run-off.  Despite the anxiety about the closeness of the race, Macron's lead has widened in recent days to around nine percentage points.  Sterling closed below $1.30 for the first time since 2020 on Tuesday before recovering to $1.3070 yesterday.  It extended the gains marginally today (~$1.3080) to test the 20-day moving average.  It has not closed above this average here in April.  It found some sellers in early European activity, but the upside may not be done.  As long as the $1.3040 area holds, we suspect it can have another run at $1.3100.  

America

The US 10-year yield fell by nine basis points yesterday, the most in nearly a month, having been turned back after nearing 3%.  The 30-year yield pushed a little above 3% seemingly triggering bond buyers who pushed the yield to a new low for the week near 2.86%.  However, the implied yield of the December Fed funds futures contract rose to a new high of 2.525%.  The swaps market sees the terminal Fed funds rate between 3.0% and 3.25%.  Depending on the assumptions, arguably around 3% on the long end may be fairly priced, but the two-year note, yielding around 2.57% looks rich. We suspect the yield there needs to get closer to 3%.  This assessment seems perfectly consistent with the strong reception at yesterday $16 bln sale of 20-year bonds.  It produced the strongest bid-cover (2.8x) in its brief (May 2020) modern history.  Moreover, indirect bidders took down a record share of almost 76%.  Indirect bidders are often foreign investors.  It lends credence to our view that the strong dollar is not yet curb on demand for US financial assets.  The TIC data, out at the end of last week, showed foreign demand for US stocks and bonds were a record in the six-months through February.  

The US reports the April Philadelphia business survey.  Recall that at the end of last week, the first of the regional Fed surveys, the Empire State manufacturing survey was unexpectedly strong (24.6 vs. -11.8 in March and expectations for a 1.0 reading).  The Philly survey stood at 27.4 in March and the median forecast (Bloomberg) is for some slippage. Weekly initial jobless claims may draw more attention than usual as this week's report covers the period in which the non-farm payrolls survey is conducted.  The highlight of the session though may be Powell (and Lagarde) at an IMF panel around 1:00 pm ET today as they talk about the global economy.  To be sure, the market is fully pricing in a 50 bp hike by the Fed in both May and June and leans strongly for a similar move in July.  

Canada and Mexico have light economic calendars today.  Canada reported stronger than expected March CPI figures yesterday (6.7% from 5.7% in February) and the average of the underlying measures also rose.  The swaps market shows a strong leaning toward another 50 bp hike at the next meeting on June 1.  The market sees another 50 bp hike at the September 7 meeting as well.  

The Canadian dollar rallied more than we expected yesterday and there is follow-through buying today. The US dollar slumped to almost CAD1.2470 yesterday after beginning the session above CAD1.2600 and toying with the 200-day moving average (~CAD1.2630).  The greenback has eased to about CAD1.2460 today.  Immediate resistance is around CAD1.2500, where a $1.2 bln option expires today.  The US dollar posted an outside up day on Tuesday against the Mexican peso and it is consolidating yesterday in a narrow range around MXN20.00.  It is still in a narrow range today, but firm and looks set to challenge the highs seen earlier this month a little shy of MXN20.20.  Support is now seen near MXN19.95.  

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Source: Yuan Slump Continues while Hawkish ECB Comments Lift the Euro