US equities struggled for direction overnight, with the S&P 500 and Nasdaq almost unchanged, while the Dow Jones eked out a small gain. The outcome is hardly surprising with Wall Street tying itself up in knots and whipsawing itself over the last week under the deluge of inputs from the geopolitical, central bank and data space. The emerging theme seems to be that higher-for-longer inflation will see central banks continuing to tighten economies into a recession, before having to reverse course again into 2023. Something seemingly hinted at by both Jerome Powell and Christine Lagarde at the ECB forum overnight.
US bond markets are certainly seeing it that way, with short-dated yields holding steady while yields in the longer part of the curve headed downwards once again. It might also be that longer-duration bonds are seeing haven inflows as investors give up on the histrionics of the equity market and lock in some semi-decent long-duration yields.
US dollar rebounds
Amongst all of this, the US dollar rallied overnight, a somewhat counterintuitive move given that longer-dated rate expectations are being tempered on recession fears. Notably, the greenback rallied not only versus the G-20 space, but it also did well versus the Asian currency space ex-China, and even USD/JPY continued its rally. That suggests to me that we are seeing a broader move to safety, benefiting both the US dollar and depressing US yields. Having said that, it does look like a few regional central banks are selling a few more US dollars into the market today to smooth the Asian FX selloff.
One caveat today though is we are at the month and quarter-end. We are likely to see some chunky rebalancing flows from institutional investors across multiple asset classes. That may distort price movements and throw up a few false positives in markets today.
With Wall Street sitting on the fence, Asia has been left to its own devices today with local data appearing to dominate price moves, especially in the equity space. China equities had a negative start today but have since bounced. China’s President Xi reiterated the government’s commitment to covid-zero yesterday, a risk I have been telegraphing constantly. However, both the official Manufacturing and Services PMIs have staged a handsome reopening bounce today. June Manufacturing PMI climbed to 50.5, while the Non-Manufacturing PMI leapt to 54.7 from 47.8 in May. The climb above 50 into expansionary territory has put a floor under mainland equity markets for now. Just remember, the virus only has to get lucky once.
South Korean data has also been pretty impressive. Construction YoY for May jumped by 8.20%, Industrial Production rose by 7.30%, and Manufacturing also rose by 7.30%. All were well above forecast. Business Confidence slipped to 83.0 though, suggesting clouds ahead, while Retail Sales YoY for May rose only 0.70%, with the MoM slipping by -0.10%. Overall, it suggests that demand remains robust for South Korean products internationally with the sub-sectors also broadly recovering, but the South Korean consumer continues to grapple with cost-of-living increases. A reopening by China should boost this data in the coming months and partly explains the Korean won unwinding some of its overnight losses today.
In contrast, Japanese data was a mixed bag. Industrial Production MoM in June slumped by 7.20%, but the YoY number fell by -2.80%, still better than May’s -4.90% tumble. Once again, China’s restrictions continued to impact the numbers but assuming they stay covid-zero, could provide a positive tailwind for Japan’s exporters and manufacturers in the quarter ahead.
It is early days yet, but if the pattern in US bond markets continues, i.e., a rotation to an inverse yield curve as a US recession and Fed rate cut in 2023 are priced in, and Japan’s modest recovery continues, I believe the end is in sight for the USD/JPY rally. The 140.00 to 145.00 zone should remain intact. I will be watching this closely over the coming weeks.
Elsewhere, the Philippine PPI for May rose by 6.90% YoY, above expectations. The peso has been one of the worst performers in the Asian FX space of late, partially due to the central bank’s reluctance to aggressively hike into surging inflation. The new head of the BSP appeared to concede on this point yesterday, suggesting harsher hikes could be on the way if currency weakness persists. He might not be the last one in the region to have to concede on this point. Malaysian and Indonesian inflation is benign and may be saved at the bell from accelerating if recessions in key export markets occur. India may be a different story and the rupee has also been struggling.
Australian equity markets are lower today, with the Australian…
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