Richmond Fed manufacturing index

The monetary policy dilemma when markets won't listen The second, related, point is that it is debatable how much central banks can really tighten monetary policy on their won in a data-dependent regime. There has clearly been a reappraisal of global central banks’ reaction functions in June, but the result has been much flatter yield curves. To the extent that this is a symptom of higher short-end rates and unchanged long-end rates, this is a net tightening of financial conditions, an albeit a disappointingly limited one. The problem arises when, even as short-end nominal rates rise, long-end real rates drop. Taking EUR 5Y5Y real rates as an example, they have dropped 40bp since their peak a month ago, hardly a tightening of financial conditions.   What’s more, risk assets have taken the recent change of central bank tone in their stride, see for instance the spectacular tightening of sovereign spreads. The ECB may well gush that its policy stance is well transmitted, tighter sovereign and credit spreads suggest the cost of funding remains affordable for the economy. This is good news, but also suggests that a more hawkish stance is needed to yield results, but with increasing downsides. This is the choice faced by central bankers at this week’s Sintra conference: chase the diminishing returns of a hawkish stance, or accept that a lot of the financial variables responsible for ultimately supressing inflation are beyond their control.     Risk assets have taken the more hawkish central bank tone in their stride   Today's events and market view The data calendar this morning is dominated by Italian sentiment indicators, followed in the afternoon by US durable goods orders, house prices, new home sales, conference board consumer confidence, and the Richmond Fed manufacturing index. The ECB’s Sintra conference is underway with interventions scheduled by President Lagarde, and Dhingra and Tenreyro from the Bank of England. More curve flattening is on the cards if central banks continue to push the hawkish envelope, at the expense of a slowing economy. This may take the form of a bear-flattening, however, given the recent fall in rates. The weekly ECB MRO allotment will be in focus as the facility might be used by some banks to finance the repayment of TLTRO loans. Bonds supply will come from the Netherlands (30Y), Italy (3Y/7Y), and the UK (10Y Linker). The German federal state will publish its third quarter funding update.

FX Daily: Hawkish Sintra kicks off The ECB Symposium in Sintra starts today, with an introductory speech by Lagarde plus remarks from other ECB members. A generally hawkish tone should come from all sides: the eurozone (despite a worsening growth outlook), the UK (despite the mortgage crisis) and the US. We’ll also monitor the speech by Norges Bank Governor today and Canada’s CPI numbers.   USD: Slightly weaker into Sintra The week has started on a rather quiet tone across most asset classes. The dollar is trading softer against the pro-cyclical currencies, a sign that the FX market has also fully overlooked the weekend crisis in Russia. As highlighted in yesterday’s FX Daily, investors are fully focused on the central bank story, and with the FOMC and post-FOMC hawkish messages having now been absorbed, we are transitioning to a period where data will tell investors whether there is any need to push tightening expectations beyond the one rate hike priced in for July. The notion of first and second-tier data releases is a bit more muffled in an environment where markets are spasmodically looking for evidence of disinflation and/or economic slowdown. We will see a gradual intensification in the US data release calendar in the coming days, which will culminate with ISM services and payroll data on 6 and 7 July; and then June CPI figures on 12 July. Zooming back into this week, the Conference Board consumer confidence data today will be the highlight of the day, although some focus will also be on May’s Durable goods orders and new home sales, and on June’s Richmond Fed Manufacturing index. Consensus expectations point to a relatively firm set of numbers, and we see no reasons to strongly disagree. Considering the low likelihood of a dovish turn by Fed Chair Jerome Powell at his Sintra speech tomorrow, an acceleration in the dollar decline does not seem very likely.

FX Daily: Asia in the driver's seat The dollar is softer and pro-cyclical currencies are following the yuan higher after news that China is preparing a CNY 2tn rescue package for the stock market. The BoJ revised inflation expectations lower but signalled further progress towards the target, keeping anticipation for a hike in June alive. We expect New Zealand CPI to be soft tonight.   USD: China and Japan in focus The dollar has been mostly moved by developments from outside of the US since the start of the week. China remains the centre of attention before key central bank meetings in the developed world. Risk sentiment was boosted overnight as the Chinese government is reportedly considering a large CNY 2tn package to support the struggling stock markets. The rescue plan should be mostly targeted to the Hang Seng stock exchange, which has sharply underperformed global equities of late. This is a strong message that conveys Beijing’s intention to artificially support Chinese markets in spite of the deteriorating economic outlook in the region, and it is reported that other measures are under consideration. It does appear a temporary solution, though. Ultimately, stronger conviction on a Chinese economic rebound is likely necessary to drive a sustainable recovery in Chinese-linked stocks. For now, the FX impact has been positive; USD/CNY has dropped to 7.16/7.17 and we are seeing gains being spread across pro-cyclical currencies as safe-haven flows to the dollar are waning. Doubts about the impact of Beijing rescue package’s effects beyond the short-term automatically extend to the FX impact. It does seem premature to call for an outperformance of China-linked currencies (like AUD and NZD) and softening in the dollar on the back of this morning’s headlines. Another important development in Asian markets overnight was the Bank of Japan policy announcement. In line with our expectations and market consensus, there were no changes to the yield curve control, and forward guidance remained unchanged. Inflation projections were revised lower from 2.8% to 2.4% for the fiscal year starting in April. The revision was mostly a consequence of declining oil prices, and the inflation path continues to show an overshoot of the target for some time. All this was largely expected, and markets are focusing on Governor Kazuo Ueda’s claim that Japan has continued to inch closer to the inflation goals, keeping expectations for an eventual end to the ultra-dovish policy stance some time this year. The yen is experiencing a rebound which is likely boosted its oversold conditions. Money markets currently price in a 10bp rate hike in June. Extra help from a declining USD this morning might push USD/JPY a bit lower (below 147) today, but we suspect that markets may favour defensive USD positions as the Fed meeting approaches. Domestically, the only release to watch today in the US is the Richmond Fed Manufacturing index, which will give some flavour about the state of the sector ahead of tomorrow’s S&P Global PMIs. DXY may stabilise slightly below 103.00 once the China-led risk rally has settled.