Overnight Headlines
- President Trump announces 5% tariff on all Mexican imports from June 10
- China Manufacturing PMI fell to 49.4 below the threshold for expansion
- Fed Vice chair Clarida says downside risk could call for more accommodative policy
- Oil hits lowest since March on inventories and trade
US Markets
US equities rebounded slightly yesterday amid month-end position squaring and continued scanning of the next headlines in the ongoing trade battles. It has been the most turbulent month of the year with the escalation of the trade war. The S & P is back under 2800 but above the 200-day moving average, for now. Equity markets are in the midst of pricing a long-term trade war with anticipation of a protracted conflict and we are looking at weak openings across the board in Europe this morning.
US bonds are bid again with yields making new multi-month lows this morning. The 3mth-10yr yield curve is deep in inverted territory having surpassed this year’s low and now hovers near mid 2007 levels. Historically, an inverted curve has been a signal of a looming recession. Markets are assigning over an 85pct chance of a rate cut by the end of the year.
USD hit a 5-month high earlier in the week. Given the markets are pricing multiple rate cuts by 2020, dollar strength could be seen as slightly surprising. However, the markets have been in risk-off mode and the dollar is viewed as a safe haven currency with its reserve currency status. This is currently more than offsetting the fall in US yields as the greenback is on course to post its fourth consecutive month of gains. A weaker dollar comes when the market feels that trade policy is a deeper negative shock to the US economy.
Currency Majors
EUR/USD continues to consolidate and compress within a tight range. That wider range is 1.11-1.1205 (wider being relative of course!) with marginal new lows followed by tepid bounces. The EUR really needs to close below the major 1.1100/05 support level to indicate that a move to 1.1050 has started. The European Commission on Wednesday asked the Italian government to explain a deterioration in the country's public finances, a move that sets the stage for a possible legal clash with the eurosceptic governing coalition in Rome.
GBP’s recent consolidation looks to be over as sterling pushes lower towards support at 1.2605/10. If this level fails, then 1.2570 and 1.2476 remain as levels of support ahead of the late 2018 low at 1.2458. Trend signals are bearishly aligned across numerous timeframes. We will take note of the new GBP positioning in the weekly CFTC report out later today. Fundamentally, all eyes are on the Conservative leadership process and the candidate’s inevitable emphasis on anti-EU/hard Brexit credentials. On the flip side, the odds for a second referendum have risen so potential outcomes seem exceptionally binary, with political paralysis currently maintaining broader uncertainty in the economy.
JPY is the strongest major today amid broad-based risk aversion. After a bounce up to the 100d MA, USD/JPY consolidated just above 109. This morning has seen range expansion to the downside, breaking through that support. We need to see a close below 109 to signal the start of a sustained decline to 108.45 and below.
Watch out for AUD/JPY as this risk-off environment escalates. This pair is a classic gauge of sentiment for markets and having tracked sideways over the past few sessions, has made new cycle lows this morning.
Key Events
German CPI for May should reverse most of the rise seen last month as Easter effects drop out.
The US Core PCE deflator, the Fed’s key inflation metric is released this afternoon. The central bank considers 2pct a healthy level for price stability but has failed to hit the target for most of the past decade and expectations are for an unchanged reading of 1.6%.
Inflation has remained benign so far in the US this year, though Fed Chair Powell believes some of the factors influencing it can be considered temporary. These include the stronger dollar whose effect is most likely to persist in the coming months if trade tensions continue to flare.
We have a stacked calendar next week with the RBA and ECB meetings plus the usual US employment data to start the month. Of course, trade issues will continue to dominate.