Central banks are making big rate hikes
Central banks around the world have had their fill of Bon Jovi doling out bad monetary policy medicine over the past 24 hours, as the fight against inflation permeates even the most ardent fence keepers. South Korea and New Zealand rose 0.50% yesterday, with Canada weighing in with a crowd-pleasing 1.0% gain. You get this bad medicine whether you need it or not.
This morning, the Monetary Authority of Singapore stepped in with its second unanticipated tightening of the year, refocusing the currency’s policy range on “in-force rates”. The MAS normally announces monetary policy parameters only twice a year, in April and October. So far it has reacted in January, April and now July as core inflation rose. We can reasonably assume that October will also be a live meeting. USD/SGD fell 0.67% to 1.3905 in response. For non-Singaporean readers, the MAS uses the currency to manage monetary policy due to the nature of trade flows through the city-state. A google of “MAS” and “NEER” will allow you to do your own research on the mechanism. I recommend wrapping a cold towel around your head as you do this.
The latest news is that the Central Bank of the Philippines has just announced an unexpected rate hike of 0.75% to 3.25%. To say this is an unusual move on the part of the Bangko Sentral ng Pilipinas (BSP) is an understatement, considering they have been some of the most accommodating and reluctant trekkers in Asia. The US CPI and MAS move today, along with the relentless pressure on the Philippine Peso (PHP) swayed BSP’s hand, highlighting the pressures currently facing Asian central banks. USD/PHP fell 0.32% to 56.06, but PHP remains near record lows. We may see more from other monetary authorities in the region now that pain thresholds and the depletion of foreign exchange reserves are reaching their low points. Bank Indonesia could be the next taxi out of line, followed by Bank Negara Malaysia.
With even the Bank of England looking hawkish this week and recent rate hikes in Eastern Europe and Latin America, it’s clear that central banks around the world are laser-focused on fighting inflation. rooted that they helped to create, to hell with growth. Higher rates are coming to a convenience store near you.
This brings us to Big Kahuna, the US Federal Reserve whose FOMC policymakers meet at the end of the month. Overnight, US inflation surprised markets by climbing to 9.10% YoY for June, with core inflation falling 0.10% to a cold comfort 5.90%. Futures markets rushed to price in a more aggressive Fed Funds rate hike late in the month, approaching 1.0% overnight. At least one Fed speaker – there were many of them – also mentioned 1.0% overnight. I still think it’s a bridge too far for the FOMC to go 1.0%, but hey, it’s 2022 and nothing should surprise us anymore.
Unsurprisingly, EUR/USD traded at par after the data, but after breaking through 0.9998, it rallied back to 1.0040. We also saw similar action in GBP/USD, AUD/USD, NZD/USD, USD/CAD and USD/CHF, although USD/JPY went straight to jail and hit 138.00. The surprises continued; Wall Street fell overnight, but only modestly amid recent volatility. Gold and Bitcoin also fell, but actually ended higher on the day. Oil prices were flat, also ignoring a huge increase in official crude inventories. The biggest headache for me was the US bond market. The US 2-year yield rose slightly, but yields fell across the rest of the curve. The US yield curve is now well and truly inverted from two years to thirty years.
Thus, the American markets anticipate a more rapid tightening of the Fed and a recession is imminent. Still bullish, US markets appear to be pricing in the Fed to deliver its bad medicine and send the US into a recession, but that will be short-lived and the Fed will cut rates by the second half of 2023. This likely plays into the the market’s intrinsic psychological need to find reasons to seek a return to equities this year. That’s a lot of trust to place in the Fed, inherent market biases aside. Given their inflation track record over the past couple of years, that’s a looooootttttt confidence to place in the Fed.
That said, given the mess the Fed has made with the transient/entrenched inflation narrative, it’s just as easy to assume that it’s also going to have a dog’s breakfast with a tightening. The overnight US inflation numbers should have seen bond yields and the US dollar soar, stocks should have been stretched with a season-ending injury, and gold and cryptos should have headed so far south that they ended up in Mexico. This is not what happened, quite the contrary. Respect the price action and right now seems to be screaming that a bear market correction is on the way for equities and the US Dollar rally is about to pause for breath. This matches a number of overbought/oversold technical indicators I see across all asset classes and helped by the rest of the world central banks outside of Europe and China seemingly rushing to play catch-up currency.
Yesterday, China’s June trade balance recorded a monstrous surplus of $98.0 billion, well above forecasts. Whether that’s due to a clearing of export arrears or that things in China and the rest of the world aren’t as bad as they look, I don’t know. This suggests that there is upside potential for the China data dump tomorrow, in my view. If we’re talking about bear market rallies, a healthy set of very important data releases tomorrow out of China could be the catalyst to give that some momentum.
The Monetary Authority of Singapore and the Reserve Bank of Australia will sharpen their tightening pencils today, despite the MAS action this morning. Singapore’s 2Q YoY advanced GDP surprised on the upside, up 4.80%. This comes after healthy retail sales data earlier in July and improved inflation assessments by the MAS this morning.
In this lucky country, the economic temperature needle reached overheated territory today. Australian employment for June rose by 88,400 jobs, well above the 30,000 forecast, and follows excellent numbers in May. Significant gains were made in full-time and part-time jobs. A high CPI post on the 27the will lock in and charge another 0.50% hike in early August by the RBA, possibly 0.75% if the FOMC moves to 1.0% a few days before. The fact that AUD/USD remains close to year-over-year lows is even more surprising in this context, although the AUD is buoyed by international investor sentiment these days, and falling prices from energy, industrial and agricultural commodities over the past six weeks means that Australia’s terms of trade are likely to ease in the third quarter.
Regarding agricultural raw materials, Turkey and the United Nations seem to have achieved a miracle and are about to negotiate an agreement between Russia and Ukraine allowing the partial resumption of Ukrainian agricultural exports from the Black Sea. This could put downward pressure on commodity futures in the near term, although any impact from Ukrainian exports will have a significant time lag, and quite frankly to say it would cause implementation issues is an understatement. .
This will be of limited comfort to Europe, with emerging markets being the most likely immediate beneficiaries, and rightly so. Observers from Europe should circle the 21st/22n/a of July in their calendars. The annual Russian maintenance of the Nord Stream 1 pipeline to Germany ends that day, and the Canadians have returned their pipeline pump to the Russians. The question is whether the gas starts flowing again. If not, EUR/USD at 1.0000 will be a thing of the past and there will be no bearish rally for European asset markets.
Looking at the rest of the day, Japan’s 20-year JGB auction and industrial production data are unlikely to move the needle. India is releasing WPI inflation for June this afternoon, and if it stays around 15.80% or higher, the pressure on the rupiah, local equities and the Reserve Bank of India is likely to continue. European releases are second level this afternoon, and the US PPI tonight will have been drowned out by the noise of inflation data overnight.
All roads lead to China’s data dump tomorrow, including GDP, retail sales and industrial production. Next came heavy retail sales and consumer sentiment data in the United States.
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