Familiar themes were the focus of attention for FX and macro markets this week, as the dollar continued to lose ground at a modest pace, US-China tensions escalated further, and China Q2 GDP handily beat expectations. Risk appetite on the whole has remained intact, despite a curious midweek fall in Chinese equities that did not result in a global rout.
For the euro, the tone of next week’s trading is likely to be set by the weekend’s EU summit.
Hopes for a breakthrough have been managed downwards by several leaders including Dutch and German heads of government. However, should the summit fail to make any progress whatsoever, the euro may find some of its recent progress undermined ahead of next week’s flash PMI readings.
- Tuesday, 21st July. Minutes from the Reserve Bank of Australia’s latest meeting will be accompanied by a speech from Governor Phillip Lowe. The RBA kept rates, forward guidance, and its yield curve control target unchanged in July’s meeting, so the minutes and speech will be interesting primarily for gauging the RBA’s sensitivity to any further deterioration in the outlook. This is particularly relevant in light of the recent re-tightening of lockdown measures in Melbourne, and rising case counts in several regions.
- Wednesday, 22nd Canadian Consumer Price Index inflation. At 08:30 ET the latest inflation data from Canada is released for June. There has been substantial focus on the inflation data by the central bank, not only due to its mandate to target inflation at 2% but also due to the shifting composition of consumer spending habits. Governor Macklem referenced this in his speech on June 22nd labelled “targeting inflation during the pandemic” with the latest Monetary Policy Report including adjusted inflation data based on high-frequency payment data. Thus far, the difference between headline CPI and the adjusted rate has increased from 0.1% to 0.3%, meaning focus on Wednesday won’t just be on the headline rate but more likely the Statistics Canada report as a whole.
- Thursday, 23rd July. The Central Bank of the Republic of Turkey will announce its latest rate decision at 12:00BST, having surprised markets by keeping rates unchanged at 8.25% at its last meeting. The MPC judged that maintaining “sustained disinflation” for the sake of lowering sovereign risk was more important than further easing aimed at stimulating the economy. Given that inflation has recently accelerated to 12.6% in June from 11.4% previously, real interest rates are more negative than they were at the last meeting, and we think the MPC will choose to hold fire again.
- Thursday, 23rd July. The South African Reserve Bank is expected to announce its latest monetary policy decision at around 13:00BST. We expect a 50bp cut, more on that below.
- Friday 24th July. PMI-mania as the UK and eurozone release flash PMI results for July throughout the morning, while UK retail sales data for June is also expected at 07:00BST. US preliminary PMIs are also released in the afternoon of the European session at 14:45BST. More on the PMIs below.
- Friday, 24th July. The Central Bank of Russia are set to announce their key rate at 11:30BST with Governor Nabiullina to hold a news conference at 13:00BST. After cutting rates by a staggering 100bps, economists will watch on as the CBR decide whether to cut rates by 25 or 50 basis points after Governor Nabiullina highlighted a slowing pace of easing back in June. With another meeting not scheduled until the 18th September, will the CBR opt to front-load their stimulus or instead hold fire to preserve ammunition in case economic conditions change? All will be revealed on Friday with inflation sitting 1.1% below target in June.
MAY’S INFLATION PRINT PAVES THE WAY FOR FURTHER EASING FROM THE SARB
At the South Africa Reserve Bank’s last meeting back in May, MPC members voted 3 to 2 in favour of a 50bp cut. However, the 2 dissenting members, who opted for a smaller 25bps cut instead, meant the decision was a more hawkish cut than markets were expecting. This was evident in the South African rand, which rallied over 1.6% against the dollar after the announcement.
The resistance seen at the last SARB meeting left speculators and analysts, ourselves included, questioning whether that was all the easing the MPC was willing to commit to in the near-term. After the May meeting, we expected the pace of easing to slow to 25bps at this Thursday’s meeting, with risks tilted towards an unconventional smaller cut, but more likely a hold in rates. However, as recently as last Wednesday, our view on the SARB’s likely actions have changed. This is predominantly due to the latest CPI inflation data. Headline CPI fell below the SARB’s 3-6% target range for the first time since 2005 with a reading of 2.1%. While we appreciate much of the reduction in the headline reading was due to lower oil prices, petrol prices fell 25.9% YoY in May down from -12.8% in April, the lower core reading highlights the risks to the SARB’s optimistic outlook. An extension of curfew measures and bans on the sales of certain consumer goods such as alcohol and tobacco are likely to weigh on demand conditions yet again. With this in mind, we now believe the risks are heavily skewed towards a greater interest rate cut, likely 50bps at Thursday’s meeting.
SARB’s adjusted forecasts in May’s MPR (previous)
Inflation pressures drop off as the headline rate falls below the SARB’s target range
In addition to the slump in inflation data, South Africa continues to battle to contain the domestic outbreak, with the average number of daily new cases rising from 109 to 210.2 in the space of just two weeks leading up to the 14th July. Coupled with limited new fiscal spending measures announced in the supplementary budget, the likely persistence of containment measures means we believe the economic projections from the SARB are also ambitious.
Taken all of this into account, we anticipate another 50bps cut from the SARB at their meeting on Thursday, but don’t discount the probability of a smaller cut of 25bps given the resistance in May’s meeting. However, unlike previously, we now believe the development in economic conditions rules out a hold from the central bank.
Option markets are also anticipating rate cuts with a reduction of 36bps already priced into ZAR forwards
US-CHINA TENSIONS ESCALATE, BUT TRUMP BACKS DOWN FROM ATTACK ON HDK PEG AS PRESSURE ON CURRENCY EASES
US-China relations remained on a solidly downwards trajectory this week, with US President Donald Trump signing a bill paving the way to more sanctions against Chinese officials in retaliation for the imposition of security laws in Hong Kong. China quickly retaliated with their own sanctions on US lawmakers. Reports emerged of a potential ban on China-owned social media app TikTok. However, arguably the most significant development of the week was the confirmation that the US was not seeking to target the Hong Kong Dollar’s peg to the greenback. Previously, the media had reported White House advisors were pushing for such a move, which would have required the drastic step of limiting access to US dollars for the island’s financial system as a whole.
The Hong Kong dollar has been buffeted by various contradictory drivers recently, with factors such as capital inflows and high HIBOR rates supporting the currency, but the potential risk of a US attack on the HKD peg acting as a downside risk. So far, the former factors have prevailed, with spot USDHKD remaining stuck to the bottom of its permitted range.
However, a number of changing circumstances suggest that the outlook for the pair remains highly uncertain:
- Spreads between HKD interbank rates and London USD interbank rates have narrowed in recent weeks, from highly elevated levels in April and May.
- HKMA intervention, which was focusing on selling the domestic currency to ease appreciation pressure due to capital inflows, may now ease somewhat and therefore prevent any significant HKD depreciation.
- Last week, the overnight HIBOR rate fell below the equivalent USD LIBOR rate for the first time since March, potentially marking a period of less attractive carry potential for HKD. Despite both of these ostensibly negative factors for HKD, the currency remained close to the lower bound of its USDHKD range for most of this week.
- The imposition of new security laws may risk capital outflows, although there is no sign of this yet.
- We will assess the outlook for USDHKD in greater detail in a note early next week.
HKD HIBOR Converges to ICE USD Libor
JULY’S PMI DATA TO CAUTIOUSLY REFLECT THE PACE OF THE ECONOMIC RESUMPTION
June Purchasing Managers’ Index data generally followed the upward trend that started in May, when lockdown measures started easing in many areas around the globe. However, while the indices have shown a sustained rebound across sectors and economies since the all-time lows in April, the June readings still displayed below-50 levels in general. Methodologically, the 50 benchmark represents the line between expansion and contraction territory on a monthly basis. This means that, in theory, any sign of rebound from an extremely depressed base – like the one in April – should be gauged by an above-50 PMI index, as businesses see a resumption in activity.
An apparent misalignment in latest PMI data drove confusion among investors, given that high-frequency real activity indicators suggested that economic output started to recover from the April dip.
The reasoning behind this contradiction lies within the data collection itself and the way the survey is interpreted by respondents. Even though the survey asks for monthly changes in activity, empirical correlation between hard data and PMIs indicates that the latter are partly a signal of longer-term assessments of business conditions. PMIs are more strongly correlated to growth on a 3-month moving average basis than on a month-to-month one, suggesting that respondents do not actually report changes from the previous month, but relative to a broader time span.
This finding is particularly insightful when reading the upcoming July flash indices in two ways:
- A reading below 50 won´t necessarily imply that activity is shrinking from June levels, nor that the economic recovery in most countries hasn’t already started. As per the previous analysis, “contraction” PMI levels in the current context might suggest that economic output is subdued compared to pre-pandemic levels instead. This is particularly relevant since the recent virus outbreak in the US and the consequent pause to reopening measures may have led to a reversion of the previous economic rebound in Q2. While the former may be reflected in small changes to the June readings, PMIs sufficiently close to the 50 benchmark could be consistent with a continued economic recovery, although at a slower pace. In this sense, it will be more enlightening to look at relative changes in the indices as opposed to absolute levels.
- While it is fair to say that the surveys have not perfectly matched the depth of the downturn and the extent and timing of the recovery, PMIs are still the best timely gauge at hand to assess how economies and sectors are faring compared with others.
US: June data signalled a slight stabilisation in manufacturing, services and the composite PMIs in the US after massive contractions in April and May. Business confidence data showed a better improvement in June among both the service and manufacturing sector, with the Philadelphia Fed Business Outlook surging to 27.5 vs the forecasted negative 21.4 and a May reading of negative 43.1. The Business Outlook release for July printed slightly worse at 24.1, likely because of increased fears of a second wave considering the surge in new cases and diminished hopes of further relaxation of the lockdown measures, which may show a glimpse of what shape the July PMIs will take. Even though jobless claims have continuously been falling in recent weeks, the rate of improvement has slowed, showing signs of weak economic resumption amid the surge in new cases. The slow pace of recovery in the US labour market may show up in the upcoming PMI data.
EU: After having tumbled to unprecedented depths in April and remaining below the expansionary mark of 50 in May despite positive output growth, June’s services and composite PMIs are expected to print at 51.0 while the manufacturing PMI is forecasted just below the benchmark at 49.5. Given the discrepancy between the previous output figures and contrasting PMI readings, markets will likely look beyond the headline PMI releases next week and consider hard data releases to visualize the speed and shape of the economic recovery in the eurozone.
UK: UK PMI data has followed a similar trajectory to the eurozone, but hard data releases point to a grimmer outlook for the UK. May’s monthly GDP data showed that economic output is still down around -25% compared to February. For the eurozone, the European Central Bank foresees a 17% fall in output in H1. Markets will consider the upcoming flash PMI figures to gauge whether the UK is getting itself back on its feet, especially now that the UK has followed in the eurozone’s footsteps and further eased lockdown measures this month.
Which sector and country is leading the pace of the economic recovery?
Size of circles represent composite PMI value
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, Junior FX Market Analyst