Market Briefing - Hawkward Moments

Turnaround Tuesday, it wasn’t. A recovery helped support risk-sensitive currencies early yesterday morning, but a renewed wave of selling ultimately saw yields pop higher, equities tumble and the dollar add to its gains. 

Equity futures are pointing to reduced turbulence at the open, but with traders cutting directional position-taking ahead of this afternoon’s Fed meeting, this could be the calm before the storm.

The European Central Bank called an emergency meeting, raising hopes that it would announce measures to reduce fragmentation risk in the euro area. Pressure has been growing in recent weeks, with increases in peripheral bond yields threatening to impair monetary policy transmission. 

Yield spreads collapsed and the euro jumped in response, but conditions remain volatile as traders watch the central bank’s news feed. No clarity has yet been provided on when the meeting might end.

As several observers have noted, the incongruity associated with simultaneously tightening policy and buying peripheral government debt could prove politically toxic, posing challenges for monetary policymaking down the road. 

Chinese retail sales fell by less than expected in May, and industrial production grew 0.7 percent year-over-year as Shanghai and other manufacturing centres began to reopen. Fixed asset investment showed signs of recovery, up 6.2 percent in the first five months of the year, suggesting that government stimulus efforts are gaining traction. The yuan climbed last night as the People’s Bank of China opted not to cut benchmark lending rates, preserving existing interest differentials. 

US retail sales numbers for May are due at 8:30. Consensus estimates suggest growth will slow to 0.2 percent month-over-month from April’s 0.9 percent. The headline print will be flattered by higher gasoline prices, but consumers - who claim to be feeling terrible about the economy - are shifting buying activity from tangible goods toward services, while spending more than ever.  

Canadian housing starts are projected to hit a seasonally-adjusted annualized rate of 255,000 units in May, down from 267,330 in April, as tighter monetary policy and spectacularly-high home values begin to weigh on demand. The loonie continues to dance to a tune played elsewhere, 

With its inflation-fighting credibility on the line, the world’s most powerful central bank is expected to deliver a 75 basis point rate hike, along with updated forecasts and hawkish messaging on future moves.

Last week, the Bureau of Labor Statistics said prices climbed 8.6 percent in the 12 months through May, but the University of Michigan’s consumer sentiment survey - which showed a sharp rise in inflation expectations - may prove to have been the clincher for a triple-barrelled rate increase. The Fed remains deeply concerned about letting consumer psychology become untethered, and all signs suggest policymakers are willing to respond aggressively to any shift in perceptions. 

A temporal gap could emerge between the release of the Statement of Economic Projections - which is prepared prior to the meeting - and the press conference, where Chair Powell will outline the committee’s latest thinking. 

The dot plot is likely to show inflation - as measured by the headline personal consumption expenditure index - moving up from the previously-estimated 4.3 percent to almost 5 percent this year, before falling in 2023. With financial conditions tightening rapidly and sentiment levels dropping, unemployment projections could rise modestly over the forecast horizon.

Perhaps most critically, terminal interest rate forecasts could jump to 3.5 percent in 2023 - up from the 2.8 percent expected in March, but below the 4.2 percent now priced into financial markets.

Mr. Powell is widely expected to convey an extremely hawkish message, downplaying the need for a “soft landing” as he prepares markets for another 75 basis point move in July and raises terminal rate forecasts closer to 4 percent. 

This suggests that the risk profile in foreign exchange markets is slightly asymmetric. It seems unlikely now, but if Powell sounds more dovish than expected on any level, the dollar could fall and buying activity might shift toward risk-sensitive currencies elsewhere.

Forgive me for the exorbitant word count - there’s a lot happening out there!

EVENTS

WEDNESDAY

CAD Housing Starts, May

USD    Retail Sales, May

EUR    European Central Bank Speech, Panetta

USD    Department of Energy Weekly Inventories

EUR    European Central Bank Speech, Lagarde

USD    Federal Reserve Rate Decision

BRL    Central Bank of Brazil, Rate Decision

THURSDAY

EUR European Central Bank Speech, Panetta

GBP    Bank of England, Rate Decision

USD    Weekly Jobless Claims

FRIDAY

JPY    Bank of Japan, Rate Decision

USD  Federal Reserve Conference on Dollar's Role

USD   Baker Hughes Weekly Rig Count