Risk sentiment took another hit overnight, after US President Donald Trump threatened to impose tariffs on all Mexican imports until illegal immigration through Mexico stops. The safe havens JPY, CHF and USD strengthen, while government bond yields slid further, with the US 10-year treasury rate hitting a new 20-month low. As for today, we get the US yoy core PCE rate for April, which is the Fed’s favorite inflation gauge, Germany’s preliminary CPIs for May and Canada’s GDP data for Q1.
The dollar continued gaining against most of the other G10 currencies. It underperformed only against JPY and CHF, while it was found virtually unchanged against SEK. The main losers were NOK, AUD, and NZD in that order.
The strengthening of the safe-havens and the weakening of the commodity-linked currencies suggest that markets turned risk-off again at some point. Although most EU and US indices traded in a recovery mode yesterday, the Asian ones dipped overnight after US President Donald Trump threatened to impose tariffs to all Mexican imports until illegal immigration through Mexico stops. Japan’s Nikkei 225 and China’s Shanghai Composite closed 1.63% and 0.23% down respectively. The Mexican peso tumbled nearly 2.4% to three-month lows.
Trump said that the tariffs on Mexican goods will take effect on June 10th, at an initial rate of 5%. The rate would then start rising towards 25% until illegal immigration stops. With investors mainly focused on the conflict between the US and China, Trump’s threat towards Mexico caught them off guard and sparked another round of flight to safety, evident, not only by the strengthening of the yen, the franc and the dollar, but also by the further tumble in government bond yields. US 10-year rates hit a fresh 20-month low of 2.178%, with the Treasury yield curve inverting even further.
Investors are clearly afraid that if the US-China spat turns into a US-World one, the risk of a recession would increase, something that would add more pressure to central banks worldwide to consider further simulative actions. It also increases the chances for the Fed to hit the cut button before year end, despite the message we got from the latest gathering (and its minutes) that the current “patient” approach could remain appropriate “for some time”. According to the Fed funds futures, the probability for interest rates to be lower by December has jumped to 90% from around 84% yesterday. There is a 32% chance to get only one quarter-point cut, while the chances for two are even higher, near 36%. The remaining 22% is for even more cuts.
Yesterday, Fed Vice Chair Richard Clarida said that the Fed may consider acting if inflation remains low and global economic and financial developments present a material downside risk to the US outlook. His comments confirmed the already elevated expectations with regards to easing policy by the Fed, and perhaps turn attention to today’s release of the core PCE index for April.
This is the Fed’s favorite inflation gauge and expectations are for the yoy rate to have remained unchanged at +1.6%. That said, given that the core CPI rate for the month ticked up, we see the risks surrounding the core PCE forecast as tilted slightly to the upside. However, even if the core PCE index ticks up to +1.7%, it would still be below the Fed’s objective of 2%, and is very unlikely to alter expectations with regards to the Fed’s future course of action. In our view, a rebound closer to 2% is needed in order for market participants to take some of their cut bets off the table.
The Nikkei 225 index closed today’s trading session in the negative territory and also finished the week heavily in the red. The price made a lower low and continues to trade below a short-term tentative downside line taken from the high of May 3rd. For now, unless that line gets broken, it seems that the direction for the index could be mainly south, hence why we will take a more bearish stance.
As we can see, Nikkei 225 broke and closed below this week’s low, at 20720, and travelled down. Such a move is not in favour of the buyers yet, as the index still has some room for a further slide. We will now examine a possible test of the 20545 support area, which is the high of February 8th. There is a chance to see a small rebound from there, but if the price stays below the 20720 barrier, this might result in another wave of selling. A drop, and this time a break, below the 20545 obstacle could open the door to a support zone, which is slightly lower, at 20480. That zone marks the high of February 11th.
In order to shift our short-term view to a more positive one, we would like to see a break of the aforementioned downside line and a strong push above the 20985 barrier, marked by yesterday’s high. This way, Nikkei 225 could travel towards the 21095 hurdle, a break of which could clear the road for a further move north. This is when we will target this week’s high, at 21290 level.
Up until yesterday, the bulls still had hope that they would be able to push USD/JPY higher, maybe even beyond the short-term tentative downside resistance line drawn from the high of April 24th. But after the US markets have opened, the pair started sliding and wiped out all the weekly gains overnight. This morning, we can see that the fall continued, which forced the rate to test a key support zone, at 109.00, marked by the lowest point of May, so far. For now, we will remain bearish and aim towards slightly lower areas.
If USD/JPY continues to slide and breaks below that 109.00 hurdle, this would confirm a forthcoming lower low and could clear the path to the 108.72 zone, marked by the low of February 1st. If the rate gets held around there, we may even see a small retracement back up. But if the pair struggles to get back above the 109.00 obstacle, this might interest the bears again, as they could try to take advantage of the higher rate and send USD/JPY back to the downside. If this time the 108.72 level fails to withstand the bear-pressure, a break of it could lead the rate towards the 108.50 mark, which acted as a strong support on January 31st.
In order for us to abandon the bearish case and take a more neutral approach in the very short run, we need to see the pair climbing all the way back to the aforementioned downside line. In order to examine the upside, we would wait for a clear break of that line and a push above the 109.83 barrier, marked by this week’s high. This way, more bulls could start joining in and driving USD/JPY further up towards the 110.36 obstacle, a break of which might open the door to the 110.95 level, marked by the high of May 21st.
During the European morning, we get German retail sales and preliminary inflation numbers for April and May respectively. Retail sales are expected to have rebounded 0.4% mom, after sliding 0.2% in March, something that will drive the yoy rate into positive territory, to +1.1% from -2.1%. With regards to inflation data, both the CPI and HICP rates are anticipated to have declined, to +1.6% yoy and +1.4% yoy from +2.0% and +2.1% respectively. Something like that could raise speculation that the headline CPI rate for the Eurozone as a whole, due out on June 4th, could move in a similar fashion. Coming on top of the bloc’s disappointing PMIs, slowing inflation could prompt investors to raise more bets with regards to additional policy measures by the ECB, beyond the new round of TLTROs, as well as for another delay in the timing of when interest rates could start rising.
Later, from the US, alongside the yoy core PCE rate for April, we get personal income and spending data for the same month. Personal income is forecast to have accelerated to +0.3% mom from +0.1%, but bearing in mind that the monthly earnings rate for the month held steady, we see the risks surrounding the income forecast as tilted somewhat to the downside. Spending is anticipated to have slowed to +0.2% mom from +0.9%, something supported by the slide in April’s retail sales.
From Canada, we get GDP data for Q1 and March. The qoq annualized rate is anticipated to have risen to +0.7% from +0.4% in Q4 2018, while the mom rate for March is anticipated to have risen to +0.4% from -0.1%.
We also have one speaker on today’s agenda: New York Fed President John Williams.
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