Sample Category Title

Despite coming under some pressure against its US counterpart lately, the British pound remains the best performing currency year-to-date. Will it continue performing well henceforth? With underlying inflation creeping up again in April, investors are hoping that the Bank of England will intensify its efforts to bring it to heel. But will policymakers rise to the occasion?

UK inflation slows, but core unexpectedly accelerates

With the BoE abandoning its recession call and signaling that they will not hesitate to raise rates further should inflation pressures persist, market participants remained convinced that officials could deliver two more quarter-point increases by the end of the year.

However, that was the case before May 24, the day when the inflation numbers for April were released. The data revealed that the headline CPI slowed by less than expected, to 8.7% year-on-year from 10.1%, but what was much more worrisome was the unexpected acceleration in underlying inflation to 6.8% y/y from 6.2%. This suggested that price pressures are becoming more embedded in the broader economy, and that the decline in the headline rate was just the result of a slowdown in the prices of volatile items like energy.

With no recession calls, investors double their BoE hike bets

With that in mind, investors have doubled their bets, now almost 100bps worth of additional rate increments by December, with a first quarter-point cut being nearly fully priced in for May 2024. And all this even after preliminary PMIs for May disappointed last week. Perhaps investors are content with the fact that the composite index is still pointing to expansion, which enhances the view that the UK economy may have avoided a recession.

After November, when the BoE predicted the longest recession in the UK economy’s history, the financial community viewed the Bank’s slow and cautious tightening as a wise choice, but with all the economic engines performing better than feared then and inflation remaining out of control, market participants are now hoping for, or even demanding, more aggressive action by the Bank.

Will Bailey and co rise to the occasion?

Bailey and his fellow policymakers may have no other choice than to signal that more tightening is needed. Although the PMIs came in weaker than expected, they revealed that output charges continued to rise, and although they eased to the slowest in three months, they remained elevated by the survey’s historical standards. What’s more, average weekly earnings accelerated in March, which means that consumer demand could stay strong in the months to come and thereby keep inflation elevated.

Consequently, a 25bps hike at the BoE’s upcoming gathering may not constitute an adequate reason for celebration. Pound traders may feel satisfied and willing to add to their long positions if the Bank appears willing to keep raising rates as forcefully as needed to tame the inflation beast.

The pound may benefit heading into the June meeting by the fact that investors are taking a leap of faith and trust that the BoE may continue raising interest rates more aggressively than any other major central bank, while the currency may strengthen even more if policymakers appear determined to do whatever it takes to bring inflation to heel.

Pound remains the best performing major currency year-to-date

Although it pulled back against its US counterpart recently, the British currency remains the top performer among the majors since the beginning of the year, and monetary policy may have not been the only source of fuel. Due to the UK’s twin deficit, sterling has turned into a risk-linked currency the last few years, strengthening when equities rise and vice versa.

With Wall Street in an uptrend mode, it seems that the pound may have indeed benefited from investors’ willingness to keep increasing their risk exposure. But why didn’t the other traditional risk-linked currencies aussie and kiwi follow suit? Perhaps due to Chinese data suggesting that after the post-reopening boost, Australia’s and New Zealand’s main trading partner is losing momentum.

Currently, equity traders seem to be indifferent, or less interested, to Chinese data, preferring to ride the artificial intelligence (AI) trend as optimism and better forecasts of tech firms are probably on top of their lists.

Putting everything together, with the dollar staging a decent comeback lately due to the market reevaluating its implied Fed rate path, pound/dollar may not be the best choice for exploiting further gains in the pound, at least in the short run. The yen and the kiwi may be more appropriate candidates as the BoJ is sticking to its ultra-loose monetary policy and the RBNZ seems to be over with this tightening cycle.

Pound may continue to benefit the most against the kiwi

Having said that, choosing the yen carries more risks as the BoJ may eventually proceed with more normalizing steps, while an unexpected turbulent market episode will not only weigh on the pound, but also benefit the safe-haven yen. So, ultimately, the best option could be the pound/kiwi pair as the risk-on characteristics of both currencies are somewhat offsetting each other and thus, the probability of violent swings when sentiment changes may be smaller. Even if the sentiment-related forces are not equal, the current market landscape suggests that the pound has an advantage either way. It gains more in risk-on episodes and loses less in risk-off.

Indeed, since last Wednesday, when the RBNZ hinted that it is probably done raising interest rates, pound/kiwi has been in a fly mode, breaking above the high of April 26 just this Tuesday and signaling the continuation of the prevailing uptrend.

The pair now looks to be headed towards the 2.0700 territory, marked by the highs of May 2020, the break of which could carry extensions towards the 2.1000 zone, which acted as a ceiling between mid-March and mid-April of that same year.

For the outlook to turn bearish, the bears may have to drive the action all the way down and below the 1.9800 area, which offered strong support this month and coincided with the 38.2% Fibonacci retracement level of the February 3 – April 26 upleg.

The May ISM Manufacturing Index registered 46.9, barely changed from April's 47.1 reading and roughly in line with expectations for a 47.0 print.

New orders pulled back 3.1 percentage points (pp) to 42.6, while new export orders ticked up 0.2 pp to 50.0.

The backlog of orders sub-index tumbled to 37.5, down 5.6 pp from April's 43.1 print. This is the lowest reading since March 2009.

The production and employment indexes both reflected growth, rising 2.2 pp and 1.2 pp, respectively, to 51.1 and 51.4.

The supplier deliveries sub-index fell to 43.5 from 44.6 in April, reflecting faster supplier deliveries. The prices index showed raw materials gave back some of their gains from April as the index pulled back 9.0 pp to 44.2.

Four of 18 manufacturing industries reported growth in May. The industries reporting growth are Nonmetallic Mineral Products; Furniture & Related Products; Transportation Equipment; and Fabricated Metal Products.

Key Implications

The slowdown in the manufacturing sector continues with little relief in sight. Nine consecutive months of falling new orders and order backlogs contracting at their fastest clip since the Great Recession reflect a sector whose near-term outlook is facing significant headwinds.

Looking forward, macroeconomic conditions are unlikely to improve the sector's prospects. Strong labor market data is lifting the odds that the Fed may have to extend its rate hiking cycle – prolonging the pain for the interest rate sensitive goods sector. That said, there is a silver lining to this report as the Transportation Equipment sector reported expansion in the month. With falling supplier delivery times, and clearing backlogs, the prospect of increased inventory in the automotive sector will be a welcome development for firms and households that have delayed purchases amidst historically tight supply conditions.

• Disinflation Trends might be back as prices paid plunged 9 points in the ISM manufacturing report
• ADP Report: Pay growth is slowing substantially
• Still waiting on layoff announcements to hit jobless claims data

US stocks are rising after some dovish Fed speak and as the House was able to advance the debt ceiling bill to the Senate. ​ So far everything with the debt ceiling deal is going as planned after both the House Rules Committee and House of Representatives did their part to get this bill closer to President Biden’s desk. Last night’s House vote showed one of best bipartisan votes in history as 165 Democrats and 149 Republicans supported the bill. ​ The deal is now in the Senate’s hands and the question is not if they will pass the bill but on when they will get it done. Majority Leader Schumer noted they are trying to get it done as soon as possible. ​ A vote could happen today as lawmakers signal they are going to try to restrict amendments. ​ ​ ​ ​ ​

The latest Fed speak was rather dovish as Jefferson and Harker voiced support for skipping a rate hike at the June meeting. ​ The Fed Whisperer Timiraos also noted that the FOMC is likely to hold rates steady in June. ​

Wall Street decided to shrug off a hot ADP report and another low jobless claims print and focus on a lower final reading on unit labor costs. ​ The labor market is still looking strong, but perhaps we are seeing some signs that wage growth is gradually falling. Treasury yields rose on ADP, but tumbled after a near 2-point downward revision with labor costs. ​ ​ ​

US Data

Private payrolls posted another robust beat as employment increased by 278,000 in May, much higher than the 170,000 consensus estimate and slightly lower than revised 291,000 prior reading. The ADP report noted, ““Pay growth is slowing substantially, and wage-driven inflation may be less of a concern for the economy despite robust hiring.”

The 830am economic data drop showed jobless claims remain anchored for now and that first quarter unit labor costs were revised significantly lower. ​

The ISM manufacturing report was somewhat mixed as prices paid tumbled to contraction territory, export orders were stable, and new orders along with the backlog of orders remained rather depressed. ​ ​

The key takeaway from the ADP report and unit labor costs is that wage pressures are showing clear signs of weakness, and this is supporting the argument for the Fed to skip the June meeting. ​ The ISM report is showing that the manufacturing space is getting close to finding a bottom as commodity prices come down and as lower prices should bring back buyers. ​

The NFP report might not show a significant weakening in the labor market, but the downward trend should be in place. ​

S&P 500 Daily Chart

The US 100 stock index (cash) opened June’s trading session on a neutral note, though the formation of a bearish doji at the top of the uptrend keeps feeding speculation that the latest remarkable rally has probably peaked.

The RSI and the stochastic oscillator are witnessing overbought conditions. Yet, with the former standing above 70 and the latter preserving a horizontal trajectory around 80, upside pressures could last a bit longer, especially if the 14,215 nearby support area stands firm.

In the event the price heads lower, the next destination could be the 13,885-13,750 zone, where the 20-day simple moving average is converging. The 13,550 territory may attract greater interest as the resistance line from February’s high and the ascending trendline from March’s low intersect each other at this point. Failure to pivot here could shift the spotlight on the 50-day SMA at 13,300.

Conversely, if the index pivots near 14,215, the bulls will target the 14,375 barrier, which overlaps with the 23.6% Fibonacci retracement of the 6,634-16,767 uptrend. An extension beyond the 14,529 top could stall somewhere between 14,795 and 15,000, while higher, the next obstacle could pop up around the constraining region of 15,275.

All in all, the US 100 index might be on the verge of a new bear run. A close below 14,215 could extend the pullback from May’s one-year high.  

Markets

The bond market rally from earlier this week took a breather this morning. With no more than two 25 bps ECB interest rate hikes discounted through summer and expectations for an additional Fed hike pushed back to July, one might have expected the case to push for more dovishness to have become less compelling, unless it would be backed by outspoken soft data. Indeed, EMU May headline inflation dropped from 7.0% to 6.1%. Core inflation also slowed more than (initially) expected from 5.6% to 5.3%. However, this was no big surprise after national data released earlier this week. Still, 5%+ core inflation is far from a guarantee for the ECB to be sure it is on track to sustainably return inflation back to 2.0%. In the accounts of the early May ECB meeting, developments on core inflation was still seen as a major source of concern. In this respect, ECB ‘hawks’ wanted a directional bias, clarifying that, despite slowing down the pace of hikes to 25 bps, further steps would be warranted. The EMU CPI release left few traces on (interest rate markets). However early in US dealings, yields reversed the early rise, probably as markets still pondered yesterday’s guidance from Fed governors Harker and Jefferson to ‘skip’ a June rate hike and take time to asses incoming data. The ADP labour market report at least didn’t bring much of a strong case for the ‘skip’. 278k of additional US private sector jobs in May again beat the consensus by a wide margin. Jobless claims at 232k also suggested persistent labour market strength. However, a downward revision of the Q1 US unit labour costs from 6.0% to 4.2% was enough to push daily yield changes back in red. Whether this ‘outdated’ series is important input for the Fed’s assessment is subject to discussion. Even so, US yields currently are ceding between 3.5 bps (2-y) and 6 bps (5-y). After finishing this report, the US manufacturing ISM still has to published. The price action on the early morning data at least suggests a tentative dovish bias going into the release. German yields also reversed an initial rise to currently cede up to 3 bps (10-y). Better than expected Chinese data (Caixin PMI) and a (potentially/hoped for) more benign inflation environment initially supported a comeback of European equities. However, the intraday dynamics is far from convincing. The Eurostoxx 50 only gains 0.45% after yesterday’s 1.7% decline. US indices open little changed.

On FX markets, the dollar eases off recent peak levels. DXY is at risk of falling below the 104 big figure. EUR/USD tries to regain the 1.07 barrier mainly on USD weakness rather than on outright euro strength. It’s too early to call off the downward alert. USD/JPY is further drifting off the 140 barrier (139.10). Sterling continues outperforming both the dollar (Cable 1.2475) and the euro. At EUR/GBP 0.858, key 0.8547 December low is coming with reach.

News & Views

The National Bank of Belgium upwardly revised the Q1 GDP figure from 0.4% Q/Q to 0.5% Q/Q (1.4% Y/Y from 1.3% /Y). Details were constructive. Household consumption rose by 0.6% Q/Q, with the increase driven by purchases of non-durable goods. Business investment grew by 1.9% Q/Q while government consumption declined by 0.7% Q/Q. Inventories decreased by 0.2% Q/Q. Imports and exports of goods and services both contracted 1% in Q1 (net export 0%). In the supply-side breakdown, value added in the manufacturing industry declined by 0.6% Q/Q. The services sector grew by 0.8% Q/Q and the building industry by 0.3% Q/Q. Domestic employment rose by 0.3% Q/Q (1.3% Y/Y). Separately, StatBel reported a 9.8% annualized increase in the hourly labour cost in Q1 2023, which is the strongest since the start of the series in 2000. The sharpest increase is registered in Accommodation and food service activities  with 10.5%, while the lowest increase was observed in Electricity, gas, steam and air conditioning supply with +7.7%.

The Slovak Republic raised €2bn today via a new 10yr syndicated deal. Order books totaled over €7.7bn, resulting in a significant price concession compared to initial price takings in the MS +95 bps area and revised guidance at MS +85 bps. The bond was eventually priced at MS + 80 bps. Slovak debt agency Ardal is well-advanced with this year’s funding. YTD, they now raised €8.26bn. The lion share of the amount came from today’s syndication and from two other benchmark deals in February (€2bn Feb2035 & €1.5bn Feb2043). In its official funding plans, Ardal estimated this year’s gross borrowing requirement at €13bn, but they aimed for only €8bn of bond issuance with EU funds and the cash buffer doing the rest of the job.

Daily Pivots: (S1) 138.93; (P) 139.66; (R1) 140.07; More...

Intraday bias in USD/JPY remains neutral for the moment. Downside of retreat should be contained above 138.22 support to bring another rally. Break of 140.90 will resume larger rise from 127.20 to 142.48 fibonacci level. However, considering bearish divergence condition in 4 hour MACD, break of 138.22 will confirm short term topping, and turn bias back to the downside for 55 D EMA (now at 135.89).

In the bigger picture, rise from 127.20 is seen as the second leg of the corrective pattern from 151.93 high. Stronger rally would be seen to 61.8% retracement of 151.93 to 127.20 at 136.34. Sustained break there will pave the way back to retest 151.93. On the downside, however, break of 133.73 support will argue that the pattern could have started the third leg through 127.20 low.

Daily Pivots: (S1) 0.9055; (P) 0.9102; (R1) 0.9153; More...

Further rise is expected in USD/CHF as long as 0.9013 minor support holds. Current rally is seen as correcting whole down trend from 1.0146. Further rise should then be seen to 38.2% retracement of 1.0146 to 0.8818 at 0.9325. On the downside, below 0.9013 minor support will turn intraday bias neutral first.

In the bigger picture, fall from 1.1046 (2022 high) is seen as a leg in the long term range pattern from 1.0342 (2016 high). So, downside should be contained by 0.8756 to bring reversal. Sustained break of 0.9058 support turned resistance will be the first sign of medium term bottoming. However, decisive break of 0.8756 will carry larger bearish implications.

Daily Pivots: (S1) 1.0637; (P) 1.0687; (R1) 1.1.0739; More...

Intraday bias in EUR/USD is turned neutral again with today's recovery. Considering bullish convergence condition in 4H MACD, break of 1.0745 minor resistance will indicate short term bottoming at 1.0634. Intraday bias will then be back on the upside for rebound to 55 D EMA (now at 1.0836). Nevertheless, break of 1.0634 will resume the fall from 1.1094 to 1.0515 cluster support, 38.2% retracement of 0.9534 to 1.1094 at 1.0498.

In the bigger picture, as long as 1.0515 support holds, rise from 0.9534 (2022 low) would still extend higher. Sustained break of 61.8% retracement of 1.2348 (2021 high) to 0.9534 at 1.1273 will solidify the case of bullish trend reversal and target 1.2348 resistance next (2021 high).

US ISM Manufacturing PMI dropped from 47.1 to 46.9 in May, below expectation of 47.0. Looking at some details, new orders dropped from 45.7 to 42.6. Production rose from 48.9 to 51.1. Employment rose from 50.2 to 51.4. Prices dropped sharply from 53.2 to 44.2.

ISM said: " "This is the seventh month of contraction and continuation of a downward trend that began in June 2022. That trend is reflected in the Manufacturing PMI's 12-month average falling to 49.4 percent."

"The past relationship between the Manufacturing PMI and the overall economy indicates that the May reading (46.9 percent) corresponds to a change of minus-0.6 percent in real gross domestic product (GDP) on an annualized basis."

Full US ISM manufacturing release here.