US National Holiday Kept Volumes Low

Markets

UK gilts sold off yesterday and dragged its core peers along. A YouGov and Citi poll showing UK public inflation expectations for the year ahead rose to 5% in June (from 4.7%) helped explain the underperformance. The front end of the curve rose more than 11 bps in the UK, 8 bps in Germany and 6 bps in the US before momentum ebbed away as we moved into the publication of the June US ISM manufacturing gauge. The index unexpectedly slipped further to 46 from 46.9 (47.1 expected). Production fell (46.7), as did new orders (though not as quick as in the month before, 45.6) and employment (48.1). Prices paid tumbled to 41.8. Core bonds extended gains in a kneejerk move higher but almost as equally fast gave them up again. Changes eventually ranged between +2.2 to 6.9 bps in the UK, 0.6-6.7 bps in Germany and 0.3-4.7 bps in the US with all of the curves deepening the inversion. Large intraday swings in yields had little to no effect on currency markets. EUR/USD flipflopped around the 1.09 big figure just to close almost unchanged north of that big figure. DXY did about the same around 103 and EUR/GBP around 0.86. The Japanese yen lost some ground again with USD/JPY still near the September 2022 FX intervention levels (145). Stocks struggled for direction. European equities finished flat and Wall Street ended a holiday-shortened trading day marginally higher. Oil only temporarily rebounded on a Saudi announcement that it will extend its voluntary 1 mln b/d production cut into August.

The RBA policy decision was the focal point in Asian trading this morning (see below), delivering a minor hit to the Aussie dollar. CNY strengthens marginally after the PBOC continued its streak of stronger-than-expected fixings. Japan’s yen stabilizes. Core bonds trade sideways. US cash markets are closed for Independence Day though. This looming US national holiday kept volumes low already yesterday as many enjoy an extended, four-day weekend. Absence of US investors and a near-empty economic calendar will result in uninspired, technical trading. We remain focused on the latter part of this week, especially after yesterday’s interesting market reaction on a slightly disappointing US manufacturing ISM. Its meaning may be that markets look through weak(er) activity data and keep a closer eye on inflation and the Fed’s response. But it just as well might suggest that cracks are starting to show in the recent yield rally, with a potential correction lower in the making with a proper trigger. The dominating narrative for this week, and perhaps several next, will depend on the data still scheduled for release (US ISM services on Thursday, payrolls Friday etc.).

News and views

The Reserve Bank of Australia kept its policy rate as expected unchanged at 4.1% this morning. It’s the RBA’s second pause this year after keeping rates stable in April (at 3.6%) only to implement back-to-back rate hikes in May and June afterwards. Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve. The decision to hold interest rates steady this month buys time to assess data and associated risks. Growth in the Australian economy has slowed and conditions in the labour market have eased, although they remain very tight (wage inflation up). Australian inflation has passed its peak, but inflation is still too high and will remain so for some time yet. The Board remains alert to the risk that expectations of ongoing high inflation will contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the still very low rate of unemployment. The Aussie dollar lost some ground (AUD/USD 0.6645 from 0.6685) with AUD swap yields up to 4 bps lower at the front end. Money market still discount a final rate hike before year-end.

Megan Greene, who joins the Bank of England’s Monetary Policy Committee in August, argued in an FT column, argues against estimates by NY Fed Williams and some of his colleagues that the long-run neutral rate (r-star) has barely budged after the combined hit of the pandemic, Russian war, energy crisis and end to the low inflation era. The IMF for now is also on that line. Greene says that even if R-star hasn’t already risen (given it’s a concept, not something that can be observed), that doesn’t mean it won’t. Her comments suggest she’ll be a hawkish vote within the MPC.