China data improves on domestic and external factors
Unexpectedly, China’s NBS PMI surprised higher providing evidence that the China growth story remains undervalued and there is still solid external demand. China’s June NBA manufacturing PMI increased to 51.7 above 51.0. The good data was driven by new orders and higher production readings. Production index increased to 54.4 from 53.4 in May while new orders rose to 53.1 from 52.3 in May.
Clearly, rumours of a domestic collapse is far from reality, as China’s domestic activity remains resilient regardless of distant signals of decelerations. There has been some slowing due to softer investment activity indicating that the government’s drive to shutdown areas of “shadow” banking has been effective. Chinese authorities, in our mind, are doing a decent job balancing the need to deleveraging and support the economy. Micro-tuning in credit availability will likely slow interest rate sensitive areas such as real estate and infrastructure financing but it is unlikely to derail growth broadly. We still anticipate 6.8% GDP growth for 2017.
The other bright spot of the data release was the exports orders index, which continued to improve to 52.0 – a five-year high. Solid export growth alongside general risk appetite should support investors’ demand for regional EM FX currencies. From a relative value standpoint traders should be favouring Europe and Asia EM over the US. European growth has surprised to the upside, China’s economy slowing is less than expected with plenty of bright spots while the US data has underperformed and political uncertainty makes outlook significantly challenging.
The euro stabilises amid sharp gains
Despite an upward shift in the German yield curve and better-than-expected inflation data (HICP printed at 1.5 y/y in June versus 1.3% median forecast) the single currency struggled to extend gains as it tumbled on the $1.1447 resistance (high from May 11th 2016).
On the short-end of the curve, German 2-year yields stabilised at -0.55% after rising more than 40bps since February. On the long-hand, 10-year yields kept on climbing higher – 0.46% compared to 0.18% in February – amid rising inflation expectation.
Indeed, the sharp pick-up in the 5y5y inflation swap forward rate (up 9bps to 1.61% in less than a week) shows that market participants have revised upwardly their inflation expectations, which naturally translated into higher nominal rates, helping the EUR to gain momentum.
In the US, the upside surprise in 1Q GDP failed to reverse the sell-off that has sent the USD to a multi-month low but it did at least help to stop the bleeding. The final revision of the first quarter GDP printed at 1.4% q/q (annualised), while personal consumption got some colour back and rose 1.1q/q (saar: seasonally adjusted annual rate). The dollar index fell to its lowest level since early November last year and hit 95.47, erasing completely the gains that followed the election of Donald Trump.
Given the quick and sharp debasement of the greenback, we think investors are eager to take those profits home and take time to reassess the situation, especially after the muddled comments from Carney and Draghi on Wednesday.
A return of EUR/USD to the 1.12 level (38.2% Fibonacci on April-June rally) cannot be ruled out; however the pair should take a pause at around 1.13 before any potential downside move. Given the recent brightening of the EU economic picture, we maintain our long EUR bias against the USD.
Swiss data improves, sell CHF
Switzerland’s KOF Leading Indicator reversed the prior month’s weak read surging to 105.5 (from 102.0 in May). The jump nearly covered last month’s decline and highlighted that the upwards trend indicates near term outlook remains solid. This recovery should help alleviate some concern that the Swiss economy was decelerating quicker due to the stronger CHF. The strongest drive was manufacturing, which offset some of the negative pull of construction. As discussed in the piece on China, stronger external demand helped improve the Swiss outlook around incoming orders.
We suspect that the improvement in sentiment around business climate and competitiveness can be traced to the slightly weaker CHF against the Euro. Improvement in growth and low political uncertainty has sent capital back into Europe allowing the SNB to decelerate FX intervention preventing CHF appreciation.
We remain bearish on the CHF as the SNB monetary policy is not likely to shift any time soon while ECB, Fed and members of the BoE have increasingly signaled moves toward “normalisation” and tighter policy. We view the GBPCHF as the best way to manifest this policy divergent view.
