Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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FX Update: Stretched positioning is pent-up energy.
John J. Hardy
Global Head of Macro Strategy
Summary: The US June jobs report on Friday failed to confirm the wildly strong ADP payrolls change numbers the prior session. The negative revisions to prior payrolls and slightly soft print pushed US front-end yields lower and took the US dollar down a few notches, if not decisively. The JPY jumped higher and reminds us to have a look at the latest update to the latest weekly currency futures positions in the US, which suggest considerable stored energy in the yen, sterling and others.
FX Trading focus:
- US jobs report Friday fails to confirm the wildly strong ADP payrolls numbers from the prior day.
- Upside risks for the JPY due to positioning. If we follow positioning logic – could be broad phenomenon.
- AUD remains soft on China CPI pointing to deflation risks, NOK jumps on hot CPI
- US CPI the focus this week, but RBNZ and Bank of Canada also on tap.
The official US June jobs report on Friday failed to confirm the wildly strong June ADP payrolls growth numbers from the prior day. Not only was the Nonfarm Payrolls print a touch softer than expected at 209k vs. consensus near 230k, but the revisions of the prior two months’ data was -110k. On the positive side, average hourly earnings were a touch firmer than expected despite an 0.1 hour uptick in the average weekly hours (which increase the denominator). The market reaction was quite brutal for the US dollar as front-end US yields pushed lower still after a spike higher and reverse the prior day. Longer US yields actually rose, steepening the US treasury yield curve further.
JPY firmed again Friday – plenty more room for positioning to cause trouble for shorts.
Following up on the stronger JPY that I discussed in Friday’s piece, in which I noted how remarkable it is to see the coincidence of a stronger JPY late last week even as US long treasury yields also rose sharply (particularly on Thursday’s wild US June ADP payrolls print). The JPY-US 10-year correlation, as measured by the R-squared for the last 500 trading sessions is 0.89. As I argued Friday, one explanation for the action late last week was from a positioning angle: simply that short positioning in the JPY is quite aggressive, and when volatility across markets picks up on weak risk sentiment, position unwinding often sets in.
To quote my piece on Friday:
“….any event that sparks significant general volatility and risk aversion can lead to position squaring in what have been the most profitable trades – like long MXNJPY and CADJPY, BRLJPY, etc. Some of those flows were predicated on the idea that rates were set to fall as EM banks might prove the first to cut rates as growth and inflation ease off. Those flows can overwhelm other considerations (like the prior negative focus on the JPY on rising global yields, especially at the long end of yield curves – continuing to challenge the Bank of Japan’s ongoing easing, etc.). “
The firm JPY on Thursday might be have been driven by the dynamic described above, as we also saw very weak EM currencies that day. But Friday’s jobs report took the steam out of some of the prior day’s developments, as MXN and sterling jumped back higher on the US jobs data lowering yields at the front end of the US yield curve as the crazy jump in the ADP numbers was not confirmed.
Chart: US Non-commercial futures market positioning: JPY, GBP, MXN, EUR (vs. USD).
Overall FX positioning has likely not yet been significantly unwound by the action last week, and if risk sentiment weakens further, I would expect significant further risk of JPY strength, possibly indiscriminate across all JPY pairs, but more likely concentrated against other currencies where positioning is the wrong way around: on that note GBPJPY stands out in the US futures positioning data as noted below, with the non-commercial participants the longest they have been of sterling versus the US dollar save for three other occasions since the global financial crisis. Arguably, the most powerful signal supporting a further JPY rally this week would be softer than expected US CPI inflation numbers that fails to support risk sentiment, but anything that engineers significantly weaker risk sentiment may be enough to drive a JPY rally.
Tale of diverging CPI’s: China versus Norway
China reported its CPI and PPI for June overnight, with the former coming in at a stunning 0.0% YoY vs. +0.2% expected and core CPI hardly above zero either at 0.4% YoY. PPI was out at -5.4% YoY vs. -5.0% expected and -4.6% in May. China’s suddenly deflationary dynamics are getting considerable attention, with Richard Koo, who minted the “balance sheet recession” term and has been the expert on Japan’s experience for years, now seeing a surge in popularity as his framework is now seen highly applicable to China. The latest Odd Lots podcast features Koo as a guest. The soft Chinese inflation data has the AUD limping at the lower end of the range versus the US dollar again.
Norway, on the other hand, is seeing an entirely different inflationary dynamic, as its core “underlying” inflation metric surged another 0.9% MoM in June and 7.0% YoY, a new cycle high. This and the surge in crude oil prices on Friday have seen NOK making a show of strength as front-end Norwegian yields jump. Watching the sub-11.50 pivot lows from last month for more upside potential for NOK.
Macro week ahead: UK employment/earnings, US CPI, RBNZ, BoC
Plenty to focus on this week on the macro calendar, with the US CPI data the focus of the week on Wednesday. A couple of highlights:
TUE: UK Jun. Payrolls/Claims and May Earnings/Employment data.
The market could prove twitchy on these UK employment and earnings data on significant surprises. There was an enormous surge in claims and drop in payrolls two months back that was entirely revised out in the case of payrolls and revised significantly lower in the case of claims. Earnings registered a 7.2% YoY increase, nearly matching the cycle high from back in 2021.
WED: RBNZ, US June CPI and Bank of Canada
Little drama expected from the RBNZ this week as Orr and company were early and quick to tighten and the market figures they are happy with the current level until possibly October or November, depending on where inflation is headed – and the quarterly Q2 inflation data is up next week, carrying more weight, likely, than anything that the RBNZ has to say.
The US June CPI is the data, with the headline number expected to drop all the way to 3.1% YoY from 4.0% in May due to basing effects, as the worst of the spike in gasoline prices hit in June of last year. The core inflation is expected at +0.3% MoM and +5.0% YoY vs. 5.3% YoY in May and a peak rate last September of 6.6%. The PCE data series has shown somewhat stickier core inflation than this BLS’ CPI data series.
The Bank of Canada is priced significantly better than 50/50 to hike another 25 basis points, which would take the rate to 5.00%. It makes sense for the Bank of Canada to hike again – why restart the hiking cycle in June only to pause once again? The guidance will be more important than the decision on whether to hike. USDCAD reversed sharply on Friday after the US jobs data (with ripping Canadian jobs data on Friday providing most of the impetus, together with resurgent oil prices).
Table: FX Board of G10 and CNH trend evolution and strength.
The JPY down-trend has lost considerable strength, but it will take more doing to reverse. The US dollar in focus now after Friday’s sell-off, with Wednesday’s CPI the next test there. NOK is strong on today’s CPI release and the oil rebound Friday.
Table: FX Board Trend Scoreboard for individual pairs.
AUDJPY is the first JPY cross after CNHJPY to cross to a negative trend reading, with USDJPY not terrible far away after 65 trading days – 13 weeks in positive territory. GBPJPY has been in a positive trend for 73 trading days.
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – Canada May Building Permits
- 1500 – US Fed’s Mester (Voter in 2024) to speak
- 1500 – UK Bank of England Governor Bailey to speak
- 1600 – US Fed’s Bostic (Voter in 2024) to speak
- 0030 – Australia Jul. Westpac Consumer Confidence
- 0130 – Australia Jun. NAB Business Confidence
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