Challenges mounting for US economy
Yesterday, US data revealed that the ISM manufacturing index has remained in contraction for an 8th consecutive month and 100% of the PMI sub-components are now in contraction territory. The reading for June was the worst since the pandemic plunge in May 2020. Historically, ISM reports have served as strong leading indicators for GDP growth, hence another reason to believe the expected US recession is just being delayed.
We expect the Federal Reserve (Fed) to resume raising rates this month, barring any major economic data shocks. Historically, when fed funds futures assign a probability of an outcome of more than 70%, the Fed has typically followed. However, more rates will likely lead the construction and manufacturing sectors to suffer more as we head through the second half of 2023. This will put greater pressure on the services sector to generate the growth needed to sustain employment. We see the ISM services PMI report drop in on Thursday ahead of the key US employment report on Friday, which will be the main data points of the week.
It’s US Independence Day national holiday today, so financial markets are closed across the pond, which might make for another muted day in FX markets. But volatility could easily pick up towards the end of the week with the raft of economic data due.
UK bond yields at 15-year high
The pound continues to consolidate at current levels, grappling with the $1.27 handle against the US dollar and floating above €1.16 against the euro. The rally in short-dated UK bond yields continues to provide the pound an attractive yield premium over its peers, but fears about the impact of more interest rates hikes on the UK economy remain a headwind for sterling.
Prices of over 60% of the items in the UK inflation basket are rising at a rate above 6%, whilst less than 20% are rising at a rate below 2%. Services inflation makes up 47% of the UK inflation basket and continues to stretch to fresh cycle highs. Amidst these relentless price pressures, markets now think the Bank of England (BoE) will have to go further with rate hikes just as other big central banks are nearing the end of their tightening cycles. That expectation pushed the interest rate sensitive two-year UK government bond yield to a 15-year high of 5.40% on Monday, but the pound didn’t climb higher as one would usually expect. Perhaps poor growth prospects are starting to overshadow? Moreover, with speculators raising their bullish bets on sterling to highest level since 2014, this makes positioning rather crowded and could trigger a bout of GBP weakness if these positioned are scaled back.
In the absence of any top-tier UK data this week, or BoE speeches, the pound will continue to be driven by external factors and the performance of global equities given the UK currency’s risk-sensitive nature.
Euro unresponsive to manufacturing recession
The Australian central bank left investors guessing about the future path of monetary policy and spillover effects onto other rate decisions. The pause followed yesterday’s weaker-than-expected purchasing manager indices, which showed the global manufacturing sector remained in negative territory, driven by the deterioration of industrial activity in Europe.
The European Central Bank (ECB) has increased interest rates by 400 basis points already, having lifted its deposit rate to a 22-year high of 3.5%. This has put downward pressure on cyclical parts of the economy, which, at the same time, has faced a disappointing reopening of China. Germany in particular has been singled out as the sick man of Europe with the PMI for the manufacturing sector falling to 40.6, a level that has only been reached during the Global Financial Crisis and the pandemic. The fall of the expectations component to the lowest level since November did confirm that a sharp rebound is unlikely over the summer months. Our first hard data point for May has surprised to the downside as well early today. German exports fell by 0.1% on the month, bringing down the trade balance to €14.4 billion, the lowest level this year.
EUR/USD has been resilient to the deteriorating macro picture in Europe and markets pricing back in the higher for longer narrative, with investors not expecting the Fed to cut rates until March 2024. The currency pair is trading slightly above the $1.09 level and has distanced itself from this year’s average rate of around $1.0830. The euro is still down a percent from the last Fed meeting, which gives us a short-term range of $1.0640 – $1.1000.
Yen nervy as markets on intervention alert
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: July 3 – July 7
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
