Fed speakers present opposing views on rates

• In an interview with CNBC,  St. Louis Federal Reserve President James Bullard said on Friday that the US central bank's shift this week towards a faster tightening of monetary policy was a "natural" response to economic growth, especially as inflation moves quicker than expected as the country reopens from the pandemic. Bullard said he was among the seven Fed policymakers expecting rate increases to begin next year based on his view of the inflation trajectory; he sees core inflation at 3.0% this year and 2.5% in 2022. The Fed released new interest rate forecasts – the dot plot - after a two-day policy meeting on Wednesday showing a core of 13 out of 18 officials projected rates would likely need to increase by the end of 2023, a surprise to many investors and analysts. The dot plot also surprised investors with the median forecast showing two quarter-percentage-point rate increases in 2023.
• At the other end of the spectrum, Minneapolis Federal Reserve President Neel Kashkari said on Friday he wants to keep the US benchmark short-term interest rate near zero at least through the end of 2023 to allow the labor market to return to its pre-pandemic strength. Kashkari added that higher prices are being driven by a reopening economy and will subside as supply constraints recede. He sees full employment meaning a return to at least pre-pandemic labor market strength, or stronger even. Kashkari supports the Fed's decision this week to open a discussion on when and how to reduce its USD 120bn in monthly purchases of Treasuries and mortgage-backed securities , saying he believes Fed Chair Jerome Powell is taking the Fed on a very orderly path to have the discussion and look at the data needed to make adjustments prudentially.
• Fitch raised Britain's outlook to 'stable' from 'negative' on Friday, saying macroeconomic, labor market and fiscal performance since the start of 2021 showed the economy was more resilient to the impact of the pandemic. The rating agency pointed to the successful roll-out of the UK's vaccination program which could dampen the impact of infection cases on healthcare capacity, thus supporting economic resilience. While the economy shrank by 9.8% last year, its sharpest slump in more than 300 years, the economic recovery picked up pace in April, with the fastest monthly growth since July 2020.
• The Central Bank of Egypt kept its benchmark overnight deposit rate on hold at 8.25% on Thursday, in line with our and consensus expectations. The rise in y/y inflation to 4.8% in May (from 4.1% the previous month) made any reduction in rates unlikely as the bank looks to maintain an attractive real interest rate. The bank cited an expectation that inflation would continue to be affected by ‘unfavourable’ base effects related to the pandemic. Positively, the bank’s statement said that preliminary GDP growth in Q1 2020 was 2.9%, compared to 2.0% the previous quarter.
• Turkey’s central bank also kept rates on hold last week, with the one-week repo remaining at 19.0%. The language of the statement was comparatively hawkish, stating that ‘the effects of the rising global inflation and inflation expectations on international financial markets remain significant.’ Inflation fell to 16.6% last month, from 17.1% in April, but while the next move for rates will likely be a cut, this could be pushed back later than had been anticipated given this modest change in tone. The change in tack from the FOMC could also inform the decision, given the weakness seen in the lira last week.
• Dubai has announced that travel restrictions on India, South Africa and Nigeria will be eased from 23 June, allowing vaccinated passengers who carry a negative PCR test to enter the emirate.  This is a positive development for the tourism sector as India is the largest source market for international visitors to Dubai, and passengers have been barred from entering the UAE since late April in response to the surge in coronavirus cases in India.  Travel from South Africa and Nigeria has also been restricted for several months. Separately, the CEO of Dubai Airports is targeting 28mn passengers through the hub this year, around one-third of 2019 passenger traffic.
• Broad money supply in the UAE declined -1.7% m/m and -0.2% y/y in April.  The m/m decline was due to a second consecutive monthly fall in FX and longer-term dirham deposits. Narrow money (M1) grew 0.3% m/m and 15.0% y/y.  Private sector credit grew 0.5% m/m in April but was still down -2.8% y/y.  Bank deposit growth slowed to 0.3% y/y while gross bank lending declined -0.7% y/y.  Retail lending appears to be recovering however, this was up 1.0% m/m and 2.5% y/y after contracting on an annual basis since February 2019. 

Today’s Economic Data and Events

• 5:30 AU Retail Sales (MoM) (May) Forecast 1.10%            
• 5:30 CN PBoC Loan Prime Rate Forecast 3.85%
• 18:15 EU ECB President Lagarde Speaks 

Fixed Income

• US Treasuries whipsawed last week with yields pushed higher by the market’s interpretation of the Federal Reserve’s new dot plot as hawkish before considering the Fed has the tools to contend with inflation, allowing the long-end to rally at the end of the week. The move higher in yields is firmly at the front end and belly of the curve with 2yr UST yields up almost 11bps at 0.2541% and the 3yr and 5yr adding 16bps and 14bps respectively. Meanwhile yields on the 10yr and 30yr fell 1bp and 12bps respectively with the 30yr now back to a 2% handle for the first time since February.
• European markets were more uniform in their moves lower, however, with yields on short and long-run bonds higher in gilts and bunds. The Bank of England will be in focus for the UK this week where the near-term economic outlook has softened in the face of rising Covid-19 case numbers.
• Emerging market bonds were widely mixed over the course of last week with some responding negatively to a Fed perceived as more hawkish—South African yields were up 28bps on the 10yr to 9.256%--while Turkey saw a strong performance on the 10yr with yields down 62bps to 17.21%.
• Fitch affirmed their rating on Qatar at ‘AA-‘ with a stable outlook, citing strong foreign reserves and a good outlook for lowering its debt level.
• Central bank action this week will see the PBOC set its prime loan rate on June 21, Bank Maghrib meets on June 22, Bank of Thailand on June 23 while the Philippines and Mexico will decide on June 24 along with the Bank of England.

FX

• The Fed’s shift in its dot plot helped boost the dollar as the DXY gained by its largest amount since September last year. At 92.225 the DXY index has managed to recover all of the dollar’s recent losses and is now up 2.5% since the start of the year. The rise in short-term UST yields is likely to be followed by a move higher in interbank rates which could draw more flows to the dollar, strengthening it against negative yielders in particularly over the next few weeks.
• The Euro was one of the main losers in response to the market’s hawkish interpretation of Fed policy. The single currency fell 2% last week to 1.1864, its softest level against the dollar since the start of April. While we would expect near-term weakness to be the trend for the Euro this week we would expect some of the more hawkish central bankers on the ECB governing council to again push for their own tapering of the PEPP asset buying occurring perhaps as early as the end of Q3.
• Elsewhere USDJPY added another 0.5% to push back above the 110 level while GBPUSD and CHF were the other notable underperformers amid a stronger USD outlook. The Bank of England this week is likely to keep near-term accommodation in place amid rising Covid-19 numbers while talking up the general economic recovery underway.
• Commodity currencies endured a sharp move lower as their yield differentials to the US gets compressed. CAD weakened 2.5% to the US dollar while ZUD and NZD sank almost 3% and 2.7% respectively.

Equities

• A comparatively hawkish turn by the FOMC last week weighed heavily on stock markets around the world as the dollar surged. This was especially pronounced in Europe, as big sell-offs on Friday following comments from Federal Reserve Bank of St. Louis President James Bullard which saw the composite STOXX 600 lose -1.2% w/w.
• While France’s CAC was down only -0.5% over the week, buoyed by the rapid recovery from the pandemic ongoing there, Germany’s DAX and the UK’s FTSE 100 both lost -1.6% w/w. The FTSE was also impacted by a dip in UK retail sales in May, as consumers took advantage of reopening hospitality venues.
• There were also big drops in the US on Friday after Bullard’s comments, compounding the losses seen earlier in the week. A -1.6% drop in Friday’s session saw the Dow Jones close down -3.5% lower than the previous week. The S&P 500 lost -1.9% w/w, while the tech-heavy NASDAQ was comparatively unscathed with a -0.3% w/w loss.

Commodities

• The surge in the dollar failed to dent the move higher in oil, although gains are now coming at a slower pace. Brent futures rose 1.1% last week, closing out at USD 73.51/b while WTI ended the week at USD 71.64/b, up slightly more than 1%. The fundamental picture for oil remains tight in the coming months, suggesting high prices will be able to withstand a stronger dollar.
• The Iran nuclear talks resume this week while presidential elections in Iran have seen a conservative jurist, Ebrahim Raisi, elected. He will not take office until later this summer and has indicated he supports a deal in any case. We will revise our outlook on Iran returning to oil markets in a larger manner if the terms of a deal have been reached.
• While the rise in the dollar seemingly did little damage to energy commodities metals were brutalized across the board. Gold prices fell more than 6% to USD 1,764/troy oz, driven lower by the rise in short- and mid-term rates. Among the rest of the precious metals group the sell off was worse with silver down nearly 8%, platinum down 9% and palladium off by nearly 11%.
• Industrial metals too were uniformly weaker. Aluminium on the LME fell more than 3% to USD 2,385/tonne while copper pulled back by nearly 9% to USD 9,145/tonne. The slip in copper prices may be more short lived than in aluminium given the still reasonably tight picture for the metal.

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