PBOC lowers reserve requirements for banks

• The PBOC announced a cut to the reserve requirement for major banks to 12% from 12.5% on Friday, with the change effective from 15 July.  An estimated RMB 1tn (USD 154bn) of additional liquidity will be made available for lending to firms.  The decision comes ahead of Q2 GDP data for China which is expected this Thursday.  Analysts expect growth to have slowed to 8% y/y in Q2 from 18.3% in Q1 21, although last quarter’s high growth was due the pandemic base effects in Q1 2020.     
• Japan’s core machine orders rose by a much faster than expected 7.8% m/m and 12.2% y/y in May, the third consecutive monthly rise despite tighter restrictions to contain the Covid-19 pandemic. The main driver was orders from telecommunications firms, but the data suggests that business investment is recovering and bodes well for growth in H2. Export growth has helped to support the recovery in manufacturing in Japan even as domestic restrictions have weighed on consumption.   
• The minutes of the ECB’s June meeting show that there was broad consensus to maintaining the “significantly higher pace” of PEPP purchases in order to preserve the favourable financing conditions necessary to support growth. The ECB Governing Council did not want to risk a “disorderly rise in yields” at this stage of the recovery, despite the improvement in growth prospects in recent weeks.  In a Bloomberg interview on Sunday night, ECB president Lagarde indicated that the governing council may update its forward guidance on monetary policy at its meeting on 22 July.  She said that she expects the current bond-buying programme to run until “at least” March 2022, after which there may be further monetary support in a new format.  
• UK GDP in May slowed to 0.8% m/m, almost half the 1.5% growth expected by analysts and much slower than the 2.3% m/m growth recorded in April.  Both industrial production and manufacturing production were weaker than expected in May, with growth driven by consumer services (hospitality and entertainment) as pandemic restrictions were eased in May. Inflation data due this week is likely to show a further acceleration in the headline rate to 2.2% y/y.  
• Inflation will be in focus in the US as well, with the headline rate forecast to ease to 4.9% y/y in June even as core inflation rises to 4.0% y/y.  Industrial production data and retail sales are expected to have slowed in June however. 
• Egypt’s headline CPI inflation ticked up modestly in June, rising to 4.9% y/y compared to 4.8% in May. On a month/month basis price growth slowed to 0.2%, from 0.7% the previous month, despite rising global inflationary pressures and PMI survey readings which show the purchase price component rising to the highest level in nearly two years in June. For now, firms have been absorbing the cost increases as they look to support the nascent economic recovery from the pandemic, but the likelihood remains that there will be a gradual acceleration in price growth through the remainder of the year.
• The IMF concluded its latest Article IV consultation with Saudi Arabia last week, saying that the economy is recovering well and forecasting non-oil growth of 4.3% this year, only slightly higher than our 4% forecast. However, the IMF is much more optimistic on oil sector GDP, which it forecasts at -0.4% this year.  In H1 21, Saudi crude oil production was down -7.7% from average 2020 output, and with OPEC+ yet to agree to increase production from August, the IMF’s figures on oil sector growth look optimistic to us.
• The UAE has announced a National Programme for Coders, in partnership with global technology firms including Google and Microsoft, to boost the development of the tech sector in the UAE. The program aims to establish 1000 digital companies and boost investment in technology startups to AED 4bn from AED 1.5bn currently within 5 years.

Today’s Economic Data and Events

Fixed Income

• US Treasuries remained bid last week as enthusiasm for the reflation trade ebbs and markets reprice their inflation expectations. A broad index of US Treasuries gained for a second week in a row, adding 0.44% last week. Gains remain concentrated in the belly and longer end of the curve. Yields on 2yr USTs closed last week down by 2bps at 0.2126%, after a mid-week plunge to 0.1944%. However, 5yr and 7yr yields fell by more than 7bps each while the 10yr yield closed at 1.3595%, down 6bps w/w although yields did crumble do as low as 1.2479% on July 8th.
• The 2s10s curve did manage to turn around at the end of trading last week but at 114bps is at its flattest level since February. Our expectation is for long-run yields to show a steady improvement from their current low levels, helping to steepen the curve by the end of Q3. However, downside risks remain high and any substantial downside data misses in the coming weeks could amplify the flattening trend.
• European bond markets generally displayed the same flattening trend that Treasuries showed with 10yr yields on gilts and bunds declining at a far faster pace than 2yr yields.
• Despite the drop in UST yields, emerging markets showed a mixed performance. Indian 10yr yields rose 12bps to 6.184% last week while Turkish yields added 17bps to 17.015%. South Africa was the notable outlier with yields closing lower albeit only by around 6bps to 9.233%.
• Central bank action this week sees the RBNZ and Bank of Canada on Wednesday while South Korea and Japan round out the week on Thursday and Friday respectively. In the region, the CBRT meets on Tuesday with rates expected to be held at 19% amid worsening inflation conditions. 
• Fitch lowered its rating on Tunisia to ‘B-‘ with a negative outlook..

FX

• Currency markets showed some wide two-way action as markets oscillated between anxiety over the spread of variants of Covid-19 and expectation that developed market central banks will keep policies accommodative in support of growth. The dollar ended the week generally lower although the 0.1% decline in the DXY index to 92.13 over the week was relatively modest.
• The European Central Bank has adopted a more explicit inflation target of 2% and is prepared to accept overshoots over time, a similar approach to that taken from the Federal Reserve. However, the ECB’s challenge to get inflation up sustainably on target looks more onerous than the Fed’s given productivity and demographic challenges facing the eurozone economy. Nevertheless, currency markets didn’t seem overly fazed by the prospect of loose monetary policy in perpetuity and EURUSD managed to climb in the last two trading days of the week, pushing up to 1.1876 by the end of the week, a gain of 0.09% w/w.
• On the flip side though, USDJPY has weakened as markets price in more the risk that the delta variant of Covid-19 could hamstring growth. The pair fell 0.8% last week to 110.14.
• Sterling was the most considerable gainer among major currency pairs, rising by 0.56% to 1.3901 at the end of trading. GBPUSD has recovered much of its post-FOMC swoon with the mid 1.39 level the next test.

Equities

• European and US equity markets bounced back on Friday after what had for many been a challenging Thursday, and most of the major indices closed the week higher than they had done the previous Friday. There were new record highs for the S&P 500, the NASDAQ and the Dow Jones, which closed up 1.1%, 1.0% and 1.3% respectively.
• In Europe, a surge on Friday erased earlier losses for the DAX where some strong earnings releases pushed the index up 1.7% on Friday and closing the week up 0.2%. Even Friday gains of 1.3% for the FTSE 100 and 2.1% for the CAC were not sufficient to erase earlier losses, however, with the UK benchmark closing the week flat while France’s primary share index lost -0.4% w/w
• Losses were more pronounced in Asia, where there are mounting concerns over a slowing recovery and a crackdown on digital firms in China, and pandemic risks in Japan. The Shanghai Composite managed to close up marginally, at 0.2% w/w, but the Hang Seng lost -3.4% and the Nikkei -2.9%.
• Within the region the DFM lost -1.3% w/w but the ADX continued its run with a 0.9% gain. The Tadawul lost -1.4% and the EGX 30 -0.7%.

Commodities

• Oil price slipped last week even as there remains considerable uncertainty over the status of the OPEC+ production cut agreement. Markets have displayed considerable two-way price action following the failure of OPEC+ to get to a deal and ended last week lower in both Brent and WTI futures, their first substantial weekly drop since May. Nevertheless, with Brent futures closing at USD 75.55/b and WTI at USD 74.56/b, prices are still high and forward structures are still expecting considerably tightness in the months ahead. Time spreads for 1-6 months in WTI closed at a backwardation of USD 4.55/b at the end of last week while Brent spreads for the same months closed at USD 3.79/b in backwardation.
• Reports from the IEA and OPEC will set the agenda for this week, likely calling for higher output to address a widening supply shortage in H2. Of note will be their assessment on the response of non-OPEC+ producers to currently high prices. The EIA revised its US oil supply projections up marginally in its latest assessment but the relative restraint US producers are showing is helping to underpin high oil prices. The US drilling rig count rose by 2 last week to 378, still showing a solid upward move from its lows of August 2020 and at around the same pace of addition from when the rig count recovered after plummeting in 2016.
• Precious metals were mixed last week with gold prices managing a third weekly gain as investors move some assets into havens. Silver was off by 1.4% last week while most industrial metals gained with aluminium the sole declining exception.

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