Powell defends monetary policy stance

• In his testimony to the House Financial Services Committee yesterday, Jerome Powell re-iterated the Fed’s view that while inflation has “increased notably and will likely remain elevated in coming months”, it remains largely due bottlenecks and supply constraints which will fade.  However, he said that if the Fed saw the path of inflation and inflation expectations move materially beyond levels consistent with their goal, then the Fed would adjust the stance of monetary policy appropriately.  In the meantime, the FOMC still believes the “substantial further progress” on employment is still “a ways off”. 
• Producer inflation in the US rose by 1.0% m/m and 7.3% y/y in June, above the market’s forecast of 6.7% y/y. Core PPI accelerated to 5.6% y/y from 4.8% in May.  Higher raw material prices, higher transportation costs and labour shortages have driven PPI inflation and are likely to keep consumer inflation elevated over the summer as well.   
• UK CPI came in higher than forecast at 0.5% m/m and 2.5% y/y in June, against consensus estimates of 0.2% m/m and 2.2% y/y.  The headline inflation rate was 2.1% y/y in May.  Core inflation accelerated to 2.3% y/y last month from 2.0% y/y in May, also above expectations. Like the US Federal Reserve, the Bank of England has already indicated higher inflation in the near term is transitory.  However, deputy BoE governor Dave Ramsden said inflation could reach 4% at the peak and said that upside risks were stronger now. Most other MPC members have been more sanguine about inflation in recent comments.   
• China’s GDP growth slowed to 7.9% y/y in Q2 from 18.3% y/y in Q1 21, coming in slightly lower than the 8% the market was looking for.  There are some signs the rate of growth may be slowing however; retail sales and industrial production were both softer in June than in May, at 12.1% y/y and 8.3% y/y respectively. Nevertheless, the data suggests the government’s full year growth target of 6% should be easily reached.
• The Turkish central bank kept its benchmark one-week repo rate unchanged at 19.0% yesterday, in a widely anticipated decision after inflation accelerated to a two-year high of 17.5% in June. The bank pledged to ‘take its decisions in a transparent, predictable and data-driven framework’, and maintained that ‘the current tight monetary policy stance will be maintained decisively until the significant fall in the April Inflation Report’s forecast path is achieved.’ Given that PPI inflation was 42.9% in June, the likelihood is that inflation will remain elevated for some time. This makes any rate cut over the next several meetings less probable, although the bank’s statement did cite an expected current account surplus in the second half which would offer some support to the lira in the event of a cut.
• The Bank of Canada kept its benchmark interest rate on hold at 0.25% yesterday as expected but again tapered bond purchases by one-third to CAD 2bn per week, citing “continued progress towards recovery” and “increased confidence” in the strength of the economic outlook for Canada. Rate hikes are not expected until H2 2022 at the earliest.

Today’s Economic Data and Events

• 08:30 Japan tertiary industry index forecast (June) -0.9% m/m
• 10:00 UK ILO unemployment rate (3m/3m May) forecast 4.7%
• 16:30 US Empire manufacturing index (July) forecast 18.0
• 16:30 US initial jobless claims (July 10) forecast 350k
• 17:15 US industrial production (June) forecast 0.63% m/m

Fixed Income

• The US Treasury market rallied on Fed Chair Jerome Powell’s testimony to the House Financial Services committee where he noted that the target of “substantial further progress” hadn’t been achieved and it was too early to dial back on stimulus measures. He also noted that the economy will still be short on achieving maximum employment and that supply shortages would eventually resolve. Yields were lower across the curve with 2yr UST yields down by almost 3bps to 0.223% and the 10yr yield sank 7bps to 1.3459% with both showing a downward bias in early trade today.
• UK inflation came in stronger than expected and bonds initially sank. However, over the rest of the trading day gilts came in stronger with yields being pulled down to 0.6258%. The gravitational pull of lower UST yields is weighing on other markets with bund yields also moving lower, closing at -0.32% overnight.
• The drop in UST yields is helping to give emerging market bonds some breathing room with yields falling in both Turkish and Indian markets. South African yields edged marginally even as the country grapples with serious unrest in some regions. Turkish bonds benefitted from the CBRT decision to keep rates on hold amid serious inflation pressures with yields closing at 16.66% on the 10yr.

FX

• Currency markets turned away from the dollar after a few days of gains for the greenback. The DXY index fell 0.37% to 92.41 amid a still accommodative policy stance from Fed chair Jerome Powell.
• EURUSD rallied 0.52% to 1.18 figure, benefitting from a weaker USD narrative. The single currency will likely be choppy in the week ahead of the ECB meeting where president Christine Lagarde has prepared the market for a potentially critical decision. Elsewhere USDJPY was a substantial mover with the pair sliding 0.6% in favour of the yen.
• GBPUSD rallied 0.33% on the back of faster than expected inflation and expectations the Bank of England could move on rates earlier than expected.
• Antipodean currencies witnessed large moves overnight with NZD gaining more than 1.2% as the RBNZ has pledged to bring an end to its LSAP this month. AUD also managed to rally, up 0.46% to 0.75, while USDCAD was relatively stable at 1.25.

Equities

• Jerome Powell’s defence of his loose monetary policy was broadly positive for US equities yesterday, although the moves were relatively muted. The S&P 500 closed up 0.1% having lost some of its gains earlier in the day and remained slightly off Monday’s record close. The Dow Jones also gained 0.1%, while the NASDAQ lost -0.2%.
• Within the region, Borsa Istanbul and the EGX 30 were the major gainers, gaining 1.5% and 1.6% respectively. The DFM lost -0.2% but the ADX gained 0.5% and is now up 40.3% ytd, by some distance the biggest climber among the indices we track.
• European equities were mixed, with some major markets closed for public holidays. The FTSE 100 lost -0.5%, weighed down by travel stocks after the latest ‘traffic light’ travel list announcement. The composite STOXX 600 closed up 0.1%.

Commodities

• Oil prices saw a sharp move lower on news that the OPEC+ impasse on production levels has reportedly been breached. Brent futures settled lower by 2.3% at USD 74.76/b and WTI was off by 2.8% at USD 73.13/b.
• The UAE has reportedly secured a higher baseline for its production to take effect from May 2022, allowing it to increase production more substantially from Q2 2022 onward. The deal would presumably allow OPEC+ producers to increase production for the rest of 2021 although most likely from September onward given that export levels have already been set for August. The deal will also be extended until the end of 2022, avoiding a surge in OPEC+ barrels after April. The outcome is largely in line with our baseline expectations for the oil market and we expect that prices can still be sustained in the USD 70-75/b range for Brent.
• Oil also sank as rising product stocks—for gasoline, distillates and other products—outweighed another sizeable draw in crude inventories (down 7.9m bbl last week). Production in the US managed a 100k b/d increase to 11m b/d while product supplied ticked back by 2.2m b/d to 19.3m b/d.  

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