Yellen pitches the soft landing scenario lifting optimism further

JPY: BoJ Governor Ueda fuels USD/JPY bounce

US Treasury Secretary Janet Yellen yesterday gave an upbeat assessment of current economic conditions in the US, which is very much reflected in recent market price action as falling inflation fuels optimism of a soft landing in the US. Yellen added to this optimism stating on Bloomberg TV that the US labour market is “cooling, but not faltering” given the “intensity of hiring demands on the part of firms has subsided” and that there has been no “real distress” associated with this cooling. As long as economic data releases continue to back up that rosy assessment, the greater the soft landing optimism will be, which will likely ensure the dollar remains on a modest downward trajectory. The S&P 500 advanced 0.7% yesterday with the market approaching early April levels when the entire rates/dollar surge took hold due to the inflation surge.

Retail sales data yesterday from the US were also consistent with a soft landing scenario with consumer spending continuing to grow although at a moderating pace. After some strong gains last week, the yen is beginning to underperform again in an environment certainly conducive to carry. The Topix index in Japan is 1.0% higher and the 10yr swap rate has started to retrace the surge this month after breaking above 0.70% on Friday for the first time since March. The renewed bounce in USD/JPY and the drop in longer-term yields was in part triggered by comments from Governor Ueda at the G20 summit in India yesterday. The headline that hit the screens highlighted a comment that the 2% inflation goal remains “some distance away”. However, the exact statement was that “if our assumption (inflation is some distance away) is unchanged, our overall narrative remains unchanged”. The key here is the “assumption” – and could that assumption change at the July meeting given the updated forecasts are released?

Governor Ueda did acknowledge that market functioning has improved but we already know that and really the decision on changing YCC will at this juncture be more based on the fundamentals rather than the functioning of the markets, although future risks of dysfunctional markets could be part of the decision-making process. The market reaction to the Ueda comments suggest reduce speculation over a YCC change next week although we would argue that the forecast update could still provide the justification and for the BoJ changing YCC when yields are not under upward pressure and threatening the 0.50% band limit is a more ideal time than the opposite. CPI data on Friday will remain key and the data could prompt renewed speculation once more. But in a backdrop of improved risk appetite and soft-landing optimism, USD/JPY is understandably recovering some lost ground.

12 MONTH US EQUITY OUTLOOK AFTER FED TIGHTENING CYCLE IS GOOD

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Inflation focus with UK rates elevated

The pound remains the top performing G10 currency on a year-to-date basis with elevated rates in the UK helping provide some support. The sharp weakening of inflation in the US last week and the evidence of China teetering on the brink of deflation has taken away some of the global angst over inflation. This building evidence of easing inflation pressures was on show earlier too with the release of New Zealand inflation that revealed a drop in the YoY rate from 6.7% in Q1 to 6.0% in Q2.

And just now, the UK has just released the June inflation data and finally we have a UK inflation print that has come in less than expected with the YoY rate falling from 8.7% to 7.9% - the market consensus was for a drop to 8.2%. The breakdown of the data reveals good news on the goods side but less so on the services side. Goods inflation slowed notably from 9.7% to 8.5% helped by the Food/Alcohol/Tobacco component which fell from 15.6% to 14.9%. However, the service inflation decline was much more modest, dropping from 7.4% to just 7.2%. With the BoE concerned over wage pressures, the services inflation reading will remain a concern. Still, this slowdown in services inflation was the first since January and hence still holds some significance. Core inflation eased to 6.9% but had been expected to remain at 7.1%. PPI data, also released today were generally on the weaker side as well.

The data tallies with the supermarket data released yesterday by Kantar that revealed a notable drop in food inflation from 16.5% YoY in June to 14.9% YoY in the four weeks to 9^th July. It was the fourth consecutive decline in the food inflation data and points to further declines in the ONS CPI data going forward as well. Kantar stated that shoppers are dramatically changing their behaviour to avoid higher prices which could well be indicative of increased competition helping to push prices further lower from here. The OFGEM 17% cut to the utility price cap will come through in the July data in August and with food and utility bill prices falling will help shape household inflation expectations more to the downside going forward.

For BoE deliberations into the next policy meeting on 3^rd August the CPI data should help lean the BoE more toward 25bps rather than 50bps. We have argued that the UK rates curve was overdone in terms of tightening required and we maintain two further 25bps rate hikes in August and September are likely before the tightening cycle ends. If our view is correct, that implies about 50-60bps of excessive pricing which means market rates are likely to adjust lower over the period from now through to around the September meeting. The pound is set to underperform for a period as this adjustment unfolds.

UK CPI HEADING LOWER WITH A LOT MORE TO GO

Source: Macrobond

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	Construction Output (MoM)	May	--	-0.44%	!
EC	10:00	Core CPI (MoM)	Jun	0.3%	0.2%	!!!
EC	10:00	Core CPI (YoY)	Jun	5.4%	5.3%	!!!
EC	10:00	CPI (YoY)	Jun	5.5%	6.1%	!!!
EC	10:00	CPI (MoM)	Jun	0.3%	0.0%	!!!
EC	10:00	CPI ex Tobacco (MoM)	Jun	-0.5%	0.0%	!!
EC	10:00	CPI ex Tobacco (YoY)	Jun	4.9%	6.1%	!!
EC	10:00	HICP ex Energy & Food (YoY)	Jun	6.8%	6.9%	!!!
EC	10:00	HICP ex Energy and Food (MoM)	Jun	0.4%	0.3%	!!!
US	12:00	MBA Mortgage Applications (WoW)	--	--	0.9%	!
US	13:30	Building Permits	Jun	1.490M	1.496M	!!
US	13:30	Building Permits (MoM)	Jun	--	5.6%	!!
US	13:30	Housing Starts (MoM)	Jun	7.2%	21.7%	!!
US	13:30	Housing Starts	Jun	1.480M	1.631M	!!
UK	17:00	MPC Member Ramsden Speaks	--	--	--	!!!

Source: Bloomberg