(Reuters) – A preview of the day ahead in Wayne Cole’s European and global markets
China’s inflation data for June surprised on the downside, with consumer prices slipping 0.2% on the month to leave the annual CPI flat. Producer prices fell 5.4% year-on-year, the biggest drop since late 2015.
On the face of it, this implies that there are plenty of opportunities to ease monetary and fiscal policy further. Yet it also underscores the scale of the challenge Beijing faces in avoiding a true deflationary spiral. Japan’s experience shows what deflation combined with a declining population can mean for an economy.
The soft data saw the yuan lose its first gains, but Chinese blue chips are still on the rise, in part on hopes that Beijing will loosen its regulatory grip on the tech sector.
Globally, a deflationary impulse from China could, over time, help offset service-induced inflation in developed countries. Goods disinflation is a key reason analysts expect upcoming US CPI data to show a slowdown in June.
Headline inflation in the United States is forecast at 3.1%, a remarkable turnaround from 9.1% a year earlier, even if the basic measures prove more rigid. This would be good news for the Treasury market after its recent beating.
Some funds were clearly long bonds in anticipation of a “late-tight cycle” rally that never materialized, and were hit hard when the market moved against them.
The fact that US 10-year yields are still testing 4.09% despite lower overall payrolls suggests the market is still long and there is more pain ahead.
One of the side effects of soaring bond yields was the collapse of carry trades in the foreign exchange market. Every investor and their mother borrowed cheaply in yen to invest in high-yield securities, with the Mexican peso probably the most crowded of all exchanges.
Rising yields in the developed world make emerging markets relatively less attractive and may put pressure on these positions. It was notable at the end of last week that Mexican bonds suddenly sold off and the peso slipped 2.6% against the yen in two sessions – although this followed months of gains.
These trades are usually made by selling yen for dollars and dollars for pesos, or whatever the target currency is. Thus, when the positions are reversed, it leads to the selling of dollars against yen.
This is probably one of the main reasons why the dollar fell 1.3% against the yen on Friday, and why any major unwinding of carry trades would drag the dollar lower even if its own fundamentals looked healthy.
Still, a lasting outcome seems unlikely unless and until the Bank of Japan finally abandons its yield curve control (YCC) policy. The next BOJ meeting is July 28 and many Western banks are eyeing some form of tightening, although the BoJ itself has shown few signs of satisfaction. If that happened, it would be a seismic event for the markets.
Key developments that could influence markets on Monday:
– Bank of England Governor Andrew Bailey and Finance Minister Jeremy Hunt speak at the annual Mansion House dinner
– Fed speakers at Monday’s events include San Francisco President Mary Daly, Cleveland President Loretta Mester and Atlanta President Raphael Bostic
(By Wayne Cole; Editing by Edmund Klamann)