MNI US MARKETS ANALYSIS - Froth in Fed Funds Pricing Cools

MNI (LONDON) - Highlights:

• Froth in Fed funds pricing dissipates further
• USD/JPY recovery could be false dawn
• AUD price action affirms sensitivity to risk

US TSYS: Off Post-Payrolls Lows, 3Y Auction To Offer Demand Test Amidst Volatility

• Treasuries sit a little off session lows owing to the intraday pullback in equity futures and tech names continuing to be watched, but hold most of an extension beyond yesterday’s second half selling pressure.
• The day’s move is aided by a rebound in Japanese equities, the RBA holding along with a slightly more hawkish tone and SF Fed’s Daly (’24 voter) late yesterday characterizing the labor market as reasonably solid.
• Today’s data is limited to international trade -- we likely have to wait for Thursday’s weekly jobless claims for the next US macro steer -- which leaves sentiment in the driving seat, especially with earnings season still underway, until the $58bn 3Y auction at 1300ET will be watched particularly closely as a litmus test for demand in volatile markets.
• In the interim, emergency cut odds have mostly dissipated and September cut pricing has dipped to just under 50bps with odds of a consecutive 50bp cut in November also fading.
• TYU4 is at 113-19 (- 15+) off earlier lows of 113-12, having at one point retraced more than 76.4% of the post-payrolls rally to 115-03+. Firmer support isn’t seen until 112-21 (Aug 2 low). Volumes are once again extremely elevated at 735k.
• Cash yields sit between 3.3-6.5bp higher, with increases led by 7s. 2s at 3.971% haven't been able to push above 4%. with a high of 3.9977% (4.12% pre-payrolls).
• 2s10s at -12.4bps consolidates yesterday’s pullback off brief disinversion for the first time since mid-2022.

STIR: Narrative Settling Around A First 50bp Cut Rather Than Anything Larger

• Fed Funds implied rates have cooled a little further from overnight highs as US desks filter in, leaving only a modest extension of yesterday’s bounce.
• Emergency cut frothiness has mostly dissipated: FFQ4 shows 2.5bp of cuts vs highs of 12bp yesterday and 1.5bp pre-payrolls.
• Cumulative cuts: 49.5bp Sep, 85bp Nov, 115bp Dec and 137bp Jan.
• Pricing for the September meeting holds the largest increase on the day (+4bp) as the narrative settles around a first 50bp cut rather than anything larger, barring further dovish triggers.
• Second 50bp cut prospects have also been trimmed as part of a path with 116bp of cuts by year-end (19bps fewer since ISM services and 33bp below dovish extremes).
• There is no scheduled Fedspeak today. We wouldn’t be surprised to see further commentary cautioning on overreacting to one data print, but we suspect there is only so much reaction this can now have following the rebound from dovish extremes.
• SF Fed’s Daly (’24 voter), with her labor market background, late yesterday offered further overreaction pushback, citing a still “reasonably solid” labor market. Policy adjustments will be necessary in coming quarters but she pushed back on reacting to a single data point. Details of the jobs report suggested there was more room for confidence and she wasn’t seeing or hearing of widespread permanent layoffs (recall almost three quarters of rise in unemployment in July was from temporary layoffs. MNI Employment Insight here).

ECB: ECB Will Be Unphased By Shift In Market-Implied Inflation Expectations

Market-implied measures of inflation expectations in the euro area have lurched lower amid the growth-driven equity selloff. For the time being the ECB will look through this development given that the policy setting is underpinned by the in-house inflation criteria.

• The EUR5y5y forward inflation swap has traded down to 2.1675%, down from a 2024 high of 2.3925% in April and returning to levels not seen since mid-2022. Similarly, the 7-year German inflation breakeven rate has pushed down to 1.6931% from a YTD high of 2.1740%, with similar downside occurring in French and Italian breakevens.
• The ECB has referred to market-based inflation measures less often of late, particularly compared to the 2021-2022 inflation runup and certainly compared to Mario Draghi's tenure. This may reflect increasing confidence in the staff macroeconomic projections (which had come under intense scrutiny in 2021-2022) and lower energy prices (which were previously fuelling spot and expected inflation).
• Most important, however, is the ECB's own determination of the inflation outlook which guides policy.
• It is repeatedly asserted that interest rate decisions are based on an "assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. "
• More recently the ECB has gone further and stressed the interrelationship of wages, profits and productivity as a key determinant of inflation and in turn the direction of policy rates.
• Having invested considerable intellectual capital in justifying the determination of the policy rate setting, even a significant drawdown in market-based inflation expectations would not prompt a faster rate cutting cycle.

Bounce Off Monday Lows Could Be False Dawn for the Pair

• The bounce off Monday lows for USD/JPY has provided a sense of stability in the pair, but prices remain at risk of a resumption of the short-covering JPY rally, with both leveraged funds and asset managers still maintaining a deep net short JPY position.
• This is backed up by the prevalence of JPY short-covering among leveraged funds after near-term spikes in realised volatility. As of yesterday, USD/JPY one-week realised vols printed 24 points and the highest outright level since the onset of the COVID pandemic in 2020 - while the net short JPY position among this investor class is off lows, the outright level is inline with the deepest net shorts seen across both 2021 and 2022. 
• This works in favour of a sell-rallies strategy in USD/JPY - which eyes potential triggers from the front-end of the US curve, geopolitical tensions between Iran/Iraq as well as fragile tech equities across the US, Europe and Japan.
• 15-minute candles identify 143.48 as support (late NY low/61.8% retracement of bounce) ahead of the 141.70 bear trigger. 

FOREX: Price Action Emphasises AUD Vulnerability to Waning Risk

• While RBA Governor Bullock downplayed this week's financial market volatility, Monday’s price action emphasised the Aussie’s sensitivity to a turn in risk, with AUDJPY exhibiting a huge 5.75% range. Furthermore, price action across several AUD crosses highlight the vulnerability to a further deterioration for global market sentiment. Indeed, despite a marginally hawkish RBA overnight, some renewed pressure on major benchmarks has weighed on AUD in recent trade.
• US ISM Services data offered a near entire reversal off the lows for AUDJPY on Monday, however, given the fragility of equities and the ongoing carry unwind, downside risks remain. Indeed, we have noted that both leveraged funds and asset managers still maintain a deep net short JPY position.
• The psychological 90.00 mark and 0.8606 (2023 lows) will remain important chart points to consider for AUDJPY. From a short-term perspective, 92.15 is seen as support following the low put in on the WMR fix on Monday.
• For AUDUSD, a bearish theme remains intact. Monday’s low print highlights a test of key support at 0.6463, the Apr 19 low. A clear break of this level would reinforce a bearish theme and signal scope for an extension towards 0.6339, the Nov 10 ‘23 low.
• Notably, EURAUD has also broken above downtrend resistance, drawn from the August 2023 high. Yesterday’s spike above 1.70 placed the cross at the highest level since April 2020, shortly after the onset of the pandemic.
• AUDNZD has also slipped back below the previous cluster of resistance between 1.1030/50, and a further consolidation below 1.10 might signal scope for a deeper retracement towards the June lows at 1.0734.

Markets on Watch for Next USD Strength Trigger

• The greenback is firming further headed into the NY crossover, with volumes picking up to match the price action over the past 20 minutes or so. Move coincides with a very moderate drift in equity prices, as the e-mini S&P continues to gradually chew through the bounce off the Monday low. 
• Dollar's haven status clearly playing out here, with the greenback firmer against all others in G10 - leaving markets on watch for any further deterioration in market conditions, and any trigger from global tech names (NVidia shares lower by 2% already pre-market), geopolitics in the Middle-east or any resumption in the JPY short-covering rally.
• Importantly, GBP/USD is testing key support at the Monday/Friday lows of 1.2711/1.2707, and a break below here would again be the lowest levels since early July. 
• There is no scheduled Fedspeak today, however we wouldn’t be surprised to see further commentary cautioning on overreacting to last Friday's NFP print, but we suspect there is only so much reaction this can now have. That said, today’s data is limited to international trade -- we likely have to wait for Thursday’s weekly jobless claims for the next US macro steer -- which leaves sentiment in the driving seat for now.

E-Mini S&P Rebounds Following Monday's Sell-Off

A bear threat in Eurostoxx 50 futures remains present and the contract traded lower Monday having started the week on a bearish note. Last week’s sell-off resulted in a break of 4846.00, the Apr 19 low. The breach highlights a stronger reversal and signals scope for an extension towards 4478.81 next, a Fibonacci projection. Firm resistance is 4926.40, the 50-day EMA. First resistance is 46636.00, today’s intraday high. S&P E-Minis traded lower late last week and the contract started this week on a bearish note - Monday’s move lower marks an extension of the bear cycle.  The move down has resulted in a print below 5185.50, 76.4% of the Apr 19 - Jul 16 bear leg. A clear break of this level would open 5092.00 next, the May 2 low. Monday’s intraday high of 5345.50 marks initial resistance. The 50-day EMA, a firmer level, is at 5483.35. Gains are considered corrective - for now.

• Japan's NIKKEI closed higher by 3217.04 pts or +10.23% at 34675.46 and the TOPIX ended 207.06 pts higher or +9.3% at 2434.21.
• Elsewhere, in China the SHANGHAI closed higher by 6.586 pts or +0.23% at 2867.284 and the HANG SENG ended 51.02 pts lower or -0.31% at 16647.34.
• Across Europe, Germany's DAX trades higher by 62.82 pts or +0.36% at 17402.9, FTSE 100 higher by 16.66 pts or +0.21% at 8026.42, CAC 40 down 4.89 pts or -0.07% at 7145.15 and Euro Stoxx 50 up 10.86 pts or +0.24% at 4583.45.
• Dow Jones mini up 194 pts or +0.5% at 39039, S&P 500 mini up 41.5 pts or +0.8% at 5258, NASDAQ mini up 157 pts or +0.87% at 18165.75.

WTI Futures Recover From Multi-Month Low, Bearish Threat Remains

A bear threat in WTI futures remains present and the contract traded lower Monday, extending the current downtrend. Sights are on the next key support at $72.23, the Jun 4 low. It has been pierced, a clear break would reinforce bearish conditions and pave the way for an extension towards $70.73, the Feb 5 low. Key resistance is seen at $78.88, the Aug 1 high. Short-term gains would allow an oversold condition to unwind. Recent weakness in Gold appears to be a correction - for now. However, note that the yellow metal has managed to pierce support at the 50-day EMA - at $2374.6. A clear break of this average would signal scope for a deeper retracement towards $2277.4, the May 3 low and a key support. For bulls, a resumption of gains would open $2483.7, the Jul 17 high and a bull trigger. Clearance of this hurdle resumes the uptrend.

• WTI Crude up $0.17 or +0.23% at $73.05
• Natural Gas down $0 or -0.1% at $1.941
• Gold spot up $1.98 or +0.08% at $2411.96
• Copper down $0.75 or -0.19% at $398.95
• Silver down $0.29 or -1.05% at $26.9648
• Platinum up $6.04 or +0.66% at $918.24