The anticipation surrounding potential interest rate cuts by the Federal Reserve in the United States has recently pushed two-year Treasury yields beyond 5%, causing significant ripples across global markets. This pressure has notably weakened Asian currencies, including the offshore Chinese yuan, which dipped to around 7.27 against the dollar. Consequently, the MSCI China Index and the CSI 300 Index have both experienced notable declines of 4% and 2%, respectively, from their local highs in mid-May.

There is a growing sentiment among analysts that current predictions regarding the timing of U.S. interest rate cuts are becoming increasingly ambiguous. Eric Robertsen, Standard Chartered's global chief strategist, indicated that data released last month regarding the U.S. economy mostly fell short of expectations. Key indicators, including employment figures, Consumer Price Index (CPI), and retail sales, did not meet market forecasts. Core PCE has now slipped below 3%, suggesting a potential further decline, although the pace of this decrease may be gradual. Paradoxically, the minutes from the Fed's May meeting conveyed a hesitant outlook, as policymakers displayed a notable lack of confidence regarding whether the economy was weak enough to warrant rate cuts.

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The focus has increasingly shifted to currency depreciation in Asia, prompting interventions from central banks in the region. For instance, the Bank of Japan has stepped into the foreign exchange market, while Bank Indonesia raised interest rates to stabilize the value of the Indonesian rupiah. Similarly, actions by the People's Bank of China indicate a commitment to maintaining stability in the yuan's exchange rate. Regarding the recently corrected Chinese equities market, Gao Xinjing, Goldman Sachs' chief China strategist, stated that a short-term consolidation in offshore markets would not be surprising. Investors may need more time to process recent policy shifts and the corresponding market advancements.

This week, the consumer confidence index from the Conference Board for May was reported at 102, starkly surpassing the anticipated 96, with the previous April figure revised up to 97.5. This unexpected rise in consumer confidence has stirred concerns among market players regarding whether the Federal Reserve will still proceed with rate cuts this year.

There is also an underlying narrative that links the disappointing CPI and retail figures from April to a broader pattern of declining consumer confidence, which had previously plummeted to 97, well below economists' expectations of 104. Such volatility in economic indicators has been a source of market unrest, with investors remaining uncertain about the reliability of forthcoming data.

Furthermore, a surprising turnaround in the Purchasing Managers' Index (PMI) revealed a boost contrary to the weak signals from consumer confidence and ISM survey results. Notably, the Fed's minutes from May indicated that while Chairman Jerome Powell had previously mentioned a greater likelihood of maintaining rates or implementing cuts in the near term, many Fed officials expressed a willingness to tighten policies further if necessary, highlighting a need for greater confidence before settling on inflation rates returning sustainably to their target mark.

Observations from analysts suggest that the apprehension towards weak economic data may be warranted as a concerning portion of recent figures has fallen into the category of "soft data," while "hard data," truly reflecting economic realities, paints a much brighter picture, especially regarding the labor market. Robertsen raised critical questions about the milestones needed before the FOMC perceives sufficient confidence to cut rates. Specifically, how much further does inflation need to fall for a majority consensus on rate cuts, and do enough committee members still advocate for a potential increase in rates instead? An affirmative answer to the latter would imply that substantial further declines in inflation are needed for rate cuts to become a feasible policy action.

Against this backdrop, the core PCE data set to be released this Friday is being closely watched. Economists from various foreign institutions have highlighted that rent heavily influences this index, and the central issue lies in when and how much rent prices may decline in the upcoming months. UBS has posited that a significant drop in June's data could open doors for a reduction by September, depending on the expected monthly decrease from around 40 basis points to 30 basis points. Furthermore, the firm noted that the prevailing elevated core CPI has been influenced largely by rents and non-transport-related price increases, particularly automobile insurance. Hence, tracking changes in rents and insurance prices is imperative for understanding future Fed actions, even as concerns about no observable decline in rents persist.

As the U.S. dollar has strengthened again recently, the widespread Asian currency depreciation has become a central topic of focus among market participants and policymakers alike. Action by the Bank of Japan indicates the seriousness of this concern, while Indonesia has resorted to increasing interest rates to shore up the value of its currency. Central banks in South Korea and Malaysia have similarly intensified their rhetoric on currency stabilization.

Observers like Robertsen note that the diminishing expectations of imminent rate cuts by the Fed will continue to lend support to a stronger dollar, overshadowing the trajectory of other Asian currencies, particularly as the offshore yuan's depreciation casts a shadow over their future performance. Despite observing resilient economic growth and modest inflation in many Asian economies, external factors are likely to continue steering the performance of their currencies.

With little over a month left in the first half of the year, expectations surrounding the Fed's initial rate cut are coming under scrutiny as it significantly influences the trajectory of numerous global currencies. Within the realm of emerging currencies, only the Mexican peso has appreciated slightly against the dollar since the start of the year, while the Indian rupee struggles to maintain stability. If the Fed indeed pursues cuts later this year, the trajectory of the dollar’s strength hangs in the balance, particularly if any eventual cuts are minimal and of short duration. Before the market fully accommodates and decides to react to the Fed contemplating rate cuts, volatility may remain high.

As of 5:40 PM Beijing time on May 29, the dollar to offshore yuan exchange rate stood at 7.2695, significantly reflecting the offshore yuan's notable decline against the dollar in the past two weeks. The yuan's midpoint rate recently dipped below 7.11, marking the lowest in over four months, with the current offshore spot trading nearly 2% weaker compared to its midpoint rate, hence testing the upper limit of its fluctuation range.

Economic uncertainties concerning the Chinese yuan remain pivotal in its volatility. Although the depreciation has been moderate, the pressures from reduced Fed cut expectations and the ongoing tension in China-U.S. trade relations suggest that the yuan's outlook remains precarious. Consequently, in the coming six months, managing the external environment affecting the offshore yuan is likely to become more complex.

In parallel, the Chinese stock market has witnessed a considerable bounce back only to find itself in a consolidation phase, mirroring the currency market's recent trends.

Since hitting its peak for the year on May 20, the MSCI China Index and the CSI 300 Index have pulled back by 4% and 2%, igniting investor skepticism about the continuation of this upward momentum.

Goldman Sachs pointed to a wide array of factors contributing to this retracement: the buoyed market sparked by stimulus measures, particularly in the real estate sector, has been followed by profit-taking; meanwhile, there’s ongoing anticipation for further enhancements in property sector policies; additionally, following the reopening of the Chinese capital markets, concerns have emerged over a potential liquidity squeeze due to a surge in IPOs.

Reports from major international investment institutions reveal a prevailing sentiment among analysts about the current trend of capital waiting to see whether corporate profits will rebound and the subsequent effects of stimulus measures, which makes the ongoing price consolidation seem rather commonplace.

Liu Jingjin of Goldman Sachs noted recently that historically, both bull markets and mid-cycle adjustments are common occurrences. Over the past 20 years, the MSCI China Index has risen by more than 20% on 23 occasions, during which only two instances did not experience a 10% correction. Almost all of these instances involve a technical bull market stage (20% rise from cycle low) followed by at least a 5% correction within 20 trading days. The amplitude of these corrections has ranged from a mere 6% adjustment to a significant 20% retracement. Significantly, out of the instances where corrections occurred, in 12 of those cases, markets subsequently resumed their upward trajectory, achieving an average additional gain of 31% in the subsequent three months.

“Given that the current adjustment phase appears relatively shallow and premature compared to historical parallels, we wouldn’t be stunned by further consolidation in the offshore market as investors digest recent policy updates and market improvements,” Liu remarked.

J.P. Morgan’s chief strategist for Asian and Chinese equities, Liu Mingdi, emphasized that the resilience and stabilization of corporate earnings will be crucial for any prospective market rebounds. Liu explained that some markets, particularly India and Japan, have attracted massive investments due to their strong performances in recent years. In addition, reforms to buyback and dividend policies on the Tokyo Stock Exchange have also increased returns for investors. Recently, the internet sector in Hong Kong has shown some of the best performance, supported by substantial increases in buybacks and improving earnings, which have significantly enhanced shareholder returns.