Greenback Softens Ahead of CPI

Overview: It appears that investors have become more concerned about growth prospects and less about inflation in recent days. The US 10-year yield that had flirted with 3.20% at the start of the week is now around 2.93%. It is approaching the 20-day moving average (~2.90%), which it has not closed below in a little more than two months. European yields are sharply lower (~4-8 bp) with the core-periphery premium narrowing. Asia Pacific equities were mixed, but China, Hong Kong, and Australia advanced, as did the Nikkei. Europe's Stoxx 600 is up more than 1%, and if sustained, would be the largest in a month. Consumer discretionary, energy, and real estate are leading today's move. US futures are 1.0%-1.3% better. The dollar is under pressure. Led by the Antipodeans and Scandis, all the major currencies are gaining against the greenback today. The euro's roughly 0.35% gain is the least. Most emerging market currencies are also stronger. Turkey, Czech, and Thailand are notable exceptions. Gold is recovering from a three-month low set earlier today near $1832. It has met new selling pressure in the European morning ahead of $1855. June WTI is rebounding after falling to $98.20. However, it stalled as it approached $104. Reports suggest that Russia's gas deliveries via Ukraine are being interrupted for the first time since the war began. Yet, US natgas prices are about 1% higher after yesterday's 5.1% gain, and Europe's benchmark is off around 3.5% to unwind all of yesterday's gain and more. Iron ore prices surged 4% to snap a three-day more than 13% slide. June copper is still in its trough, but the four-day decline may be ending. The June contract is up about 1.7%, the most since the middle of last month. July wheat is firm after an unchanged session yesterday and is practically flat for the week.

Asia Pacific

Food and energy prices lifted China's CPI, but the impact of the Covid lockdowns was evident in today's inflation report. Consumer prices rose 2.1% year-over-year, up from 1.5%, and a bit higher than expected. Food prices rose 1.9% after falling 1.5% in March. Fuel prices rose by more than a quarter year-over-year. Non-food prices, excluding energy were softer. Core prices, excluding food and energy, rose by 0.9%, slowing from 1.1% in March to a 10-month low. Producer inflation eased for the sixth consecutive month. The 8.0% year-over-year rate is the slowest since last April. Prices for raw materials and mining accelerated, manufacturing, products of daily use, and the price index of consumer durable goods actually fell. The data confirms, in some respects, what we already knew: inflation concerns do not stand in the way of additional policy stimulus from Beijing.

The implementation of the BOJ's cap on the 10-year bond at 0.25% is coming cheaply by some reckoning. Like yesterday, there were no sellers to the BOJ. Part of the problem is that the BOJ already owns more than three-quarters of the 10-year bond due March 2032. Last week, the Finance Ministry sold JPY2.7 trillion of the bond and the demand was strong. It was over-subscribed 5.7x compared with 3.6x previously. It was the strongest coverage since 2005. Separately pushing back against speculation that it may increase the band on the 10-year to 50 bp from around zero, officials noted that it would be tantamount to a rate hike, something they explicitly want to avoid.

Japanese officials had cautioned about the sharp moves in the exchange rate and the market has complied. The dollar is in a relatively narrow range against the yen, straddling the JPY130 area inside yesterday's range (~JPY129.80-JPY130.60). The Australian dollar tested the $0.6900 area, its lowest level since mid-2020. It has recovered today to approach the $0.7000 area. A move above $0.7050 would lift the tone, but it looks too far for today. The intrasession momentum studies are stretched in the European morning. For the first time in eight sessions, the greenback did not rise above the previous day's high against the Chinese yuan. It traded between CNY6.7160 and CNY6.7350. It is a narrower range than seen recently but still wider than typical until the middle of last month. Some signals for Chinese officials suggest a level of contentment with the weaker currency but seek a more stable tone now. The PBOC set the dollar's reference rate at CNY6.7290, close to but lower than expectations (CNY6.7302, according to the median in Bloomberg's survey).

Europe

The euro has forged a base in the $1.0480-$1.0490 area. It is possible to imagine a diamond pattern, which is understood as a reversal pattern. A move above $1.06 is needed for confirmation. The swaps market has about a 20 bp hike priced in for the July ECB meeting. It would be highly unusual to change policy without updated staff forecasts. The risk is that the longer it waits the harder it may be as it is reasonable to expect that the economic slowdown will become increasingly pronounced. The median forecasts in Bloomberg’s survey continue to look for a euro recovery, which may be an indication that the euro bulls have not capitulated. By the end of June, they see it at $1.07 and $1.11 at the end of the year. In the futures market, there may be more evidence of capitulation. Last week, the net speculative position switched to short for the first time since the first week of the year.

Reports suggest that UK Prime Minister is preparing to formally jettison the Northern Ireland protocol as early as next week. It has been a constant source of tension with the EU. From a cynical perspective, it appears Johnson supported the protocol as an expeditious way to finalize Brexit, but a border in the middle of the sea, which his predecessor scoffed at, may never have been practical. Northern Ireland was like Schrodinger's cat. It was still part of the EU, and it wasn't. The need for a united front in the face of Russian aggression had appeared to sublimate other tensions, but last week's local elections, especially in Northern Ireland may be forcing the issue.

Ahead of the US CPI report, the euro is trading in about a quarter-cent range on either side of $1.0550. It remains well within the congestion seen in recent days. The daily momentum indicators have stopped falling but remain over-extended. The two-year interest rate differential between Germany and the US is also chopping around sideways between around 2.35% and 2.55%. The peak was set a month ago. A close above $1.06 would lift the tone. Sterling is still within the range set on Monday (~$1.2260-$1.2405). It is in the upper end of the range in the European morning. A move above $1.2400 could spur another quick half-cent gain. However, the upticks have already stretched the intraday momentum indicators. 

America

The year-over-year pace of US CPI accelerated for seven consecutive months through March. The first easing is expected. To be sure, the month-over-month rate likely rose last month but not as much as in April 2021 (0.6%). Still, the 0.2% rise projected by the median forecast in Bloomberg's survey would be the smallest monthly increase since January 2021. The headline rate may slow to 8.1% from 8.5% and the core rate is forecast to ease to 6.0% from 6.5%.   Everyone recognizes that price pressures are elevated, but the idea is that if inflation is near a peak, then interest rates may be, and the greenback by extension.

The US dollar has risen against the Canadian dollar for the past six weeks (for about 3.6%) and is up more than 1% this week so far. Canada's job creation in April was disappointing and full-time positions fell, but the economy is doing well, and it was likely a fluke. Q1 GDP will be released at the end of the month and is seen around 4% at an annualized pace, putting it at the top of the major economies. The central bank is raising rates and allowing the balance sheet to shrink. What ails the Canadian dollar lies elsewhere. First, trying to link it to oil prices is not particularly helpful. Over the past 60 sessions, the correlation of changes in WTI and the exchange rate is about 0.11. For all practical purposes, insignificant, and more post of March the correlation was inverse, where the Canadian dollar would weaken as oil prices rose.  On the other hand, the correlation between the Canadian dollar and the US S&P 500 is nearly 0.70. The 30-day correlation is a little stronger. The Canadian dollar weakens as US stocks sell-off.

Brazil reports IPCA inflation today. It is expected to have accelerated to a little over 12% from 11.3% in March. Moreover, the month-over-month rate may have increased by more than 1% for the third consecutive month. Central bank Governor Neto has recognized the need to lift rates further. The swaps market has Selic rate rising 100 bp to a peak of 13.75% in the next six months. It could be done before the October 2 election.

The four-day rally that saw the greenback rise from around CAD1.2715 to about CAD1.3050 yesterday seems to be over. With equities higher, the Canadian dollar has caught a bid. The US dollar is pushing through yesterday's lows in late-European morning turnover. Support is seen in the CAD1.2880-CAD1.2925 band. That said, like we noted with other currency pairs, the intrasession momentum indicators are stretched. The US dollar held below the 200-day moving average against the Mexican peso (~MXN20.44) yesterday and has come back offered today in line with the stronger risk appetites. It is slipping through MXN20.24 and appears poised to test Monday's low around MXN20.1550. The central bank is widely expected to hike the overnight target rate 50 bp tomorrow to 7.0%. Another 50 bp hike is anticipated next month too (June 23). 

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