As
April draws to a close, the systemic stress in the banking sector continues to
subside, and the market is turning its attention to likely rate hikes by
Federal Reserve and European Central Bank in early May. Although, as in March,
the market sees the May hike to 5.25% to be the last Fed hike. Before the bank
stress, the swap market had been leaning to a 5.75% terminal rate. It is still
early to fully appreciate the magnitude and duration of the tightening in
lending standards. Yet, to assume that it is worth 50 bp of Fed tightening
seems premature. Given the still robust labor market, elevated service prices,
and more than an 8% depreciation of the dollar on a trade-weighted basis over
the past six months, would suggest that the risk of another hike after the May
meeting. That seems more likely than a rate cut in Q3 as the Fed funds futures
market is discounting.
The Bank of Japan meeting, the first under
new management, draws attention. Yet officials have shown sense of urgency to
change policy. A majority in a Bloomberg poll see a change coming in June.
Still, the central bank's new forecasts will be scrutinized for insight into
the central bank's thinking. Sweden's Riksbank is the other G10 central bank
that meets. While most expect a 50 bp hike, there is some risk of a larger
move. In term, of data, both the US and eurozone report their first estimates
of Q1 GDP. The US also reports Q1Employment Cost Index and the March PCE
deflator. As seen in the CPI, the headline is falling but the core rate still stubborn.
Among emerging markets, Brazil, and Turkey's central bank meet. Both are most
likely to stand pat, though there is speculation that Brazil's central bank
could cut rates in H2 23.
United States: What had appeared as wide divergence
between the Atlanta Fed's GDP tracker and market expectations (median forecast
in Bloomberg' survey) for Q1 GDP has narrowed. The median projection in
Bloomberg's survey is 2.0% and the Atlanta Fed's tracker sees 2.5%. In either
case, growth for the third consecutive quarter is above what the Fed sees as
the non-inflationary pace (1.8%). The Employment Cost Index, which includes pay
and benefits, and is free from compositional changes that impact will be
reported for Q1. It averaged 0.7% a quarter in the three years before Covid.
Last year, it rose by an average of 1.23% a quarter. After slowing to 1.0% in
Q4 22, the median forecast is for a slight acceleration to 1.1% in Q1 23.
The GDP figures will include an estimate
for personal income and consumption in March, but the deflators may still draw
attention. The headline deflator jumped 1.0% in March 2022, and it is likely to
be replaced by a 0.1%-0.2% gain. This will see the year-over-year rate ease to
4.1%-4.2% in March, the slowest since May 2021. The core rate rose by nearly
0.4% (0.375%) in March 2022. It is expected to have risen by 0.3% last month,
which could see the year-over-year rate slip to 4.5% from 4.6%. Like the CPI,
the core rate is seen moving above the headline rate. Meanwhile, the Treasury's
room to maneuver around the debt ceiling may be aided in the near-term by tax
revenues, but the one-year credit default swap (cost of insuring against a US
default) rose to a new high (~104.5 euros vs. ~ 15 euros at the end of last
year, with the usual caveats are these price indications). House Republicans
may take up an extension of the suspension of the debt ceiling through Q1 24,
in exchange for spending cuts. Many market participants are not convinced it
will pass and were less eager to buy the new three-month Treasury bill, which
covers the period seen were default risks are the highest. The yield is now
higher than the six-month bill. Uncertainty of when the limit is reached
appears to have encouraged strong demand for the four-week bill, which finished
the week with a yield a little above 3.25%.
The Dollar Index spent last week in the
range set on Monday, April 17 (~101.55-102.25). It has frayed the 20-day moving
average (~102.00) without closing above it since March 15. It snapped a
five-week decline but by going sideways rather than rallying. The overextended
momentum indicators are correcting as the DXY during this consolidation. It may
take a break of 102.75-103.00 to signify anything important. On the downside, a
move below 101.35 weakens the technical tone.
Japan: The performance of the Liberal Democratic
candidates in the regional elections (second round April 23) may determine if
Prime Minister Kishida calls for an election perhaps as early as this summer.
Support for the cabinet has risen in recent weeks and next month's summit (in
Hiroshima) will put the PM in favorable light. Governor Ueda leads
his first Bank of Japan meeting. At its conclusion on April 28, it will update
its forecasts. The forecast are not simply macroeconomic projections but also
are a channel of communication. The key issue is whether the new leadership
sees prices pressure being sustained. The previous forecasts were skeptical,
though that was before the spring wage round. In January, it saw this fiscal
year's 3% inflation easing to 1.6% next year and 1.8% the following year.
Higher revisions here especially above 2% in the next couple of years would
seem to be a necessary precursor to a change in policy. In January, the BOJ
shaved this year's growth forecast to 1.9% from 2.0% and next year to 1.7% from
1.9%. For fiscal 2025, the BOJ cut its growth forecast to 1.1% from 1.5%.
A few hours before the BOJ meeting ends,
Tokyo reports April CPI figures. Tokyo's CPI offers valuable insight into the
national figures, which will not be released until May 19. Little change from
the 3.3% heading pace in March and the 3.2% core rate (excludes fresh food) is
expected. However, the measure that exclude both energy and fresh food rose to
a new cyclical high in March. Processed food producers are still lifting prices
and this underlying measure shows the pressure lurking below the surface,
beyond the energy subsidies. Separately, Japan also reports March industrial
production, retail sales, and employment. The market is not particularly
sensitive to these reports, but they will help economists fine tune forecast
for Q1 GDP, which is not released until the middle of May. The current
forecasts are for growth around 1% (annualized pace) after nearly stagnating in
Q4 22 (0.1%).
Eurozone: The highlight for the week for the
eurozone is the first estimate of Q1 23 GDP. (April 28). The median forecast in
Bloomberg's survey conducted April 5-13 looks for a flat number, the same as in
Q4 22. The previous month's survey showed a 0.1% contraction. However, the risk
seems to be on the upside high-frequency reports have mostly been stronger than
expected in recent weeks. The German government is expected to lift its
forecast for this year's growth (April 26) from 0.2% to 0.4%. Still, even with
flat growth, the ECB is seen continuing its tightening cycle. The hawks at the
central bank have spurred the market to price about a 25% chance that it hikes
by 50 bp on May 4.
Last week was the first losing week for
the euro since the end of February. The loss was of little meaning, less than
0.15%. Like with the Dollar Index, the euro set last week's range on Monday
(~$1.0910-$1.1000). It was firm and traded above $1.0980 every session last
week. The momentum indicators warn of corrective pressures but are correcting
in the euro's sideways movement. A break of the $1.09 area is needed to open
the downside, but even then, support is seen around $1.08.
United Kingdom: After last week's slate of reports
(employment, CPI, retail sales, and flash PMI), the week ahead it considerably
quieter, with house prices featured. The swaps market has become more convinced
of not only a May hike (to 4.50%), but also another hike. In fact, the swaps
market sees about a 40% chance that the terminal rate is 5.0% rather than 4.75%.
Sterling proved to be resilient last week. It recovered from Monday's low near
$1.2355 to set the week's high on Wednesday near $1.2475. The momentum
indicators are trending lower and did not confirm the year's high set on April
14 (~$1.2545). The five-day moving average looks set to cross below the 20-day
moving average for the first time since mid-March. Key support is $1.2345, and
a break of it would signal a proper correction as opposed to this
consolidation.
China: Despite some sense that China's
re-opening has been disappointing, Q1 23 growth was stronger than expected at
4.5% year-over-year. Still, there were pockets of weakness, including
industrial production, where, of note, the production of semiconductor chips
and smartphones fell. The governor the central bank indicated recently that
PBOC has generally stopped intervention in the foreign exchange market. It has
found other ways to manage the currency. The yuan continues to track the yen
and euro, as one might expect given their weights in the CFETS basket that
officials use. On a rolling 60-day basis, changes in the yuan and yen are
correlated more than 0.50 over the past six weeks, up around 0.40 in the
December-February period. The correlation of changes in the yuan and euro is
little changed net-net since the end of last year slightly higher than 0.60.
Meanwhile, the three-month implied volatility of the dollar-yuan has fallen
from around 6.5% in late March to almost 5.1% in recent days, the lowest since
last August. The dollar has not settled outside of the CNY6.85-CNY6.90 range in
a month.
Canada: Economic activity in Canada is off to a firm start
this year. It expanded by 0.5% in January and appears to have slowed in
February (monthly GDP will be released on April 28). Easing of prices pressure
(average of trimmed and median core CPI has eased to 4.5% in March from
slightly above 5.1% at the end 2022) and soft February retail sales (-0.6%
after a 1.4% gain in January) likely keeps the Bank of Canada's
"conditional pause" intact.
There are three other developments to
note. First, the swaps market has unwound most of though not all the rate cuts
that were previously discounted. It was seen below 4% as recently as the first
week of April and finished last week near 4.25%. Second, the correlation between
changes in the S&P 500 and the exchange rate has eased. On a 60-day rolling
basis, it had been a little above 0.80 in early February, just shy of the
10-year high set late last year. It is now near 0.50, the lowest since last
April. The correlation with oil has increased by near 0.35, it is little
changed from the end of last year. The correlation with the two-year US-Canada
yield differential has increased a little this year. It is now near 0.25 after
finishing 2022 near 0.10. Third, the large strike by federal workers poses a
downside risk to April and Q2 growth. Moreover, a protracted strike could
potentially disrupt the minority Liberal government that relies on support from
the labor-friendly New Democratic Party (NDP).
The greenback snapped a three-week
downdraft and jumped 1.3% against the Canadian dollar last week. It settled
above the 20-day moving average ahead of the weekend for the first time since
April 24 to approach the (50%) retracement of the US dollar's losses since the
March 10 peak on March 10 near CAD1.3860. The retracement is found around
CAD1.3580 and above there the (61.8%) retracement is closer to CAD1.3650. The
momentum indicators have turned up and the five-day moving average is set to
cross above the 20-day moving average for the first time since March 27. Support
now is likely in the CAD.13480-CAD1.3500 area.
Australian Dollar: The market is not convinced that the
Reserve Bank of Australia is done with its rate hikes. Minutes from the recent
meeting underscored that the pause was primarily to gather more information.
Next week's information comes in the form of the Q1 CPI. The
quarter-over-quarter rate is expected to slow to 1.3% from 1.9% in Q4 22.
Australia's CPI rose 2.1% in Q1 22. This base effect means that the year-over-year
pace will slow to about 6.9% from 7.8%. Not only is the 1.3% quarterly increase
too rapid but the underlying measures (trimmed and weighted median) are proving
resilient. Economists surveyed by Bloomberg see the weighted median CPI ticking
up to 5.9% from 5.8%, which would be new cyclical high. The futures market is
discounting almost a 20% chance of an RBA hike at the May 2 meeting. This may
underestimate the risks, which we would subjectively put closer to 50% between
the May and June meetings.
The Aussie closed poorly ahead of the
weekend. It was the lowest close in nine sessions, and a marginal new
intrasession low was set for the week too (slightly below $0.6680). The
Australian dollar has been in a $0.6600-$0.6800 trading range since mid-March
and continues to vacillate around the middle of it. After approaching the upper
end of the range, the rule of alternation instructs to be prepared for a test
on the lower end.
Mexican Peso: The Mexican peso established last week's
range on Monday (~MXN17.93-MXN18.1550). Neither a disappointing February retail
sales report (-0.3% vs. 0.5% gain forecast by the median in Bloomberg's survey)
nor a rise in the US two-year yield to its best level in more than a month
managed to shake it out. The year's low was set in early March near MXN17.8980.
It was a 5.5-year low. The low from 2017 was around MXN17.45. Ultimately, it
still seems to be primarily a carry story, and what makes the yield pickup
attractive is that the exchange rate volatility has fallen. The historic
(actual) three-month volatility has fallen to almost 6%, the lowest since last
October.
Other Latam countries, such as Brazil and
Colombia offer higher rates but the actual currency volatility more than twice
the pesos. At the start of the new week, Mexico will report inflation for the
first half of April, and it is expected to have slowed further. Nevertheless,
most expect Banxico to follow the Fed in raising rates next month. Mexico
reports the March trade balance on April 26. Mexico's trade balance has
deteriorated. Last year's average shortfall was about $2.2 bln. In 2021, the
average deficit was near $910 mln. In the first two months of 2023, trade
deficit has increased compared to the first two months of last year at a higher
level of both imports and exports.
Disclaimer
Reviewed by Marc Chandler
on
April 22, 2023
Rating:
