There are different ways to
measure it, but the dollar just put in its best week of the year. The greenback
rose against all the G10 currencies, and the Dollar Index rose by the most
since last September. It also appreciated against most emerging market
currencies, with the notable exceptions of a handful of Latam currencies. It
seems to be an overdue technical correction. Few genuinely believe that the US
will default given the ominous consequences, but the dysfunctional appearance
weighs on sentiment. The KBW regional and large bank indices tumbled again
(~-6.2% and -3.5%, respectively, last week). The market continues to price aggressive rate
cuts, with a year-end effective rate of about 4.38% (the effective rate now is
5.08%). That is up from 4% on May 4, but still seems to require some
significant development and soon to force the Fed to reverse itself. It is not
that it cannot happen, it seems more like a tail risk than the base case.
On technical grounds, the
dollar looked oversold but there is a fundamental narrative that may help frame
the correction. The bear story for the dollar has been discounted. Can the
pendulum of sentiment swing toward even more Fed cuts? Hawkish rhetoric from a
couple Fed officials and the jump in consumers' 5–10-year inflation expectation
in the preliminary May University of Michigan survey (3.2% from 3.0%, and
forecasts for it to decline) is renewing thoughts of a June hike. The ECB's
target rate is 3.25%. The market sees one and maybe two hikes left. And the
regional economy looks like it stalled after a strong start of the year. Yes, a
winter crisis was averted. Now what? The risks to growth are on the downside.
Less than 24 hours after the Bank of England revised away its recession
forecast, ONS reported an unexpected 0.3% contraction in the March monthly GDP.
It eked out a 0.1% quarter-over-quarter expansion, but, like the eurozone, no
momentum going into Q2. The good news is known.
United States: The focus of the high-frequency data
shifts from prices to the real economy near the mid-point of the second
quarter. The world's largest economy is proving more resilient than many
expected, seemingly also the Federal Reserve. The Atlanta's Fed's GDP tracker's
final iteration for Q1 growth of 1.1% proved spot on the official initial
estimate. It sees Q2 GDP tracking about 2.7%. The stronger-than-expected April
auto sales (15.91 mln vehicles, seasonally adjusted annual rate, from 14.82 mln
in March and slightly less than 11.5% over April 2022) hint that retail sales
likely recovered from March's 0.6% decline. Industrial output may have stalled,
and manufacturing production may have stabilized after falling by 0.5% in March.
Recall that in Jan-Feb, manufacturing output jumped 1.5% and 0.6% respectively,
the most two-months since Oct-Nov 2021. Surveys for May begin with the NY Fed's
services and manufacturing surveys and Philadelphia Fed's business survey.
Housing starts and existing home sales for April are due, and weakness is
likely to still be evident. Meanwhile, the Leading Economic Indicators index
looks to have extended its decline for the 13th consecutive month. The duration
and pace of the decline is associated with recessions, but expectations for a
downturn continue to be pushed out to later this year or early next year.
The Dollar Index bounced last
week and its nearly 1.5% gain was the most since last September. The downtrend
had stalled near 101.00, and the week's close near 102.70 was the highest close
in almost two months, The five-day moving average crossed above the 20-day
moving average for the first time since mid-March. The underlying drags,
however, remain debt ceiling drama, the pressure on bank shares, and the aggressive
rate cuts the market is pricing in for the Fed this year. Despite the
disruption in the T-bill market and the credit-default swaps, a US default does
not seem like the most likely scenario, but brinkmanship requires going to the
brink. Still, corrective technical forces could lift the Dollar Index
further. Overcoming initial resistance about 103.00 could signal gains in the
toward 103.50-104.00 area.
Eurozone: Germany and France reported
terrible March industrial production data (-3.4% and -1.1% respectively).
Italy's also disappointed, falling by 0.6% instead of rising by 0.3% as the
median forecast in Bloomberg's survey projected. These reports more than offset
the better Spanish reading (1.5% vs. 0.3% expected). The aggregate figure (May
15) will feed into the details and revisions of Q1 GDP, which was initially
estimated at 0.1% (quarter-over-quarter). The preliminary estimate was that the
Germany economy stagnated, but the weak retail sales, exports, and industrial
production numbers warn that the eurozone's largest economy may have
contracted. In turn this points to a downward revision of the aggregate figure. The
weakness in the May Sentix survey and poor news stream warns of weakness in the
ZEW survey. The bloom is coming off the European rose that dodged a winter
energy crisis and now stark economic resurfacing, and it is further behind
inflation than the US. In April, eurozone inflation was 7.0% higher than a year
ago, and in April 2022, CPI had risen 7.5% over the previous 12-months. The US
CPI stood at 8.3% in April 2022 and was at 4.9% in April 2023.
The euro peaked a little shy of
$1.11 in late April. As we have noted, the momentum indicators did not confirm
the new highs. Yet, a "buy on dips" strategy gave the single currency
a resilience, and that ended last week. The euro was closed below its 20-day
moving average and the five-day moving average fell below the 20-day moving
average for the first time since mid-March. The euro was pushed through support
in the $1.0880-$1.0900 area and settled at session lows, around $!.0850. The next chart support is near $1.08 and then
$1.0740. A move back above the $1.0940-50 area stabilizes the technical tone.
Japan: The world's third-largest economy
provides its first estimate of Q1 GDP on May 17. The median forecast in
Bloomberg's survey is for a 0.2% quarter-over-quarter expansion (0.8%
annualized). The economy was flat in Q4 22. Net exports are expected to have
halved growth (-0.2%), while inventory accumulation may have added 0.1
percentage to growth. Consumption likely drove growth, rising 0.4%, while
business investment has been weak and likely offset the increase in consumption.
The GDP deflator is seen at 1.8%, up from 1.2% in Q4 22. On May 18, Japan's
April trade balance is due. Seasonally, it almost always deteriorates from
March. It recorded a trade shortfall of JPY755 bln (~$5.6 bln) in March. Japan's
trade deficit averaged JPY1.73 trillion in Q1 23 and JPY1.13 trillion in Q1 22.
Most of the thunder for the April national CPI has been stolen by the Tokyo
report that was reported at the end of April. The Tokyo figures are very good
approximations of the national figures. In March, the national headline and
core (excludes fresh food) were at 3.2% and 3.1%, respectively, 0.1% below the
Tokyo readings. The measure that excludes fresh food and energy was at 3.8%,
and 3.4% in Tokyo. In April, this measure in Tokyo rose from 3.4% to 3.8%. The
risk is that the national figure comes in higher still, which may bolster ideas
that the BOJ will adjust policy as early as next month.
The dollar traded between
JPY133.75 and JPY135.75 last week and it was covered in the last two sessions. It settled on the highs, which were the best in seven sessions. The greenback has risen in five of the past six sessions. The vagaries of US
yields continue to seem like the most important driver of the exchange rate.
For the better part of three months, the dollar has been in a roughly
JPY130-JPY137.50 trading range. It looks like it can persist a bit longer. The
greenback looks poised to test the JPY136.00-15 area. The momentum indicators
are constructive, and near-term potential may extend toward JPY137.00, where
the 200-day moving average is found. The five-day moving average (~JPY135)
approached the 20-day moving average (~JPY134.80) but has remained above it
since April 11.
United Kingdom: The Bank of England hiked the base
rate last week, and with double-digit inflation, a pause seems unlikely. The
hike brought the base rate to 4.50%, for a cumulative move of 440 bp. The swaps
market continues to favor a terminal rate between 4.75% and 5.0%. The next
labor market report is due May 16. The UK's labor market has been resilient and
wage growth firm, and these are important data points for the central bank's
reaction function. Sterling is the strongest G10 currency this year, up about
3.0%, and reached its best level since June 2022 last week near $1.2680 before
profit-taking kicked in. Sterling snapped a three-week advance, and
its roughly 1.5% loss last week was the largest in three months. It finished the week below the 20-day moving average (~$1.2505) for the first time in
nearly a month. Ahead of the weekend, it approached the low so far for this
month (~$1.2435), which is the top of a band that extends to $1.24 and may
offer support. Unlike the euro (and Dollar Index), the five-day moving average
has not crossed below the 20-day, but the technical tone is softening. The
momentum indicators have turned lower. Even under a shallow correction, given the magnitude of its rally since mid-March sterling can fall toward $1.2350.
China: It is particularly hard to get a good read
on China's economy. Many have long been suspicious of its data, and now it has
become even less forthcoming, apparently because some foreign groups have used
its data to reveal industry and military ties that serve other countries' sanction agenda. One recent indirect approach to try to understand size of
China's economy is based on some algorithm related to the light it produces and
the takeaway is that the world's second-largest economy may be 10% smaller than
official data suggests. China reports April industrial production, retail
sales, and fixed-asset investment on May 15. The data is expected to show that
the recovery is gaining traction and sequentially improving on a year-over-year
basis. However, the weakness in imports and prices are seen as a sign of
underlying economic problems and many are looking for more monetary support
here in H1. A cut in required reserves seems favored over a rate cut. Property
investment (May 15) and new house prices (May 16) will provide clues into the
state of the real estate crisis. Between the new limits on access to Chinese
data and the crackdown on some foreign firms may discourage portfolio and
direct investment flows, and hasten the decoupling, which seems industry (and
country) specific.
The yuan fell every day last
week against the dollar for a cumulative decline of nearly 0.70%, its largest
weekly loss since late February. It was the fourth weekly loss in the past five
weeks. Disappointing exports, weak lending, and soft inflation figures bolster
speculation that officials will ease monetary policy by the end of Q2. The
dollar finished last week above the 200-day moving average (~CNY6.94). There is
little to deter a test on this year's high set in February and March in the
CNY6.9730-70 area. Should the dollar's correction against the euro and yen
continue, a return to the CNY7.0 area is reasonable and implies a dollar gain
in percentage terms slightly less than last week's rise.
Canada: The Bank of Canada remains on a
conditional pause announced in January. Growth at the start of the year was
stronger than the central bank anticipated, but it remains confident that the
economy will slow this year. Canada reports April CPI on May 16, and Governor
Macklem reminded that if necessary to bring inflation down, the Bank of Canada
could raise rates again. The market thinks it is highly unlikely and continues
to fully price in a quarter point cut from current levels late this year. Inflation
peaking in June 2022 at 8.1%, and it stood at 4.3% in March. The base effect
from Q2 22 suggests scope for a further decline. Making a conservative
assumption of a 0.4% average increase per month in Q2 would bring the CPI close
to 3% by mid-year. The second half of the year is a different story. Canada's
CPI fell ever so slightly in Q3 22 and rose by less than 1% at annualized clip
in Q4 22. In Q1 23, Canada's CPI has risen at an annualized rate of about 5.6%.
The trimmed and median core rates were sticky through late last year even
though they peaked in the summer, but the pace of slowing has accelerated in
recent months. Still, in H2, the comparisons will be more difficult. Turning to
the March retail sales (May 16), another soft report is likely, but it needs to
be placed in the context of the 1.6% surge in January. Like we saw in the US,
consumer front-loaded, and February saw a month-over-month decline. US retail
sales also decline in March and between the two months, around half of
January's gain was offset. In proportionate terms, Canada's retail sales would
have declined by 0.4%-0.5%
The US dollar recorded the low
for the month at the start of last week a little above CAD1.3300 and rebounded
to CAD1.3565 at the end of the week. The US dollar has surpassed the (61.8%)
retracement target of its losses from the April 28 high. There
is little from a technical perspective that prevents a return to the
CAD1.3650-70 highs seen earlier this month, and even the CAD1.3700-30 area. The momentum indicators are mixed
but sentiment toward the Canadian dollar is soft in the absence of a bullish
hook. It offers little consolation, but the Canadian dollar's 1.30% decline
last week, made it the fourth best performer among the major currencies, after
the yen, Swiss franc, and Norwegian krone. It did better than the Australian
dollar (~-1.55%) and the New Zealand dollar (~-1.60%). This comparative
performance suggests that it might not be about the Canadian dollar, but US
dollar.
Australia: The central bank's surprise hike
earlier this month helped lift the Australian dollar from the lower to the
upper end of its trading range from around $0.6600 to $0.6800. The central bank
meets again on June 6. The futures market shows a high confidence that it will
stand pat. The strong jobs report on May 18 could inform expectations.
Australia's jobs market remained strong in Q1. It created 35.4k jobs on average
a month, the best quarterly showing since the middle of last year, and all
those jobs were full-time positions (average 35.9k). The government's budget,
the projected surplus and the new spending initiatives no surprise given the
press reports ahead of it. It seems supportive of the economy, but expectations
of the trajectory of monetary policy were not altered.
The Aussie was turned back
after the mid-week push above $0.6800. It finished the lower quartile of its
two-cent range (i.e., below $0.6650). The risk is that after being rejected at
the upper end of its range, it now tests the lower end (~$0.6600). The momentum
indicators are poised to turn lower. Last week's 1.55% loss was the largest
since the end of February. It has now fallen for three of the past four weeks,
but what seems like a trend is in a two-cent trading range. The edges of the range have
been frayed but not sustained. We suspect the next big move will be higher, but
this does not rule out a downside break first that could toward $0.6550.
Mexico: The combination of the peso's
strength and the gradual easing of price pressures suggest that Banxico will
not raise rates at its meeting (May 18). Central Bank Governor Rodriguez
recently indicated a pause was possible. The overnight target rate is 11.25%.
April CPI stood at 6.25%. The peso has appreciated by about 10.5% against the
US dollar this year and is reached levels not seen in six years. The Supreme
Court decision to block AMLO's attempt to weaken the election watchdog suggests
that alongside the central bank, shares an independence and strength to helps
ease broad concerns about AMLO's policies. That said, it is interesting to note
that unlike Brazil's Lula, who wanted to reduce the reliance on the dollar,
AMLO endorsed the greenback as the world's principal currency. Mexico attracts
direct investment to locate in the USMCA and have access to the US market, and
this includes Chinese companies. Industries left Mexico after China joined the
WTO and now changes in the geopolitical climate, lessons about supply change
management, and the rise of economic nationalism are creating a new opportunity
for Mexico.
The Mexican peso remains a
market darling. Its low volatility and high interest rates appeal to carry
strategies. It is stretched from a technical perspective. However, given the
wide interest rate differentials, even in a consolidative market, one is paid
to be long pesos. The longs have not reason to get out, and new peso buyers are
entering it appears on shallow pullbacks. The US dollar reached nearly
MXN17.5350 on May 11. The low from 2017 was closer to MXN17.45. It is more a
mile-marker rather than technical support (i.e., the price can bring in new
demand). In the bigger picture, with the break of the MXN17.82 area, the dollar
has unwound half of its gains against the Mexican peso from 2008 (~MXN9.86) to
the 2020 high (~MXN25.79). The next retracement (61.8%) is near MXN15.94. This
seems too far away to take seriously. Yet, based on current volatility, a move
toward MXN16.50 is reasonable by the end of the year (reasonable in this
context is one standard deviation from the year-end forward).
Reviewed by Marc Chandler
on
May 13, 2023
Rating:
