Euro's Recovery to $1.09 Looks Vulnerable while Yen Falls to New Lows for the Week After Strong Pay Raises Confirmed

Overview: At the end of last week, the derivatives market was again pricing in nearly four Fed cuts this year, but this week's data have seen expectations re-converge with the Fed's three rate cuts signaled in December, while cutting the odds of June hike to the lowest in the more than four months. This has helped lift the dollar against all the G10 currencies this week. As is often the case in a firm US dollar environment, the Canadian dollar has fared the best, slipping only 0.4%. Despite heightened speculation that the Bank of Japan could hike rates as early as next week and strong wage gains for employees at large companies, the yen is off by more than 1% this week and trading recorded a six-day low today. Emerging market currencies are mixed today, with central European currencies outperforming Asia currencies. That said, note that the JP Morgan Emerging Market Currency Index is up slightly this week, which if sustained would be the third consecutive weekly advance, the longest since last October. It had fallen in the first eight weeks of the year. 

Asia Pacific equities were mostly lower today and for the week. Chinese markets were the notable exception. They edged higher today and closed higher on the week. Mainland shares that trade in Hong Kong fell by almost 1.5% today to pare this week's gain to almost 3%. Europe's Stoxx 600 is softer for the second consecutive session as it hovers near record levels. US index futures are steady-to-firmer. Benchmark 10-year yields in Europe are little changed on the day but at their highs for the week. Italian bonds have performed best this week, with the 10-year yield rising about eight basis points. German and French yields are up 12-13 bp. The US 10-year yield is a little softer at 4.28% and is up 18 bp this week. Gold has found support near $2150 this week after reaching $2195 at the end of last week. It is consolidating within Tuesday's range (~$2150-$2185). May WTI is consolidating its two-day surge that lifted it from around $77.30 to slightly above $81.00 yesterday, its best level since last October. The IEA's projections have swung from a net surplus of supply this year to a deficit and US private oil inventories fell for the first time in seven weeks.

Asia Pacific

The PBOC left its benchmark one-year Medium-Term Lending Facility rate unchanged at 2.5%. It was last cut in August 2023 by 15 bp. Some, like Bloomberg economists, expected a cut, seemingly largely to reinforce the impact of the cut in reserve requirements that was implemented last month. While achieving the 5% growth target this year will require more stimulus, we are not convinced a small cut in the MLF will do much and deflationary forces appear to have ebbed. The PBOC withdrew CNY94 bln (~$13 bln) of liquidity on a net basis using at the MLF. Separately, aggregate financing slowed to CNY1.6 trillion, which was half of last February's pace. 

Japan's index of the tertiary activity ticked up by 0.3% in January, which barely blunts the impact of a series of poor data for the start of this year. The earthquake on New Year's Day saw industrial production drop a dramatic 7.5% in January. Housing starts fell. Household spending plummeted 6.3% (year-over-year) after a 2.5% drop in December. The median projection in Bloomberg's survey was for a 4.1% decline. Separately, Rengo, a federation of unions, secured an average wage deal of 5.28% (3.8% a year ago), which included a 3.7% increase in base pay (2.33% a year ago). The yen seemed to fall victim of buy the rumor sell the fact activity. It had weakened initially on a newswire story indicated the increase would exceed 5%, and when it did, the yen was sold to new session lows.

The weekly MOF portfolio flow data showed Japanese investors stepped up their purchases of foreign bonds last week (through March 8), snapping up nearly JPY1.58 trillion (~$10.7 bln). It was the second most since last September. Last year, as the BOJ tweaked lifted its cap on the 10-year yield, Japanese investors bought around JPY19.6 trillion of foreign bonds. They had sold JPY21.7 trillion of foreign bonds in 2022. According to the US TIC data, Japanese the dollar value of Japanese holdings of US Treasuries rose from $1.075 trillion at the end of 2022 to $1.138 trillion at the end of last year. On the other hand, foreign investors were large buyers of Japanese bonds. The JPY1.15 trillion net purchases was the most since April 2023. Foreign investors also bought nearly JPY377 bln of Japanese equities. In the first ten weeks of the year, foreign investors bought JPY4.25 trillion of Japanese equities. In the first ten weeks of 2023, foreigner sold JPY1.27 trillion of Japanese stocks. 

The dollar a five-day high in North America yesterday near JPY148.40. The (50%) retracement of the dollar's pullback from the late February high (~JPY150.85) is near JPY148.65, which has been seen today. The (61.8%) retracement is almost JPY149.20 and the 20-day moving average is around JPY149.40. The 10 bp jump in the US 10-year yield yesterday had more impact that the Japanese newswire story claiming that the BOJ is poised to lift rates next week. The report did not seem to go beyond the bevy of similar claims in recent days. The Australian dollar also fell to five-day lows near $0.6570 in North America yesterday. It met the (50%) retracement of the rally from the March 5 low (~$0.6480) to the US employment day high (~$0.6670). The (61.8%) retracement is near $0.6550.It has been approached today and lies below the 20- and 200-day moving averages (~$0.6555 and $0.6260, respectively). Nearby support is seen near $0.6535, ahead of $0.6500. The dollar's recovery against the yen translates into a firm dollar against the Chinese yuan. The dollar rose to new highs for the week around CNY7.1970. The CNY7.20 is a formidable cap. The PBOC set the dollar reference rate at CNY7.0975 (CNY7.0974 yesterday) and the average of the Bloomberg survey was CNY7.2018 (CNY7.1882 yesterday). The dollar settled at a six-day high against the offshore yuan (~CNH7.2025) yesterday and is trading near CNH7.2045. 

Europe

The market continues to feel confident that the European Central Bank will deliver its first rate cut in June. The swaps market does not have it fully discounted as it did at the end of last week, but that was the anomaly over the past three weeks. The market has average better than a 90% probability. Dutch central bank President Knot is one of the most hawkish ECB governing council members and he was quoted by the media saying, "I personally penciled in June to start cutting rates."  Like the Federal Reserve, and most other G10 central bankers, ECB officials want to have greater confidence that inflation is moderating back toward the 2% target. We expect the ECB to be reassured by the next two CPI reports. In March and April 2023, eurozone inflation rose by a combined 1.5%. As these drop out, with conservative assumptions, the headline rate may be near (and possibly below) 2% (from 2.6% in February).

The day before the Bank of England meeting on March 21, the UK reports February CPI. It is on the verge of falling sharply. Recall that in 2023, it rose 1.1% in February, 0.8% in March, 1.2% in April, and 0.7% in May. As these drop out and are replaced with much slower gains, the year-over-year rate will likely be more than halved from January's 4.0% year-over-year pace. Yet, with services inflation sticky (6.5% year-over-year in January), and the economy stabilizing after contracting in Q3 and Q4 23, the BOE is not in a hurry to cut rates. The market has virtually no chance of a cut next week or in May. The odds of a June cut are slightly more than 50%. It finished last week, slightly below 50%. Separately, note that Prime Minister Sunak has laid to rest speculation that a national election would be called for May 2, the same day as local elections and mayoral contests. This delays what seems to be nearly inevitable, but some Tories may seek to replace Sunak earlier. 

The euro fell to a five-day low near $1.0880 yesterday as the market now sees a greater chance that the ECB to cut rates before the Federal Reserve. It was sold slightly below $1.0875 in Asia Pacific turnover before trading up to almost $1.0900 in the European morning. We suspect it will be sold in North America. The rally from the mid-February low around $1.07 has ended, and the euro has retraced almost a third of its gains (38.2% is slightly above $1.0870). The 20-day moving average, which the euro has not settled below since February 19 is near $1.0860, while the (61.8% retracement and 200-day moving average are slightly below $1.0840. Sterling posted a bearish outside down day by trading on both sides of Wednesday's range and closing below its low. It also saw a five-day low near $1.2730. The (50%) retracement of the rally from the March 1 low (~$1.2600) to last week's high ($1.2895) was met near $1.2750. The (61.8%) retracement is a little above $1.2710 and the 20-day moving average, which sterling has closed above since February 21 near $1.2700. A break targets the $1.2650-60 area. 

America

US February retail sales rebounded from the revised 1.1% drop (initially -0.8%) in January, but the 0.6% increase was softer than expected. Moreover, the components that some GDP models use, which excludes autos, gasoline, food services, and building materials was flat. The median forecast in Bloomberg's survey was for a 0.4% gain after a revised 0.3% decline (from -0.4%) previously. Recall that in GDP terms, consumption rose by more than 3% a quarter last year, except for a 0.8% rise in Q2 23. Slower consumption and weaker investment are expected to slow US growth this year. The median Fed projection in December was for 1.4% year-over-year GDP this year. The IMF's latest forecast is for 2.1% growth, which is also the median forecast in Bloomberg's monthly survey. The Atlanta Fed's GDP tracker sees the US economy growing 2.3% in Q1, down from 2.5% a week ago. February PPI was a bit firmer than expected and the year-over-year headline rate rose to 1.6% from a revised 1.0% (initially 0.9%). It is the highest since last September. The core rate was unchanged at 2.0%.

Attention today turns to the US Fed industrial production, which is expected to be aided by a recovery in manufacturing output (~0.3% after a 0.5% decline in January). Import and export price indices are also due. Import prices on a year-over-year basis have been negative since last February. The pace of decline is moderating and is least negative seen the run began. Excluding oil, US import prices are expected to have fallen by 0.2% last month, the first decline since last October. Export prices fell every month in Q4 23. They bounced by 0.8% in January and are expected to have risen by 0.4% in February. The FOMC meets next week. Although late last year, the Fed funds futures have a 25 bp cut fully discounted, the odds have fallen almost every week this year (eight of 11 weeks). The odds of a June cut have been downgraded for the past five sessions to stand near 65%, the lowest since last October. 

Weaker US equities and the broad dollar gains once again underscore the weak correlation between the Canadian dollar and oil prices. May WTI strung together a two-day $3.40 rally that lifted the black gold to $81 a barrel, its highest level in 4.5 months. The US dollar rose to six-day highs against the Canadian dollar, reaching CAD1.3535. This corresponds to the (61.8%) retracement of the losses from last week test on CAD1.3600. The greenback has tested chart resistance near CAD1.3550.  A recovery in US stocks would help stabilize the Canadian dollar. The US dollar initially slipped closer to the multiyear low set last July against the Mexican peso before recovering to close above MXN16.70. The greenback is trading with a firmer bias today, reaching almost MXN16.74. If the dollar's gains are sustained today, it would be the first back-to-back gain in three weeks. Banxico meets next week. Inflation is gradually subsiding, and the economy has slowed. The other large economies in the region have already begun cutting rates. The central bank fiercely defends its independence and if it does not cut rates next week, the next meeting (May 9) may be too close to the June 2 national election to change the direction of policy without giving the appearance of political motivation. That thinking could see some position squaring in the coming days. 

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