The March US employment data were stronger than expected and
lend support to the re-acceleration hypothesis and an extension of US
exceptionalism. In Q1 24, nonfarm payrolls rose by an average of 276k. It was
the strongest quarter in a year and compares with an average monthly job gain
of about 251k in 2023. The unemployment rate slipped as the household survey
jumped around 500k after falling in the previous two months. The workweek
increased, and the participation rate rose. Reasons to dismiss the employment
data are becoming thinner. The economy is still growing faster than what the
Fed regards as the long-term non-inflation pace (1.8%). The US two-year yield
rose 12 bp and approached the high for the year (4.75%), and the 10-year yield
set a new high (4.43%) and settled up 19 bp. Still, the US dollar closed softer against most of the
G10 currencies last week but the Swiss franc, Japanese yen, and the Canadian
dollar. Several commodities, including gold, oil, and copper, rose sharply,
which seems incongruent with higher rates and a stronger dollar.
The week ahead features the US inflation gauges, the
European Central Bank, and the Bank of Canada meetings. The US CPI is expected
to remain firm. The ECB and Bank of Canada are seen standing pat but preparing
the ground for rate cuts. Chinese markets reopen Monday after being closed for
the last two sessions. With the dollar near the upper end of the approved band,
the PBOC's fix on Monday may give more insight into official efforts. CPI is
expected to remain positive but less so than the 0.7% year-over-year pace in
February, while deflationary forces continue to grip producer prices. Japanese
Prime Minister Kishida and Philippine President Marcos meet with President
Biden, and security issues can be expected to dominate discussions. It would
seem awkward for Japan to intervene in the foreign exchange market around the
summit.
United States: Federal Reserve officials need greater
confidence that inflation is on a sustainable path toward its 2% average
target. It is unlikely to find such evidence with this week's report of the
March CPI, which comes on the heels of the stronger-than-expected jobs data at
the end of last week. The 303k jobs created last month were the most in 10
months. The participation rate rose to 62.7%, a four-month high, and the
average weekly hours ticked up. The headline and core CPI rates are expected to
rise by 0.3% after 0.4% increases in February. The base effect means that the
headline rate will rise to 3.4% from 3.2%. It was at 3.4% at the end of last
year. At an annualized pace, CPI would have risen by about 4% in Q1 24,
ironically the same pace as in Q1 23 and twice the annual pace in Q4 23. The
core rate may remain steady at 3.8%. That would be only the second time since
last April that the year-over-year core measure has not fallen. At an
annualized pace, core CPI would accelerate to 4.4% in Q1 24, down from 4.8% in
Q1 23 and 3.2% in Q4 23.
Economists will take the CPI and some components of the PPI
to forecast the PCE deflator, which is what the Fed targets. The minutes from
the March FOMC meeting will be reported a few hours after the CPI on April 10.
The Summary of Economic Projections provided quantitative information, but the
minutes may be more important for their qualitative insight. We suspect that if
it were not for the Chair, the rest of the FOMC is split evenly between the two
and fewer camps and the three or more camps.
The Dollar Index saw a bout of profit-taking after setting a
new high for the year to start last week, a little above 105.00. On the
pullback, DXY approached the 20- and 200-day moving averages (103.80-85) before
recovering after the better-than-expected employment data. Although the initial gains were pared, it still closed higher. We suspect the risk
is on the upside through the inflation reports in the coming days, but the
inability to sustain the post-jobs momentum is somewhat disappointing. Still,
the economic divergence should still underpin the greenback. The next target
for the Dollar Index may be closer to 105.50, but the continued "US
exceptionalism" could see it return to last November's high near 107.00,
with intermittent resistance around 106.00.
China: China had been experiencing deflation, a negative CPI
on a year-over-year basis, more or less since the middle of last year. It
finished last year at -0.3% year-over-year slumped to -0.8% in January before
bouncing to +0.7% in February, which was more than twice what was expected.
Food prices rose 3.3% month-over-month in February (pork prices rose 7.2%) and
this was likely related to the Lunar New Year. Similarly, though with less
weight in the CPI basket than foods, the holiday also appears to have boosted
travel prices. The risk is on the downside and CPI may have slowed to around 0.3%. Core CPI rose 1.2% year-over-year,
and this overstates the case too, following a 0.4% gain in January. Producer
prices have been falling on a year-over-year basis beginning in October 2022.
For the last seven months, it has been bouncing between -2.5% and -3.0%.
Although there are sometimes arguments made trying to link Chinese prices to US
consumer prices (though by the time the American consumer buys an imported
product the price is well above the imported price as shippers, marketers,
insurance, storage add costs and profits), the trade balance is more
politically sensitive. China's trade surplus fell by about 2% last year in
dollar terms and in yuan terms, it rose by almost 3.5%. What is most striking
is that Chinese exports to the US, Europe, and Japan have been falling, while
its exports to the global south, including India, Brazil, Vietnam, Indonesia,
and South Africa, not to mention Russia. Lastly, lending tends to be strong in
March, and robust figures will underpin ideas that the Chinese economy is off
to a strong start.
Chinese officials, like Japanese officials, are resisting
the stronger US dollar. The PBOC fix on Monday, after the two-day holiday, will
be scrutinized for clues of official intentions. There does not seem to be a
compelling case to fight the market too hard. It is easy to see it as more a
case of a strong dollar than a weak yuan. We suspect that the dollar will be
allowed to gradually return to the previous CNY7.25-CNY7.30 range. As the
greenback approached JPY152 in 2022 and 2023, it neared CNH7.37 against the
offshore yuan and could do so again.
Eurozone: The ECB meets on April 11. The last time the swaps
market had a cut fully priced in for this meeting was the end of January. It
seems almost unbelievable that at the end of last year, the swaps market had
not only one cut discounted but also a 70% chance of a second cut. Without
pre-committing, ECB President Lagarde is unlikely to provide much new
information or perspective, keeping expectations in place for a June cut. The
market has about 90 bp of cuts discounted for this year (three cuts and ~60%
chance of a fourth). After the ECB's March meeting, the market had four cuts
fully priced into the swaps curve.
The three-day short squeeze last week lifted the euro from
$1.0725 to about $1.0875. In response to the US jobs report, the euro was sold
back to about $1.0790. The (61.8%) retracement of the bounce is slightly below
$1.0785. The euro recovered almost back to session highs (~$1.0845) before
retreating in the waning hours of last week's activity. The divergence between
the US and the eurozone will be highlighted in the middle of next week. The US
will likely report little progress on moderating inflation with the March CPI
on Wednesday and less than 24 hours later, a dovish hold by the ECB. The euro's
low in Q1 was set in mid-February, the day after the US January CPI, near
$1.07. A retest seems likely.
Japan: Two reports begin the week. However, February's labor
cash earnings have been superseded by the recent wage round. And Japan's
current account movement is very seasonal. The February balance is always (past
20 years without fail) better than January. On the current account basis, Japan
recorded a JPY6.63 trillion (~$47.2 bln) trade deficit last year after a
JPY15.74 trillion shortfall in 2022. Meanwhile, Japanese investors continue to
buy foreign bonds. They bought JPY5.74 trillion in the first 12 weeks of the
year, down from JPY10.79 trillion in the same period in 2023. Prime Minister
Kishida will meet with US President Biden on April 10. We suspect security
issues will trump economic issues. Japan may take on some role in the AUKUS
arrangement and/or perhaps a new defense pact that would include US, Japan, and
the Philippines. The US has a defense agreement with both, but a new pact would
solidify Tokyo and Manila's defense alliance.
Helped by stronger household spending figures, the yen
reached an 11-day high before the US jobs data saw it retreat. The US dollar
fell to JPY150.80 and then recover back to JPY151.75. For nearly two weeks now,
the dollar has been in a saw-tooth pattern, alternating between daily gains and
losses but has gone nowhere. The five- and 10-day moving averages have
converged (~JPY151.50-55). By using word cues that have signaled intervention
in the past and not intervening now, Japanese officials risk diluting their
goodwill. Maybe the MOF is playing for time, like it did in 2022 and 2023, when
perhaps it thought that US rates were near a peak. The US 10-year yield set a
new high for the year last week near 4.43%. It closed up about 1 b8p for the
week and about 50 bp higher than the end of last year. That is the fundamental
consideration that Japanese officials are thwarting. It warns us that if/when
the JPY152 level gives way, a dam of sorts may burst, with some participants
looking for JPY155.
United Kingdom: The UK reports February monthly GDP and
details. The Bank of England embraces the definition of a recession as two
consecutive quarters of contracting GDP to mark a recession, and by that
definition, the UK experienced a shallow recession in H2 23. The economy
expanded by 0.2% in January, and it may have stagnated in February. The PMI
warns that manufacturing is still struggling, but services may buoy the
economy. January's 1.1% surge in construction is unlikely to be repeated. UK
trade balance often improves in February (15 of the past 20 Februarys). If the
seasonal pattern holds, it will be less of a drag on growth. Exports were off
10.3% year-over-year in Q4 23 and may be contracting at a slower pace at the
start of this year. Imports fell on a year-over-year basis every quarter last
year.
Sterling found support near $1.2540 in the beginning of last
week, and the short squeeze lifted it to about $1.2685. It stalled in front of
the 20-day moving average ($1.2690) before US jobs data pushed it back to
$1.2575. Sterling recovered almost fully and reached about $1.2635 in the North
American afternoon ahead of the weekend. We suspect sterling has entered a new
trading range of roughly $1.2520 to $1.2720. Meanwhile, the euro recorded a
higher low against sterling every session last week. A move above GBP0.8600,
last month's high, the 200-day moving average, and the (50%) retracement of
this year's losses, could lift the tone, while being a headwind for sterling
against the dollar.
Canada: There is little doubt that the Bank of Canada will stand pat when it meets on April 10. The overnight lending rate will remain at 5.0%, where it has been since last July. The Bank of Canada's business outlook survey showed some relaxation of inflation expectations. Fewer firms expect a recession (27% vs. 37% in Q4 23). However, the central bank is not in a hurry to cut rates. The swaps market has around a 20% chance of a rate cut after the disappointing March jobs report and around a 75% chance of a cut in June, when it meets next, up from about 66% over the course of last week. After the Bank of Canada meeting, attention will turn to the March CPI on April 16. Headline inflation looks poised to slow from February's 2.8% year-over-year pace. Recall that in February, the median and trim core measures eased by more than expected. The former fell to 3.1% from 3.3% and averaged 3.5% in Q4 23 and 3.9% in Q3 23. The latter eased to 3.2% from 3.4%. It averaged slightly more than 3.6% in Q4 24 and 3.7% in Q3 23.
The diverging employment reports sent the Canadian dollar to
a new low for the year. In the first 14 weeks of the year, the Canadian dollar
has posted gains in only two of them. The greenback reached almost CAD1.3650,
its best level since last November before pulling back and settling near
CAD1.3580. Initial support may be in the CAD1.3540-60 area. The US two-year
premium over Canada rose to a new high for the year as well (~55 bp). There
seems to be little standing in the way of a test on CAD1.3700, and maybe
CAD1.3750.
Australia: The formal ending of the China's boycott of
Australian wines is a nice step, but it does not fundamentally alter trade
flows or the larger relationship. China is Australia's largest trading partner,
accounting of for a little more than a quarter of Australia's two-way trade.
Last year, Australia reported almost A$180 bln of exports to China and imported
A$104 bln of goods and services from China. The futures
market sees the Reserve Bank of Australia to be among the last of the G10
central banks to cut rates. There is about a 55% chance discounted for August
and almost an 80% chance of a September cut. The market has one cut fully
discounted and about a 50% chance of a second cut this year. At the end of
2023, the market was leaning toward three cuts this year.
After reaching almost $0.6620 the day before the US
employment report, the Australian dollar was sold to about $0.6550 after it.
The Aussie recovered nearly fully and returned to almost $0.6590. The momentum
indicators have turned higher, and it looks constructive. It has not closed
above $0.6600 since March 13, and doing so would lift the tone and could spur a
move into the $0.6660 area. A move below $0.6545 would sour the mood.
Mexico: March CPI will be reported on April 9. The bi-weekly
estimates show that the pace of moderation is slowing. It may reinforce market
uncertainty about the next central bank meeting in May. The swaps market
favors, without fully discounting, a cut in Q2. Mexico reports February
industrial production figures a couple of days later. Auto production rose, and
the manufacturing PMI rose for the first time in three months (52.3 vs. 50.2).
On the other hand, the IMEF manufacturing index slipped to its lowest level
since last May. Of note, the March manufacturing PMI saw the largest decline in
new export orders in five months, with responding companies highlighting weaker
demand from the US.
The peso solidified its hold as the world's strongest
currency this year. It rose to new nine-year highs ahead of the weekend. It
barely reacted to the US employment report and continued to power higher. It is
up a little more than 3% this year. None of the G10 currencies have risen
against the dollar this year, and only the Colombian peso and Peruvian sol have
also gained on the greenback. The dollar was sold to about MXN16.44. Our
earlier concern about unwinding peso longs ahead of the election has proved for
naught. The logic may be if the peso has done so well under AMLO, who is not
particularly friendly to investors, the likely election of his handpicked
successor, Mexico City Mayor Sheinbaum, may not be disruptive either. She is
seen as somewhat less extreme than AMLO. Since the end of January, the dollar
has risen in only two weeks, suggesting that in addition to the carry, it is
also a momentum/trend-following play. The MXN16.50-60 may offer resistance now.
On the downside, a move toward MXN16.0 does not seem as much of a stretch.
Reviewed by Marc Chandler
on
April 06, 2024
Rating:
