Stronger than expected data and hawkish FOMC minutes helped lift US rates and the greenback last week. That market continues to also reduce the extend of ECB easing this year is notable but did not prevent the euro from snapping a five-week advance. The 10-year Japanese government bond yield rose above 1% last week for the first time since 2012, but the US dollar traded above JPY157 for the first time since the BOJ is believed to have intervened earlier this month. Sterling's resilience in the face the pullback in May's flash composite PMI (52.8 vs. 54.1) and dreadful April retail sales (-2.3%) is notable. Those reports were unable to offset the impact on rate expectations spurred by the firmer than expected CPI. The swaps market does not have the first rate cut fully discounted until November. Before the CPI print, a cut had been priced in for August. The UK two-year yield rose by 16 bp last week, the most in Europe. Ahead of the weekend, sterling posted its highest settlement in more than two months. The draft of the G7 finance minister statement will be noted for its tougher against China's trade practices. In early June, the EU is expected to announce new tariffs on Chinese-made autos. A key question is whether the dollar's setback before the weekend signaled the resumption of the lower trend that began in mid-April, with the notable exception of the yen. We lean against it, and in the analysis below, identify key chart areas that could signal otherwise.
Next week's highlights include the preliminary eurozone May CPI and Tokyo's May CPI. Both are likely to have risen after softening in April. A firmer eurozone reading will not deter expectations for rate cut on June 6. Nor will a higher Tokyo print impact expectations for the BOJ. Owing to a different basket and methodology, the US PCE deflator, which the Fed targets is unlikely to show the mild softness of the April CPI. Looking further ahead, we note that the median forecast for the June 7 US May nonfarm payroll in Bloomberg's survey has fallen from around 225k to 180k (175k in April), of which the private sector is seen accounting for 115k, which would be the least in six months. It accurate, it still might not reach the threshold of Fed concerns.
United States: Although the "stagflation"
framing of the US economic situation seems exaggerated, the incoming data in
the week ahead could fan such talk. Growth in Q1 disappointed expectations and
looks likely to be revised lower (toward 1.2% from 1.6%), while the April
income and consumption are set to slow. Meanwhile the monthly PCE deflators are
unlikely to see the small improvement shown by the April CPI. Since the March
CPI (April 10), the futures market has discounted less than a 50% chance of Fed
cut in June. The market prices in no chance of June cut. Despite some
economists arguing for another rate hike, and some apparent desire to hedge
such a risk, the Fed funds futures have consistently priced in at least one cut
fully. What has changed is that starting on April 10, and with the one-day
exception when the April CPI was released (May 15), the market has not been
confident of a second rate cut this year. Still, the market leans in that
direction with pricing reflecting about a 35% chance of a second cut. At the
end of April, the market had nearly completely priced it out. We suspect the
pendulum of market sentiment will returned to that view. While we think the US
economy is slowing, it appears to be a gradual process and the recent string of
disappointing data may have overstated the case. This suggests better US data
likely with the May prints and the key may be the next ISM services survey
(back above the 50 boom/bust level?) and the jobs report (June 7, 225k?). Note
that that the ECB is widely expected to cut rates the day before the US
employment data.
The Dollar Index set the year's high in mid-April near 106.50 and trended
lower to reach almost 104.00 on May 16. Since then, it recovered, but stalled
near the 20-day moving average, a little above 105.00. This met the minimum
retracement objective (38.2%). The next retracement (50%) is closer to 105.30.
Despite the pullback ahead of the weekend, the technical tone remains constructive,
and the momentum indicators are turning higher. The five-day moving average
looks set to cross back above the 20-day moving average in the coming days. A
break of the 104.40-50 area would likely negate this constructive view.
Eurozone: The preliminary May CPI will be reported on May 31. Barring
a dramatic upside shock, the ECB is set to cut rates in early June. On the one
hand, the base effect warns of the risk to the upside of the 2.4%
year-over-year pace recorded in March and April. The CPI was flat in May 2023.
On the other hand, the euro was a bit stronger and oil prices softer. The bar
to the ECB not cutting next week is high, but ECB may try to
deliver a hawkish cut as it were, by welcoming the economic green shoots, and
playing down the likelihood of a cut at the July meeting. The CPI data will
also feed into the ECB's updated economic forecasts to be released at the June
6 meeting. Encouraged by evidence that a recovery is taking hold and official
comments suggesting no consensus after the June ECB meeting, the swaps market
had been scaling back expectations of ECB cuts this year. Recall that end of
last year, the market was discounting 180 bp of cuts. By the end of February,
it was halved. After the preliminary May PMI last week, the market slipped to
less than 60 bp.
The euro snapped a five-week advance, slipping by about 0.20% last week.
That was only the second weekly loss here in Q2. It recorded a two-month high
slightly below $1.09 on May 16 and a week later approached $1.08. Several
technical indicators converge in the $1.0785 area. A break would boost
confidence that a high is in place. The daily momentum indicators have turned
lower. A move above the $1.0860-65 area would negate the bearish scenario. In
the bigger picture, since the start of last year, the euro has been trading
broadly sideways, mostly between $1.05 and $1.10. The average over this period
is around $1.0815. This year's average is a few hundredths of a cent higher.
Japan: In terms of revealed preferences, BOJ Governor Ueda
appears to be making monetary policy effective again by taking the official foot off the
accelerator. The short-run economic fluctuations do not matter much to this strategic objective. And there
are good reasons to look through the contraction in the first quarter. Indeed,
more recent data underscore that the downturn was a function of the
idiosyncratic factors from which the economy is already recovering. April
retail sales and industrial production figures due at the end of the week
should lend confirmation. The April jobs report will be issued then, as well. The
unemployment rate has been (with two exceptions) 2.5%-2.6% for more than two
years. It was 2.6% in March. The market may be most sensitive to Tokyo's May
CPI due shortly before the real sector national data. Tokyo's CPI is a
reasonable proxy for the national figures, which will not be available for a
few weeks. Recall that in March, abolishing high school tuition saw the
headline and core measures fall below 2% (1.8% and 1.6%, respectively).
Rising US rates helped lift the dollar above JPY157 for the first time since
May 1. BOJ data out next week is expected to confirm two bouts of intervention
for what appears to be about JPY9 trillion or around $58-$60 bln-on par with
the intervention seen in 2022. We expect the market to turn cautious as JPY158
is approached, which is where the BOJ's last intervention is thought to have
taken place. Even though the moves have been modest, it has been close to a
one-way market. The dollar has retreated in one session in each of the past
three weeks. Still, one-month implied volatility is below 8.5%, back to
mid-April lows. It was near 11% before the first bout of BOJ intervention is
thought to have taken place. The dollar settled above the five-day moving
average every session last week. It begins the new week near JPY156.65.
China: The continued deflation in China's producer prices
and the relatively low level of capacity utilization warns that industrial
profits likely remain weak. That the returns on capital are weak underscore the
existence of excess investment. Industrial profits were 3.5% lower
year-over-year in March after dropping 19.2% in year-over-year in March 2023. China
reports the April estimate early on May 27. Three days later, the May PMI is
due. Recall that the manufacturing PMI was above the 50 boom/bust level
back-to-back months in March and April for the first time since the end of Q1
23. The non-manufacturing PMI has fared better. It was above 50 all of 2023,
though slowed in Q4 23 and finished the year at 50.4. It reached 53.0 in March
before slipping back to 51.2 in April. The composite ended last year at 50.3. It
reached a 10-month high of 52.7 in March and eased to 51.7 in April. The
general sense is that more stimulative measures will be needed if the 5% growth
target is to be achieved.
The yuan will take a seven-session losing streak into next week. Since
coming back from the May Day holidays, the yuan has fallen in all but three of
the 15 sessions. We note that the rolling 60-day correlation is at the high for
the year (~0.52) while the 30-day correlation is higher (~0.80). To be sure,
the argument is not that China has pegged the yuan to the yen,
but rather that they share a common characteristic. The yuan (offshore) and yen
make attractive funding currencies. The dollar is approaching last month's high
against the yuan (~CNY7.2475). The dollar briefly traded above CNH7.26 against
the offshore yuan. Last month's high was around CNH7.2830. Chinese officials
may resist more forcefully yuan weakness if the equity market slide is extended.
The 2.25% loss in the last two sessions brings the CSI 300 back to late April
levels.
United Kingdom: The UK reports mortgage lending and consumer
credit figures, alongside money supply. The markets tend not to be sensitive to
these reports. The UK has a bank holiday, and so, like in the US, British
markets are closed Monday (May 27). The Bank of England will see another
employment report and CPI before the June 20 meeting. After last week's CPI,
retail sales, and preliminary estimate of May PMI, the swaps market downgraded
the chances of a cut next month to less than 10% from almost 60% a week ago
(May 17). The market was fully confident that the base rate would be at 4.75%
by the end of August but no longer. It is now seen as only a 40% likelihood. The
first cut is now fully discounted for November and swaps pricing in consistent
with 31bp of cuts this year, down from a little more than 60 bp on May 15.
Sterling recorded the low last week near $1.2675 after the disappointing
retail sales report. However, it recovered and made new session highs after the
stronger-than-expected US durable goods orders. Sterling took out the previous day's high and reached $1.2750, just below the week's high; $1.2760, which was also a
two-month high. Sterling has risen in four of the past five weeks. Without
$1.2650 yielding, sterling can make a new high, but the momentum indicators
warn not to expect a large move. Initial resistance is seen near $1.2800.
Canada: Canada is one of the last G10 countries to report Q1 GDP,
but it will be reported on May 31. The economy contracted by 0.5% in Q3 23
(annualized rate), driven primarily by weak consumption, a contraction in
business investment, and a drag from trade. The economy snapped back in Q4. It
grew by 1%. The economy appears to have strengthened further in Q1 24:
consumption may have quickened, capex appears to have risen for the first time
in three quarters, and government spending increased after falling in Q4 23.
The contribution from net exports may have been reduced. The monthly GDP rose
by 0.5% in January and 0.2% in February. The Bank of Canada meets on June 5 and
the odds of a hike in the swap market has been hovering slightly above 60% in
the second half of last week.
For the third time in four sessions, the US dollar was bought on a dip below
CAD1.36 at the start of last week. It rose to almost CAD1.3750 on May 23, which
corresponds to the (61.8%) retracement of the losses from the year's high set
on April 16 (~CAD1.3845). Retail sales disappointed before the weekend. Canada reported its the
third consecutive decline in retail sales. The 0.6% decline excluding auto sales, was the
largest drop since last June. Still amid corrective forces, the greenback was sold to a little through CAD1.3650. Initial support is likely to be found in near CAD1.3625. Momentum indicators have turned higher, and the five-day
moving average crossed back above the 20-day ahead of the weekend.
Australia: Australia reports April retail sales and CPI
in the coming days. The futures market has been all over the board. As recently
as early February, the market had two cuts this year fully discounted and
around a 2/3 chance of a third cat. By the end of April, it was discounting
about a 40% chance of a hike. Expectations have settled down with about a 65%
chance of a cut. Retail sales fell 0.4% in March and have not fallen in
consecutive months since 2021. However, over the past six months they have been
flat, underscoring the weakness of the Australian consumer. The monthly CPI
print (RBA puts more weight on the quarterly figure) peaked at 8.4% at the end
of 2022 and fell to 3.4% at the end of 2023. Improvement stalled in Q1 24 and
was at 3.5% in March.
The Australian dollar fell to an eight-day low, slightly above $0.6590 before recovering back to $0.6620 ahead of the weekend. Last week's high was set on Monday near $0.6710. The Aussie was the worst performed in the G10 last week, falling by almost 1%. The momentum indicators have turned lower. Still, the five-day moving average could fall below the 20-day moving average early next week. It last crossed in late April. The $0.6580 area is the (38.2%) retracement of the gains from the year's low set on April 19 (~$0.6365). On the other hand, a move back above the $0.6650 area would be constructive.
Mexico: The central bank's inflation report is bound to
recognize the slowing pace of improvement. With the unemployment rate (March)
at a generation low of 2.28% (April's estimate due May 30), officials no not
appear in a hurry to cut rates again. The fact that the Fed is not seen cutting
until late this year also gives Banxico room to maneuver. Mexico holds national
election on June 2. While Sheinbaum looks to hold on the presidency for the
Morena coalition, the outcome of the legislative elections will likely shape
her legislative program.
The dollar initially extended this month's slide, slipping briefly through
MXN16.63 on May 21 before staging a key reversal (new lows for the move and
then settling above the previous session's high). Follow-through dollar buying
tested the MXN16.75 area. The dollar's gains (~0.50%) last week, snapped a
three-week slide during which it fell by about 3.2%. Despite the pullback to
around MXN16.6750 ahead of the weekend, the greenback's recovery does not appear
over. The momentum indicators have turned higher. The next target is around
MXN16.90.. Falling copper
prices, a 50 bp rate cut and promises of more to come, took a toll on the
Chilean peso, which was the weakest currency in the world last week, falling by
about 1.5% rivaling the South African rand for the weakest emerging market currency. It was the peso's first loss in six weeks. The peso appreciated by
around 8.3% in that run. South Africa holds elections May 29.
Reviewed by Marc Chandler
on
May 25, 2024
Rating:
