The dollar is mixed as trade tensions ease. DXY is trading slightly higher near 99.037 after some positive comments about ongoing US-China trade talks (see below). Sterling is underperforming and trading lower near $1.35 after soft labor market data (see below), while the euro is trading flat near $1.1425 despite hawkish ECB comments (see below). USD/JPY tested the 145 level after dovish BOJ comments (see below) but is now trading lower near 144.55. For now, the 140-145 range seems safe. Inflation data and a heavy UST auction schedule this week will keep the market on its toes. Those auctions start today with $58 bln in 3-year notes. These could get sloppy at the longer end and could put further pressure on the greenback.
AMERICAS
U.S.-China trade talks will continue today. Talks that began yesterday ended around 8 PM London time. President Trump said “We are doing well with China. China’s not easy. I’m only getting good reports.” Treasury Secretary Bessent said they had a “good meeting” while Commerce Secretary Lutnick called the discussions “fruitful.” National Economic Council Director Hassett said he sees quick results from these talks. He added that the talks are likely to result in China releasing rare earths for export and the U.S. easing access to semiconductors. Such a result would just take us back to the tariff truce and 30% tariffs would remain on China. We don't think any country is serious about negotiating a true trade deal when tariffs may or may not remain in effect.
The growth outlook remains solid. The Atlanta Fed’s GDPNow model is still tracking Q2 growth at 3.8% SAAR, with personal consumption seen rising 2.5% SAAR. It will be updated again next Tuesday after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q2 growth at 2.3% SAAR and Q3 growth at 2.4% SAAR. Both readings will be updated this Friday.
NFIB small business optimism rose in May. Headline came in at 98.8 vs. 96.0 expected and 95.8 in April. This was the first rise since December but remains well below that month’s cycle high of 105.1. However, the uncertainty subcomponent rose two points to 94 and NFIB Chief Economist Dunkelberg noted that “Although optimism recovered slightly in May, uncertainty is still high among small-business owners.” A net 25% of respondents see higher selling prices (same as April), while a net 12% plan to hire (down 1 ppt from April).
The Fed media blackout remains in effect this week. While the data have been a bit mixed, the overall picture supports the prevailing Fed view that it can be patient. The market sees no chance of a cut next week, only around 15% odds of a cut in July, and around 70% odds of a cut in September. A cut is not fully priced in until the October meeting. Furthermore, the swaps market is pricing in nearly 75 bp of total easing over the next 12 months. This Fed outlook will be tested by this week’s inflation data.
Inflation expectations are starting to moderate. New York Fed survey for May saw 1-year inflation expectations fall four ticks to 3.2%, 3-year expectations fall two ticks to 3.0%, and 5-year expectations fall a tick to 2.6%. Despite the drop, expectations remain above 2% across the horizon and support the Fed’s intent to remain cautious about cutting. The survey also showed some optimism about the labor market as the perceived probability of losing a job fell half a percentage point to 14.83%. CPI will be reported tomorrow. Headline is expected at 2.5% y/y vs. 2.3% in April and core is expected at 2.9% y/y vs. 2.8% in April.
Treasury auctions $58 bln of 3-year notes today. At the last auction, the bid/cover was 2.56 and indirect bidders took 62.4%. Appetite for USTs will be tested with heavy supply this week as $39 bln of 3-year notes will be sold tomorrow and $22 bln of 30-year bonds will be sold Thursday. Coming amidst elevated uncertainty and May inflation data, these auctions could get sloppy. Stay tuned.
Brazil reports May IPCA inflation. Headline is expected at 5.39% y/y vs. 5.53% in April. If so, headline would fall for the first time since January but would remain well above the 1.5-4.5% target range. At the last meeting May 7, the central bank hiked rates 50 bp to 14.75% and noted that the easing cycle in in an “advanced stage” and that calibration of monetary policy depends on how inflation behaves. The bank warned that risks to the inflation outlook in both directions are higher than usual. As such, “This scenario prescribes a significantly contractionary monetary policy for a prolonged period to assure the convergence of inflation to the target.” Next COPOM meeting is June 18 and a 25 bp hike to 15.0% is expected. After that, the swaps market is pricing in no more hikes in this cycle. High carry continues to underpin the real, with US/BRL trading at the lowest since October near 5.5585. The September low near 5.40 is nearing but a break below 5.5265 would set up a test of the May 2024 low near 5.0390.
EUROPE/MIDDLE EAST/AFRICA
European Central Bank officials continue to push back against easing expectations. GC member (and noted hawk) Holzmann said “The inflation goal is already in reach, so for me it made sense maybe not to cut rates until the autumn to be sure that - given the uncertainty we have everywhere about the economy - we don’t experience another bout of inflation.” Holzmann dissented in favor of steady rates this month and so his comments are not surprising. Recall that reports have emerged that ECB officials are considering a pause at the July meeting. Given the more hawkish forward guidance coming out of the ECB, the market is pricing in only 10% odds of a cut next month. However, the swaps market is still pricing in another 50 bp of easing over the next 12 months that would see the policy rate bottom near 1.5%. Villeroy, Rehn, and Vujcic also speak today.
U.K. reported soft labor market data. The unemployment rate rose a tick as expected to 4.6% for the three month period ending in April. Elsewhere, weekly earnings ex-bonus came in a tick lower than expected at 5.2% y/y vs. a revised 5.5% (was 5.6%) previously, while the policy-relevant private sector earnings ex-bonus came in two ticks lower than expected at 5.1% y/y vs. a revised 5.5% (was 5.6%) previously. Elsewhere, the number of employees on payroll dropped -109k in May vs. -20k expected and a revised -55k (was -33k), the biggest decline in five years. However, the Office for National Statistics warns that early estimates are based on partial figures and subject to significant revisions.
The data have led markets to adjust BOE easing expectations. The BOE is expected to pause its easing at the next meeting June 19. However, the swaps market is now pricing in nearly 75 bp of total easing over the next 12 months vs. 50 bp at the start of this week. This has taken a toll on sterling and is delaying another attempt to break above $1.36. On the other hand, FTSE-100 is trading at the highest since March and is nearing the all-time high from that month near 8909. Break above would target the top of a daily channel dating back to 2020 that comes in near 9025 currently.
Norway reported mixed May CPI data. Headline came in three ticks higher than expected at 3.0% y/y vs. 2.5% in April, while underlying came in a tick lower than expected at 2.8% y/y vs. 3.0% in April. For reference, the Norges Bank saw headline and underlying at 2.7% and 3.1%, respectively. Overall, the Norges Bank can afford to be patient before starting to cut rates as headline inflation is still well above the 2% target. At its May 8 policy meeting, the Norges Bank kept the policy rate steady at 4.50% and pointed out that “the Committee’s current assessment of the outlook implies that the policy rate will most likely be reduced in the course of 2025.” Next meeting is June 19 and no change is expected then, with the first cut not fully priced in until the September 18 meeting.
ASIA
Bank of Japan Governor Ueda signaled there was no urgency to tighten policy. He noted that underlying inflation remains below 2%, and was referring to CPI ex-food and energy, which has remained between 1.5-1.6% y/y this year. It’s a bit surprising that Ueda is focusing on underlying inflation when the BOJ targets core inflation (CPI ex-fresh food). Core rose 3.5% y/y in April and is tracking well above the BOJ’s FY25 forecast of 2.2% as well as the 2% target. Focusing on underlying was seen as dovish but the swaps market is still pricing in only 25 bp of tightening over the next 12 months. This cautious normalization cycle is an ongoing headwind for JPY. USD/JPY has remained in the 140-150 range since early April. Until something significantly changes in either the BOJ or Fed outlook, we expect this range to hold. However, given our bias for a weaker dollar, we expect the 145 area will be difficult to breach for a prolonged period and so look for downside risks to USD/JPY.
Reports suggest China will tap the housing provident fund to help support the property sector. The fund is reportedly worth CNY10.9 trln ($1.5 trln) and would offering homebuyers an alternative to bank mortgages. The fund had outstanding mortgage loans totaling CNY8.1 trln yuan last year. Of note, the program was created thirty years ago and was modeled on Singapore’s model, which requires both employees and employers to make monthly contributions to a pool that can then offer mortgage loans, often at rates lower than traditional bank mortgages. That said, this is unlikely to address the ongoing headwinds from the burst bubble that remains at the heart of this sector’s problems.
