- We continue to hit our medium-term FX targets much sooner than expected; the outlook for EM FX isn’t any better
- U.S. yields are rising again; the Fed is expected to hike rates 50 bp to 1.0% and announce Quantitative Tightening Wednesday; it will be a full week of key U.S. data; U.S. Treasury makes its quarterly refunding announcement Wednesday; Canada also reports April jobs data Friday
- ECB tightening expectations remain subdued; eurozone reports some key data; Germany has a busy week; BOE is expected to hike rates 25 bp to 1.0% Thursday; Norges Bank is expected to keep rates steady at 0.75% Thursday
- April Tokyo CPI Friday will be the highlight from Japan; RBA is expected to keep rates steady at 0.10% Tuesday
We continue to hit our medium-term FX targets much sooner than expected. As such, we are going to set out some longer-term targets that we didn’t think we’d be typing so soon. Of note, we believe the dollar softness at the end of last week was due to profit-taking and month-end rebalancing. As such, the dollar should resume strengthening this week. DXY traded last week at the highest since December 2002 near 103.928 and we continue to target the November 2002 high near 107. The euro traded last week at the lowest since January 2017 near $1.0470 and we continue target that month’s low near $1.0340. If that level breaks, we have to start talking about parity and below. USD/JPY traded last week at the highest since March 2002 near 131.25 and we continue to target the January 2002 high near 135.15. If that level breaks, the August 1998 high near 147.65 would come into view. Sterling traded last week at the lowest since July 2020 near $1.2410 and we continue to target the June 2020 low near $1.2250 and the May 2020 low near $1.2075. If those levels break, then we would target the March 2020 low near $1.1410.
The outlook for EM FX isn’t any better. We may be belaboring the point but the world is embarking on what is shaping up to be the most aggressive tightening cycle we've ever seen. We are closer to the beginning than the end of that cycle and yet we are already seeing significant dislocations across EM. A handful of currencies have held up due to high local interest rates but even those are cracking under the strain. CLP, MXN, and ZAR are close to being down YTD, which would leave BRL, PEN, COP as the only EM currencies to be up YTD against USD. We won't count RUB because that exchange rate has been rendered meaningless by sanctions and capital controls. The best performer BRL was up 20% YTD at its peak in early April but now it is up only 12% YTD.
U.S. yields are rising again. The 10-year yield is starting of this week at 2.94%, the highest since April 22 and nearing the April 20 high near 2.98%. Similarly, the 2-year yield is starting off this week at 2.74%, the highest since April 22 and nearing that day’s high near 2.78%. This uptrend is likely to continue as U.S. inflation continues to run hot and the Fed continues its aggressive tightening cycle (see below). Of note, the 2-year interest rate differentials have swung back in the dollar’s favor after a brief corrective phase last week. In particular, the spreads with Japan (277 bp) and the U.K. (112 bp) continue to make new cycle highs, while the spread with Germany (245 bp) is lagging a bit. All should continue to rise.
The Fed is expected to hike rates 50 bp to 1.0% Wednesday. There will be no new forecasts until the June 14-15 FOMC meeting, when another 50 bp hike is widely expected. Indeed, WIRP suggests over 50% odds of a 75 bp hike then. Looking further out, the swaps market is still pricing in a terminal Fed Funds rate near 3.25%. Because of the media blackout, there are no Fed speaker until Chair Powell’s post-decision press conference Wednesday afternoon. Then, Fed speakers will fan out to spread the word. Williams, Bostic, Bullard, Waller, and Daly all speak Friday.
The Fed is also likely to announce Quantitative Tightening. Recall that the minutes to March FOMC meeting set out a likely scenario for balance sheet runoff, with a $95 bln monthly cap seen as appropriate. This cap would be split $60 bln for USTs and $35 bln for MBS. Furthermore, the appropriate phase-in period for this cap was seen at three months or “modestly longer if market conditions warrant.” While the details may be tweaked, the pace of QT will be much faster this time around. Back in 2017, the phase-in period was 12 months and the final monthly caps were $30 bln for UST and $20 bln for MBS. The March minutes also showed that “the Committee was well placed to begin the process of reducing the size of the balance sheet as early as after the conclusion of its upcoming meeting in May.” If the Fed stays true to form, then a plan close to the one outlined here will be announced Wednesday and implemented on May 15.
It will be a full week of key U.S. data. April jobs data will draw some attention but with the U.S. pretty much at full employment, it no longer has that much impact on Fed policy. That said, consensus stands at 390k vs. 431k in March, with the unemployment rate expected to fall a tick to anew cycle low of 3.5%. Average hourly earnings are expected to ease a tick to 5.5%, while average weekly hours are expected to rise a tick to 34.7. Ahead of the jobs data, ADP reports its private sector jobs data and is expected at 395k vs. 455k in March.
The Fed will be looking for signs of weakness in the real economy. Here, the April ISM PMI readings will be key. Manufacturing PMI will be reported Monday and is expected at 57.6 vs. 57.1 in March. New orders component is expected at 54.1 vs. 53.8 in March, employment is expected at 55.0 vs. 56.3 in March, and prices pace is expected at 87.4 vs. 87.1 in March. Services PMI will be reported Wednesday and is expected at 58.5 vs. 58.3 in March. Of note, April Chicago PMI came in last week at 56.4 vs. 62.9 in March and so there are downside risks to the ISM readings.
Other minor data will round out the week. March construction spending (0.8% m/m expected) will be reported Monday. March factory orders (1.2% m/m expected), JOLTS job openings (11.2 mln expected), and April auto sales (13.9 mln annual pace expected) will be reported Tuesday. March trade data (-$107.0 bln expected) will be reported Wednesday. April Challenger job cuts, Q1 nonfarm productivity and unit labor costs, and weekly jobless claims will be reported Thursday. March consumer credit ($25.0 bln expected) will be reported Friday.
The U.S. Treasury makes its quarterly refunding announcement Wednesday. Dealers are reportedly looking for another cut in planned sales. At the last announcement February 2, Treasury cut its sales of long-term debt for a second straight quarter to $110 bln, down $10 bln from the November announcement. This week’s decision is made all the more difficult because it comes just as the Fed is about to undertake QT. In the February announcement, the Treasury Borrowing Advisory Committee (TBAC) estimated that the Fed’s balance sheet runoff could create about $1.6 trln in additional new financing needs over the next three years.
Canada also reports April jobs data Friday. A gain of 40k jobs is expected vs. 72.5k in March, while the unemployment rate is expected to fall a tick to 5.2%. If so, it would be another all-time low. With the economy pretty much at full employment, it’s full speed ahead for the Bank of Canada. WIRP suggests a 50 bp hike to 1.0% is full priced in for the next meeting June 1. Looking ahead, the swaps market is pricing in 225 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%. Ahead of the jobs data, April S&P manufacturing PMI will be reported Monday and March trade data will be reported Wednesday. April Ivey PMI will be reported Friday.
ECB tightening expectations remain subdued. WIRP suggests odds of liftoff June 9 are now around 30% vs. 40% at the start of last week, while liftoff July 21 remains fully priced in. The swaps market is now pricing in 150 bp of tightening over the next 12 months, with another 50 bp (vs. 75 bp) of tightening priced in over the following 12 months that would see the deposit rate peak near 1.5% vs. 1.75% at the start of last week. While this still seems too aggressive to us, at least markets are recognizing that 1) eurozone inflation may be peaking and 2) the risks to growth are mounting.
Eurozone reports some key data. Final April PMI readings will come out. Manufacturing will be reported Monday. Italy and Spain will be reported for the first time and both are expected to fall from March to 55.0 and 54.0, respectively. Services and composite will be reported Wednesday. Here too, Italy and Spain will be reported for the first time and both composite PMIs are expected to rise from March to 54.1 and 54.5, respectively. March PPI and unemployment will be reported Tuesday, with PPI expected to rise 36.3% y/y vs. 31.4% in February. March retail sales will also be reported Wednesday and are expected at -0.2% m/m vs 0.3% in February.
Germany has a busy week. March retail sales will be reported Monday and is expected at 0.2% m/m vs. 0.2% in February. German unemployment and trade data will be reported Tuesday. Factory orders will be reported Thursday and are expected at -1.0% m/m vs. -2.2% in February. IP will be reported Friday and is expected at -1.2% m/m vs. 0.2% in February. Germany is the engine of the eurozone economy and recent signs point to continued weakness in Q2 after both barely grew at all (0.2% q/q) in Q1.
Bank of England is expected to hike rates 25 bp to 1.0% Thursday. At the last meeting March 17, the bank hiked rates 25 bp but pivoted to a less hawkish stance. The vote was 8-1, with Cunliffe dissenting in favor of no hike. The forward guidance was changed as the bank said further tightening “might be” appropriate in the coming months vs. “likely” at the previous meeting in February. The bank also warned that the likely hit to U.K. household incomes will be “materially larger” than feared at the previous meeting. Before the Ukraine crisis, the BOE expected inflation to peak around 7.25% in April but now expects it to accelerate to about 8% by the end of June, with greater upside risks later this year. Updated macro forecasts will be released at this meeting. Also note that the bank will start planning Quantitative Tightening after the policy rate hits 1.0%, which will only add to the headwinds.
There are some minor U.K. data releases. Final April PMI readings will come out. Manufacturing will be reported Tuesday, services and composite will be reported Thursday, and construction will be reported Friday. March consumer credit will also be reported Tuesday. Recent data suggest the U.K. economy ended Q1 on a weak note and the loss of momentum is likely carrying over into Q2, as payroll tax and household energy caps were hiked in April.
Norges Bank is expected to keep rates steady at 0.75% Thursday. At the last meeting March 24, the bank hiked rates 25 bp to 0.75%, as expected, and said the rate will mostly likely be hiked again at the June 23 meeting, adding “The committee was concerned with the prospect that the war in Ukraine could result in weaker-than-expected global growth amid rising inflation. If there are prospects of persistently high inflation, the policy rate may be raised more quickly.” New macro forecasts and an updated rate path won’t be released until the June 23 meeting but the one released in March suggested a longer, greater tightening cycle ahead as the bank sees the policy rate peaking near 2.5% in 2024 vs. 1.75% previously. Swaps market is pricing in 150 bp of tightening over the next 12 months followed by another 25 bp over the following 12 months that would take the policy rate up to an expected peak near 2.5%.
April Tokyo CPI Friday will be the highlight from Japan. Headline is expected at 2.3% y/y vs. 1.3% in March, while core (ex-fresh food) is expected a 1.8% y/y vs. 0.8% in March. Of note, core ex-energy is expected at 0.6% y/y vs. -0.4% in March. Still, much of the increase is due to the cut in mobile phone rates falling out of the y//y comparisons. Policymakers are looking through that and the energy component and have signaled steady policy for the time being. Ahead of that, final April manufacturing PMI, vehicle sales, and consumer confidence will be reported Monday.
Reserve Bank of Australia is expected to keep rates steady at 0.10% Tuesday. Updated forecasts will be released with the Statement of Monetary Policy Friday. At the last meeting April 5, the bank dropped its reference to remaining “patient” on policy and instead moved to being data dependent. Governor Lowe said then that the bank will assess upcoming inflation and wage data as it “sets policy to support full employment in Australia and inflation outcomes consistent with the target.” This change in forward guidance validated market expectations for liftoff coming sooner rather than later. As such, RBA tightening expectations continue to rise. WIRP suggests over 50% odds of liftoff this week, while liftoff at the June 7 meeting fully priced in; at the beginning of March, liftoff was priced in for the August 2 meeting. The swaps market is pricing in over 300 bp of tightening over the next 12 months followed by another 25 bp over the following 12 months that would see the policy rate peak near 3.5%, up from 3.25% at the start of last week. Australia Reports March retail sales Wednesday and trade data Thursday. New Zealand reports Q1 labor market data Wednesday.