Dollar Drifts Lower As Markets Await Fresh Drivers

April 09, 2024

Win Thin

Some Fed officials are starting to soften their hawkish tone; NY Fed March inflation expectations were mixed; NFIB small business optimism softened in March; Mexico reports March CPI
The ECB released its Q1 bank lending survey; no change is expected from the ECB meeting that begins tomorrow; March U.K. BRC retail sales came in stronger than expected.
Jawboning on the yen continues; Japan reported March machine tool orders; Australia reported sentiment indicators; NZIER released its Quarterly Survey of Business Opinion; RBNZ meets overnight and is expected to keep rates steady at 5.5%

The dollar is soft ahead of CPI data tomorrow. DXY is trading lower for the second straight day near 104.032. The euro is trading higher near $1.0870 while sterling is trading higher near $1.2685. USD/JPY is trading lower near 151.80 after being unable to break above the 152 area on continued jawboning (see below). The dollar rally should continue this week on signs of persistent inflation and robust growth in the U.S. The U.S. data continue to come in mostly firmer and should keep upward pressure on U.S. yields. We believe that while market easing expectations have adjusted somewhat already (see below), there is still room to go. When the market finally capitulates on the Fed, the dollar should gain further.

AMERICAS

Some Fed officials are starting to soften their hawkish tone. Goolsbee acknowledged that the last jobs report was “quite strong.” However, he stressed that “You’ve got to pay attention to how long do you want to be that restrictive? If you’re there too long, the unemployment rate is going to start going up.” Elsewhere, Kashkari said the labor market is no longer ‘red hot’ but remains tight. He said his base case is that inflation continues to fall. Lastly, former St. Louis Fed President Bullard said three cuts this year are his base case. While the time decay of value of former Fed officials’ views is quite fast, Bullard remains relevant after he emerged as the Fed’s thought leader ahead of the tightening cycle. Odds of a June cut have fallen close to 50% while odds of a July cut have fallen below 90%. Both are the lowest since October and continues the much-needed repricing of the Fed easing cycle. More needs to be done, in our view.

New York Fed March inflation expectations were mixed. 1-year expectations remained near 3% for the fourth straight month, still well above the 2% target. 3-expectations picked up for the second straight month to 2.90%, the highest since November, while 5-year expectations fell to 2.62%. Overall, these developments will keep the Fed on its toes.

NFIB small business optimism softened in March. Headline came in at 88.5 vs. 89.9 expected and 89.4 in February. This was the third straight monthly drop to the lowest since December 2012. NFIB chief economist noted that “Owners continue to manage numerous economic headwinds. Inflation has once again been reported as the top business problem on Main Street and the labor market has only eased slightly.” Of note, the net share of small firms expecting higher inflation-adjusted sales over the next six months fell 8 percentage points to -18%, the lowest since May, while a net 28% of small firms raised prices compared to three months ago, the largest share since October.

Mexico reports March CPI. Headline is expected at 4.50% y/y vs. 4.40% in February, while core is expected at 4.63% y/y vs. 4.64% in February. If so, headline would remain stuck above the 2-4% target range. That didn’t stop Banco de Mexico from starting the easing cycle March 21 with a 25 bp cut. Minutes from that meeting were very cautious. Next meeting is May 9, and the decision then will depend in part on whether inflation resumes its downward path in April. The market is pricing in 25 bp of easing over the next three months and another 25 bp over the subsequent three months.

The extent of recent MXN strength has been a bit puzzling. The main drivers seem to be: 1) high interest rates, 2) high oil prices, and 3) strong growth. MXN is the top EM performer at nearly 4% YTD, and we believe MXN can continue to outperform relative to EM FX. COP is second best at 2% YTD for similar reasons and should also continue to outperform.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank released its Q1 bank lending survey. The survey reinforces the case for looser ECB policy settings. Net demand for corporate loans fell sharply in Q1, driven by higher interest rates and lower fixed investment. The ECB noted that “The substantial decline in loan demand from firms contrasted with banks’ prior expectations of a stabilization.” Banks expect a further net decrease in corporate loan demand in Q2. Meanwhile, net demand for housing loans saw a small decline in Q1, weighed down by the general level of interest rates and consumer confidence. Net demand for consumer credit was broadly stable.

No change is expected from the ECB meeting that begins tomorrow. However, recent data fully support a June cut and so we expect a dovish hold this week. We note that the ECB will very likely be cutting rates before the Fed and will also likely cut more over the next year than the Fed. This is euro-negative, to state the obvious.

March U.K. BRC retail sales came in stronger than expected. Same store nominal sales rose 3.2% y/y vs. 1.8% expected and 1.0% in February. This was the strongest gain since August 2023 but was largely boosted by Easter falling unusually early. Official retail sales data won’t be reported until next Friday. However, this Friday’s February GDP report will offer a clearer picture of U.K. economic activity. Bank of England expectations have remained fairly steady. The first cut is fully priced in for August, with three cuts total seen in 2024.

ASIA

Jawboning on the yen continues. Finance Minister Suzuki warned again overnight that he’s watching currency moves with a high sense of urgency and will take appropriate action against rapid FX moves. For now, the jawboning has helped keep USD/JPY below 152. Intervention risks rise on move above 152 but in our view, it’s only a matter of time before USD/JPY breaks higher, in part because we anticipate a gradual BOJ tightening process. Governor Ueda reiterated this morning that accommodative monetary conditions are expected to continue for the time being.

Japan reported March machine tool orders. Total orders came in at -3.8% y/y vs. -8.0% in February and was the best reading since December 2022. Domestic orders had been underperforming foreign orders recently but improved sharply to -0.2% y/y vs. -16.4% in February. In turn, foreign orders worsened to -5.7% y/y vs. -4.1% in February.

Australia reported March NAB business survey and April Westpac consumer confidence index. Both these forward-looking indicators point to soft economic activity and suggest more rate cuts may be in the pipeline than is currently priced in. The Westpac Melbourne Institute Consumer Sentiment Index fell -2.4% to 82.4 in April following a -1.8% decline in March. Elsewhere, the NAB March business survey was mixed. Business conditions fell a point to +9 while business confidence improved a point to 1 but remains below its long-term average. Despite recent softness in the data, the market is not pricing in the first RBA cut until November.

The New Zealand Institute of Economic Research released its Quarterly Survey of Business Opinion. The results point to a sharp deterioration in economic activity. A net 23% and 11% of firms are reporting a decline in activity over Q1 and Q2, respectively. This is a marked turnaround from the net 7% of businesses which had reported increased activity in Q4. A net 11% of firms fired workers in Q1 and only a net 2% expect to hire in Q2. NZIER economist Leung noted “If we are in for a hard landing then naturally - if that flows through to inflation slowing faster - that would allow the RBNZ to cut interest rates earlier.”

Reserve Bank of New Zealand meets overnight and is expected to keep rates steady at 5.5%. There is no press conference or updated macro projections at this meeting. However, risks are skewed in favor of a dovish surprise because New Zealand economic data have underwhelmed since the last meeting February 28. Real GDP (production-based) fell -0.1% q/q in Q4, while measures of consumer and business confidence fell to multi-month lows in March. The market is pricing in the first cut in August, with 50-75 bp of total easing seen this year.

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