Trade Clashes Peak

USD recovered some of yesterday’s losses. Stocks in Asia and US equity futures are up. Peak trade hostility and China dialing-up easing measures (see China section below) have bolstered financial market sentiment. The US and China will hold their first high-level trade talks Saturday and Sunday in Geneva. US Treasury Secretary Scott Bessent cautioned “My sense is that this will be about de-escalation, not about the big trade deal.”

Today, the Fed is expected to unanimously vote to keep the target range for the funds rate unchanged at 4.25-4.50% (7:00pm London). There are no new projections associated with this meeting. The next Summary of Economic Projections are due following the June 17-18 meeting.

The risk is Chair Jay Powell tilts dovish because some survey data points to a worsening US growth outlook. Specifically, Powell could soften the current rhetoric that the Fed is “well positioned to wait for greater clarity before considering any adjustments to our policy stance.” However, the hard data supports the view that the Fed can afford to remain patient. Fed funds futures imply roughly 30% odds of a 25bps cut in June and a total of about 100bps of easing over the next 12 months.

USD has likely entered a short-term period of consolidation after undershooting the levels implied by US-G6 2-year bond yield spreads. Nevertheless, the fundamental backdrop remains difficult for USD: the Trump administration implicitly supports a weaker dollar, the US economy faces stagflation risk, and US policy credibility has been undermined by the trade war.

Currency markets have largely ignored the India-Pakistan conflict. USD/INR is up just 0.2%, USD/PKR is steady, while CHF and JPY are underperforming most major currencies. India conducted targeted military strikes against “known terror camps” in Pakistan. Pakistan Prime Minister Shehbaz Sharif called India’s strikes an “act of war” and said his country had “every right to respond forcefully.” India’s military response against Pakistan had been brewing since the April 22 deadly shootings in Indian-administered Kashmir. Tit-for-tat conflict would be especially dangerous given that both countries possess nuclear weapons.

CHINA

USD/CNH recovered to its 200-day moving average at 7.2220. The People's Bank of China (PBOC) cranked-up easing to support economic activity. A package of 10 monetary policy measures was announced:

i) 10bps cut to the policy interest rate (7-day reverse repo) to 1.40%.
ii) 50bps cut to the reserve requirement ratio (RRR).
iii) RRR for auto financial companies and leasing firms will be cut to zero from 5%.
iv) 25bps cut to 1.50% on various special structural tools and re-lending rates for supporting agriculture and small businesses. And 25bps cut to 2% for Pledged Supplementary Lending.
v) 25bps cut to the housing provident fund loan rate.
vi) 300 billion yuan increase to 800 billion yuan in the quota for technology relending loans.
vii) 500-billion-yuan relending tool will be set up for services consumption and elderly care.
viii) 300 billion yuan increase to the quota for re-lending to support agriculture and small businesses.
ix) Combine two existing stock market support tools resulting in a total quota of 800 billion yuan.
x) Provide low-cost relending funds to purchase science and technology innovation bonds.

HONG KONG

USD/HKD is slightly firmer just above the lower-end of its 7.7500-7.8500 band. The Hong Kong Monetary Authority intervened to defend the currency peg, selling HK$129.4 billion ($16.7 billion) worth of local currency against the greenback in four intervention operations since Friday.

The USD/HKD peg has been in place since May 2005 and is as solid as it gets on economic fundamentals. In March, Hong Kong’s FX reserves totaled $413bn which is over five times the currency in circulation and about 40% of broad money supply (double the IMF’s guidelines for FX reserve adequacy). The biggest threat to the HKD peg is political. If Hong Kong loses access to US dollar clearing (in the context of heightened US-China geopolitical tensions) the peg will not be sustainable as Hong Kong will face a severe monetary squeeze.

SWEDEN

USD/SEK is range-bound above recent cyclical lows near 9.5000. Sweden inflation remained sticky in April. The policy relevant CPIF was steady at 2.3% y/y (consensus: 2.4%, Riksbank forecast: 2.3%) vs. 2.3% in March while CPIF Ex-energy rose 0.1pts to 3.1% y/y (consensus and Riskbank forecast: 3.2%). Inflation is stabilizing above the Riksbank’s 2% target, suggesting the bar for additional rate cuts is high.

The Riksbank is widely expected to keep the policy rate steady at 2.25% tomorrow. There are no new projections associated with this meeting. The next Monetary Policy Report will be published in June. At its last March 20 meeting, the Riksbank kept the policy rate steady at 2.25% and signaled it was done easing. However, the swaps market disagrees and is pricing in 35bps of further easing over the next 12 months.

NEW ZEALAND

NZD/USD is consolidating recent gains around 0.6000. New Zealand’s Q1 labor market data was mixed and still argues for additional RBNZ easing. The unemployment rate was unexpectedly unchanged at 5.1% in Q1. Consensus was for a 0.2pts rise to 5.3% while the RBNZ had 5.2% penciled-in. However, other data point to weaker demand for labor. The underutilisation rate rose 0.1pts to 12.3% (the highest since Q3 2020) and the participation rate fell 0.1pts to 70.8% (the lowest since Q2 2021). Moreover, wage growth cooled more than expected. Private wages increased 0.4% q/q (consensus: 0.5%, RBNZ forecast: 0.6%) vs. 0.6% in Q4 and slowed at an annual pace of 2.6% (lowest since Q3 2021) vs 3% in Q4.

At its April 8 meeting, the RBNZ cut the Official Cash Rate (OCR) by 25bps to 3.50% and noted it “has scope to lower the OCR further as appropriate”. The RBNZ warned that “the recently announced increases in global trade barriers weaken the outlook for global economic activity. On balance, these developments create downside risks to the outlook for economic activity and inflation in New Zealand.” The swaps market price-in 75bps of rate cuts in the next six months and the OCR to bottom around 2.75%. The risk is the RBNZ slashes the OCR towards the lower end of its 2% to 4% neutral range estimate.

RBNZ published its six-monthly Financial Stability Report and warned that financial stability risks increased due to the trade war. Encouragingly, the RBNZ also noted that banks were in a strong financial position to manage potential loan defaults.

CZECH REPUBLIC

Czech National Bank (CNB) is expected to cut rates 25bps to 3.50% (1:30pm London). Slower than expected Czech inflation in April argues for a rate cut. Headline CPI fell to its lowest level since March 2018 at 1.8% y/y (consensus: 2.1%) vs. 2.7% in March. Governor Michl stressed recently “If we lower interest rates further, it will be very cautious.” The swaps market is pricing in 50bps of total easing over the next 12 months.

POLAND

National Bank of Poland (NBP) is expected to cut rates 50bps 5.25%. At the last policy meeting April 2, NBP kept rates steady at 5.75% but unexpectedly signaled a switch to a dovish stance. Governor Glapinski said lower-than-expected inflation in the first quarter triggered a “radical shift” in policymakers’ outlook, adding that the scale of monetary easing in 2025 may exceed 100bps if the government prevents energy prices from rising.

Since then, inflation eased further in April with headline CPI declining to a 10-month low at 4.2% y/y vs. 4.9% in March and tracking below the NBP’s 2025 projection of 4.9%. The swaps market is pricing in 150bps of total easing over the next 12 months, followed by another 50bps over the subsequent 12 months that would see the policy rate bottom near 3.75%.