Dollar Firm Ahead of ECB and CPI

June 10, 2021
  • May CPI data will be the data highlight; weekly jobless claims data will be reported; BOC kept policy steady, as expected; Peru is expected to keep rates steady at 0.25%; Brazil’s May IPCA inflation came in decidedly strong
  • The ECB is expected to extend its accelerated asset purchases into Q3; tensions between the EU and the U.K. are rising; Norway and Sweden reported softer than expected May CPI data; Poland left rates unchanged yesterday at 0.1% and refrained from providing any hawkish signals
  • Japan reported firm May PPI data; China’s aggregate financing data came in mixed
The dollar is building on its modest gains ahead of the ECB decision and U.S. CPI data. DXY is up for the third straight day and is trading at the highest level since Monday at around 90.30. A clean break above 90.325 is needed to set up a test of last week’s pre-NFP high near 90.627. The euro is trading heavy ahead of the ECB decision and a break below $1.2150 would set up a test of the June 4 low near $1.2105. Sterling is underperforming as tensions with the EU rise (see below), trading just below $1.41 at the lowest level since May 17. USD/JPY remains stuck around 109.50 after being unable to sustain the break above 110 Friday. While we believe the fundamental story favors the dollar, we need a move higher U.S. rates (both real and nominal). The 10-year yield is trading back at 1.50% after dropping as low as 1.47%, while the breakeven inflation rate is steady around 2.32%, pushing the real rate higher to around -0.82%, just below the -0.79% from last Friday, the highest since late April.

The global curve flattening trend continues and seems to be accelerating. Surely positioning is playing significant role here given the popularity of short fixed income trades, but it also reflects some reassessment of the longer dated inflation trends. Indeed, breakeven rates corroborate this story. Despite the economic picture still improving, definitive signs of labor tightness have yet to emerge in the form of wage pressure. So for now, it seems as if central banks are winning the first battle.
 
AMERICAS

May CPI data will be the data highlight. Headline inflation is expected to rise to 4.7% y/y from 4.2% in April, while core is expected to rise to 3.5% y/y from 3.0% in April. For headline, this would be the highest since September 2008 and for core, this would be the highest since May 1993. Of note, the Fed’s preferred inflation measure core PCE came in at 3.1% y/y in April, the highest since July 1992 and above the 2% target. The Fed continues to say this spike in inflation is transitory. However, food and energy prices are soaring and are already feeding into higher core inflation. We suspect PPI data out next week will show that pipeline price pressures remain high.

Weekly jobless claims data will be reported. Initial claims are expected at 370k vs. 385k the previous week, while continuing claims are expected at 3.65 mln vs. 3.771 mln the previous week. Claims data continue to edge lower and that points to continued healing of the labor market. AS the JOLTS job openings data earlier this week suggest, the soft jobs numbers the past couple of months appear to be related to labor supply, not labor demand. As such, we expect wages to continue rising to help boost supply. The May budget statement (-$250 bln expected) will also be reported.

Bank of Canada kept policy steady, as expected. It maintained its pace of weekly asset purchases at CAD3 bln while keeping rates unchanged at 0.25%. The bank also maintained its view that slack in the economy will be absorbed and inflation at the 2% target in 2022, as well as its commitment to keep rates steady to H2 2022. Since the April taper, the labor market has posted two straight months of job losses and so there really was no need for the bank to change anything now. That said, the bank said that it will adjust the QE program based on its “ongoing assessment of the strength and durability of the recovery.” That suggests further tapering is in the cards as the recovery continues. There will be updated macro forecasts released at the next meeting July 14. If the outlook continues to improve and jobs growth resumes in June, then the next round of tapering at that meeting is very possible.

Peru central bank is expected to keep rates steady at 0.25%. With markets still very sensitive to politics right now, the bank should simply remain a stabilizing force by remaining on the sidelines. As things stand, there is no need for the bank to really do anything. CPI rose 2.5% y/y in May, near the cycle high of 2.7% in January but still within the 1-3% target range. Bloomberg consensus sees steady rates through early next year, with the first 25 bp hike priced in by Q2 22 and another 25 bp in Q3 22.

Brazil’s May IPCA inflation came in decidedly strong, topping 8% y/y for the first time since late 2016. That’s a long way from the 5.25% upper band of the target range. As in most countries, much spike came from headline items such as energy and fuel prices (adding a combined 0.52 ppts). But core readings were also elevated at 3.8%, right at the center of the central bank’s target, despite the 0.15 drag from the service sector. The next 75 bp hike June 16 is already fully priced in, but the IPCA print probably means that officials will keep the hawkish stance, overlooking the deflationary impact of the strong BRL appreciation since early April. Of note, the CDI market is pricing in another 75 bp hike to 5.0% at the August 4 meeting.
 
EUROPE/MIDDLE EAST/AFRICA

The European Central Bank is expected to extend its accelerated asset purchases into Q3. New macro forecasts will be released, and growth and inflation projections are likely to be revised higher. Yet the doves should have no problem maintaining its dovish stance at this meeting. Since the ECB announced accelerated asset purchases at the March 11 meeting, eurozone yields have still risen. The 10-year Italian yield traded as low as 0.57% that day, rose to a high of 1.16% May 19, and remains elevated at 0.87% currently. Similarly, the 10-year French yield traded as low as -0.13% that day, rose to a high of 0.32% May 19, and remains elevated at 0.15% currently. Italy (1.8% m/m vs. 0.3% expected) and France (-0.1% m/m vs. 0.6% expected) reported April IP. This follows a weak German reading (-1.0% m/m vs. 0.4% expected). The eurozone reading won’t be reported until June 14.

Tensions between the EU and the U.K. are rising. After a meeting with U.K. Brexit negotiator Frost yesterday yielded no progress, European Commission Vice President Sefcovic said “We are at a crossroads in our relationship. Patience is wearing very, very thin.” He warned that if the U.K. makes any more unilateral changes to the Northern Ireland protocols contained in the Brexit accord, the EU could retaliate by suspending cooperation in certain sectors (read finance and equivalence) and that quotas and tariffs “could come into play.” Prime Minister Johnson was more upbeat, saying “I think it is easily doable. What we want to do is make sure that we can have a solution that guarantees the peace process, protects the peace process, but also guarantees the economic and territorial integrity of the whole United Kingdom.” We beg to differ. If it was easily doable, it would have been done already. We suspect a bit of brinksmanship is being seen but we firmly believe that the U.K. stands to lose more than the EU does on this matter. Of note, the grace period that allows the U.K. to ship certain meats to Northern Ireland fee of customs checks expires June 30. If the U.K. unilaterally extends it, the risks of a trade war will clearly rise.

Norway and Sweden reported softer than expected May CPI data. Norway headline inflation came in at 2.7% y/y vs. 2.9% expected and 3.0% in April, while underlying came in at 1.5% y/y vs. 2.0% expected and actual in April. Sweden headline inflation came in at 1.8% y/y vs. 2.0% expected and 2.2% in April, while CPIF came in at 2.1% y/y vs. 2.2% expected and 2.5% in April. It’s worth noting that inflation in both countries started accelerating significantly at the beginning of this year, which is a bit of a contrast with most other countries that saw acceleration beginning in March due to base effects. Optimists will say that these readings from the two Scandies vindicate those that see the current spike in inflation elsewhere as transitory. We wish it were that simple. That said, the Norges Bank is likely to confirm that it remains on track to hike in Q4 when it meets next Thursday, while the Riksbank is likely to confirm it sees steady rates into 2024 when it meets July 1.

The National Bank of Poland left rates unchanged yesterday at 0.1%, as expected, but refrained from providing any hawkish signals. We had expected some minor hints given inflation trends picking up and hawkish MPC members becoming louder. Poland stands out compared to Czech Republic and Hungary, which both flagged that rate hikes are likely this month. Instead, it’s opting to side with most developed markets central banks by emphasizing the transitory nature of price increases. It will be interesting to see how this strategy measures up against Czech and Hungary in terms of how the back-end of the yield curve will behave. So far the spread between Hungary and Poland has remained relatively stable at about 1 ppt in the 10-year space.
 
ASIA

Japan reported firm May PPI data. PPI rose 4.9% y/y vs. 4.5% expected and a revised 3.8% (was 3.6%) in April. This was the highest since September 2008. Yet the acceleration in PPI inflation has yet to filter through to CPI. National CPI will be reported June 18, and headline is expected at -0.2% y/y vs. -0.4% in April while targeted core inflation (ex-fresh food) is expected flat y/y vs. -0.1% in April. Unlike much of the rest of the world, Japan is not seeing inflation, not even the transitory kind. Bank of Japan meets June 17-18 and no change is expected. There won’t be any updated macro forecasts until the next meeting July 15-16. For now, the bank is on hold but with the economy potentially contracting in Q2 as well, we fully expect another fiscal package over the summer to help boost growth and Prime Minister Suga’s popularity.

China’s aggregate financing data came in mixed. The headline figure was CNY1.9 trln, slightly below expectations, while new loans surprised modestly to the upside at CNY1.5 trln. The data also showed a pickup in government bond issuance (likely infrastructure related) along with a decline in corporate borrowing. PBOC Governor Yi Gang reaffirmed that the current level of accommodation is appropriate, noting that the bank now expects CPI inflation to fall below 2% this year. China’s assets are performing well today with the Shanghai Composite up 0.5%, probably supported at least in part by conciliatory words between U.S. and China trade representative. The two sides agreed to promote cooperation in trade and investment following a phone call yesterday.

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