Dollar Gets Some Traction Ahead of the Weekend

April 30, 2021

-We got our first look at Q1 GDP yesterday; therein lies the crux of our strong dollar outlook; keep an eye on two spreads that will support our bearishness on the euro; today’s data highlight is Chicago PMI; Colombia is expected to keep rate steady at 1.75%.
-Eurozone reported April CPI, March unemployment, and Q1 GDP data; U.K. Prime Minister Johnson may face a parliamentary investigation
-Japan reported March labor market data, IP, housing starts, and April Tokyo CPI; things are only going to get worse for Japan in Q2; Australia reported Q1 PPI; China reported soft official April PMI readings; Taiwan illustrates the K-shaped recovery being seen globally 

The dollar is getting some more traction post- FOMC.  DXY is up two straight days after trading at a new low for this move near 90.424.  The euro traded at a new cycle high near $1.2150 yesterday but there was no follow-through and it is currently trading back below the figure.  Sterling has been unable to break above the $1.40 level and is currently trading just above $1.39.  Still, it has held up fairly well in light of the rising U.K. political uncertainty (see below).  Lastly, USD/JPY traded yesterday at the highest level since April 14 just above 109 but there was no follow-through and so the pair is trading back below the figure.  We continue to look for resumed dollar strength on the strong economic outlook (see below) but this will require a more significant turnaround in U.S. yields. 


AMERICAS

We got our first look at Q1 GDP yesterday.  While growth came in a little below consensus at 6.4% SAAR, the details were strong.  Personal consumption rose a whopping 10.7% SAAR and government consumption rose 6.3% SAAR.  Inventories and trade subtracted from growth but the economy should continue to sizzle just on the strength of consumption.  Inventories should add to growth as some bottlenecks ease and businesses use that opportunity to restock.  The Atlanta Fed’s GDPNow model will report its first forecast for Q2 today, while the New York Fed’s Nowcast model currently Q2 growth of 4.6% SAAR and will be updated today. 

And therein lies the crux of our strong dollar outlook.  Compare the US with the eurozone, which just posted its second straight quarter of economic contraction (see below).  One factor being cited for recent euro strength are rising expectations that the economic divergences will narrow in Q2 and beyond.  However, we just don’t see it.  Europe is highly unlikely to post anything near the growth numbers that are coming from the US the rest of this year.  By extension, we believe the Fed is likely to taper its asset purchases in 2021 and that the ECB will have to maintain its accelerated pace of asset purchases for much longer than anticipated.

Keep an eye on two spreads that will support our bearishness on the euro.  The 10-year U.S.-German spread is currently around 185 bp, down from the April 2 peak near 205 bp but above the 179 low posted this month.  Much of the attention has been on the recent fall in U.S. rates, but German rates have been steadily rising.  At -21 bp, the German 10-year yield is the highest since March 2020.  We expect U.S. yields to rise and German yields to stabilize and so this spread should move back in the dollar’s favor.  Elsewhere, the 10-year Italy-Germany spread has been rising.  To us, this signals market discomfort with the peripheral eurozone that is perhaps driven by delays to the EU recovery fund.  At 111 bp, this is the highest since early February as Italian 10-year yields have risen faster than Germany’s to stand around 90 bp currently, the highest since last September.

Today’s data highlight is Chicago PMI.  It is expected at 65.3 vs. 66.3 in March.  Q1 employment cost index (0.7% expected), March personal income (20.2 % m/m expected), spending (4.1% m/m expected), core PCE deflator (1.8% y/y expected), and final April University of Michigan consumer sentiment (87.5 expected) will be reported Friday.  Of note, that would be the highest core PCE reading since February 2020 and should get the attention of bond markets.  Core PCE reported yesterday in the GDP data rose 2.3% SAAR, while the overall GDP deflator rose 4.1% SAAR.

Colombia central bank is expected to keep rate steady at 1.75%.  The decision to hold rates in March was unanimous and we do not think anything has changed to materially affect the voting pattern in favor of a cut.  Bloomberg consensus sees steady rates through mid-2021, with some odds of a hike in Q3 and rising to 100% as we move into Q4.  We are not convinced that the bank will hike this year.  CPI rose 1.51% y/y in March, just near the cycle low of 1.49% back in November and well below the 2-4% target range. 

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported April CPI, March unemployment, and Q1 GDP data.  GDP contracted -0.6% q/q vs. -0.8% expected and -0.7% in Q4.  Looking at the country breakdown, Germany fell -1.7% q/q vs -1.5% expected and +0.5% in Q4, France grew 0.4% q/q vs. flat expected and -1.4% in Q4, Italy fell -0.4% q/q vs -0.5% expected and -1.8% in Q4, and Spain fell -0.5% q/q as expected and vs flat in Q4.  Compare and contrast this with the U.S. figures reported yesterday and one can understand why we remain bullish on the dollar.

Elsewhere, eurozone headline inflation picked up as expected to 1.6% y/y from 1.3% in March.  This was the highest since April 2019.  However, core inflation slowed a tick as expected to 0.8% y/y.  Of note, the ECB said last week that it expects headline inflation to rise in the coming months but saw underlying price pressures to remain subdued.  For now, the ECB is on autopilot as it gathers more information. 

U.K. Prime Minister Johnson may face a parliamentary investigation.  As more revelations about the renovation of Number 10 Downing Street emerge, Labour MP Margaret Hodge  wrote to Parliamentary Commissioner for Standards in the House of Commons Kathryn Stone to request and investigation.  This comes a day after the Electoral Commission announced its own probe into the matter. Coming ahead of the May 6 local and mayoral elections, the timing couldn’t have been worse for Johnson’s Tory party.  And yet a YouGov poll for The Times reported yesterday showed the Tories enjoy an 11-point lead over the opposition Labour Party, suggesting the negative headlines have not yet taken a toll on the party’s general popularity.  


ASIA

Japan reported March labor market data, IP, housing starts, and April Tokyo CPI.  The real sector data came in strong, with unemployment falling to 2.6% vs. expectations of a steady reading at 2.9%, while the job-to-applicant ratio rose a tick to 1.10 rather than expectations of a steady reading at 1.09.  IP jumped 2.0% m/ when it was expected to fall -2.0% on top of -1.3% in February.  Unfortunately, deflationary pressures picked up in April.  Headline inflation came in at -0.6% vs. -0.2% expected and actual in March, while core (ex-fresh food) came in at -0.2% y/y vs. flat expected and -0.1% in March. 

Things are only going to get worse for Japan in Q2.  Rising virus numbers have forced nearly a quarter of the population back into lockdowns that are set to run past the Golden Week holiday.  Of course, the risk is that the restrictions will have to be extended even as the vaccine rollout lags.  With Suga’s popularity still under pressure from his handling of the pandemic and the economic impact of renewed lockdowns, we fully expect another fiscal package over the summer. 

Australia reported Q1 PPI.  Headline PPI inflation rose 0.2% y/y vs. -0.1% in Q4, suggesting little in the way of pipeline price pressures.  Earlier this week, headline CPI came in at 1.1% y/y in Q1 vs. 1.4% expected and 0.9% in Q4, while trimmed mean came in at 1.1% y/y vs. 1.2% expected.  No wonder the RBA delivered a dovish hold this month, repeating its existing forward guidance that rate hikes won’t be seen until 2024 “at the earliest.”  Next policy meeting is May 4 and we expect another dovish hold. 

Treasurer Frydenberg said unemployment will “need to have a four in front of it” to generate faster wage growth and higher inflation.  He added that full employment is now in the 4.5-5.0% range, which is slightly above the RBA’s estimate of somewhere around 4%.  This is always a moving target for any country, especially emerging from a pandemic-driven downturn.  Strangely, with unemployment at 5.6% in March, this suggests the RBA may be more willing to extend stimulus than the government is.  That said, all signs point to ongoing risks of permanent damage to the economy and so we suspect Frydenberg will deliver another dose of stimulus in his May 11 budget.

China reported soft official April PMI readings.  Manufacturing PMI came in at 51.1 vs. 51.8 expected and  51.9 in March, while non-manufacturing  PMI came in 54.9 vs. 56.1 expected and 56.3 in March.  This dragged the composite PMI down to 53.8 from 55.3 in March.  On the other hand, Caixin also reported April manufacturing PMI and it came in at 51.9 vs. 50.9 expected and 50.6 in March.  The economy appears to be losing some momentum going into Q2 and this is likely to persist as efforts at deleveraging and removing accommodation are likely to weigh on growth going forward.

Taiwan illustrates the K-shaped recovery being seen globally.  Fueled by the export boom in chips and tech, GDP surged 8.16% y/y vs. 6.0% expected and 5.09% in Q4.  This was the fastest growth since 2010 in Q1.  In turn, this has fed into higher investment as companies try to boost production facilities to meet strong global demand for their products.  Export orders remained strong in Q1, pointing to strong shipments and growth well into Q4 (and beyond).  Yet this signals an underlying problem with the global economy.  Taiwan and the richer EM economies are taking a cue from DM and posting much stronger than expected growth whilst controlling the virus.  The poorer EM countries are struggling to contain the virus and thus lagging in their economic recoveries.  How long this persists is yet to be determined but the longer the divergence, the harder it will be for the poorer countries to ever catch up.

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