- The U.S. economy continues to sizzle; therein lies the crux of our strong dollar outlook; April ISM manufacturing PMI is the data highlight
- Final eurozone April manufacturing PMI readings were reported; ECB net asset purchases for the week ending April 30 will be reported; eurozone yields are making new highs; the 10-year U.S.-German spread is currently around 180 bp; Turkey reported April CPI
- Asia will be very quiet this week as the two largest economies are on extended holidays; Indonesia reported April CPI
The dollar is giving up some of its recent gains in quiet holiday trading. After trading at a new high for this bounce near 91.387, DXY is now lower on the day and testing the 91 area. The euro found support near $1.20 and sterling found support near $1.38, and both are trading modestly higher in uninspired markets. Lastly, USD/JPY traded at the highest level since April 13 near 109.70 before falling back. A clean break of 109.65 is needed to set up a test of the March 31 high near 111. We continue to look for continued dollar strength on the strong economic outlook (see below) but this will require a more significant turnaround in U.S. yields.
The U.S. economy continues to sizzle. While Q1 GDP growth came in a little below consensus at 6.4% SAAR, the details were strong and point to further strength in Q2. The Atlanta Fed’s GDPNow model just started its forecast for Q2 with an eye-opening 10.4% print, while the New York Fed’s Nowcast model currently shows Q2 growth at a more modest 5.3% SAAR. Of note, Bloomberg consensus sees 8.1% growth in Q2 and 7.0% in Q3 before easing to 4.7% in Q4, all in SAAR terms.
And therein lies the crux of our strong dollar outlook. Compare the U.S. with the eurozone, which just posted its second straight quarter of economic contraction. Its -0.6% q/q drop translates into an annualized -2.4% and so we are looking at a difference of 8 full percentage points in Q1! 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 very unlikely to post anything near the growth numbers that are expected 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.
April ISM manufacturing PMI is the data highlight. Headline is expected at 65.0 vs. 64.7 in March, with prices paid component expected at 86.1 vs. 85.6 in March. ISM services PMI will be reported Wednesday and is expected at 64.1 vs. 63.7 in March. The employment components will be closely watched for both ahead of the jobs data Friday. Last week, Chicago PMI came in at a whopping 72.1 vs. 65.0 expected and 66.3 in April and so there are upside risks to this week’s survey readings. Auto sales will also be reported today and are expected at a 17.6 mln annual rate vs. 17.75 in March. March construction spending (1.7% m/m expected) will also be reported. Canada reports April Markit manufacturing PMI and March leading indicator.
With the FOMC meeting out of the way, Fed speakers will be plentiful this week. Powell speaks today and is expected to repeat his dovish mantra that was on full view at last week’s FOMC meeting. However, we think the minutes to last week’s meeting will be important to see if tapering was discussed by any of the participants. Those minutes will be released May 19.
Final eurozone April manufacturing PMI readings were reported. Headline manufacturing came in at 62.9 vs. 63.3 preliminary. Germany fell a couple of ticks to 62.2 and France fell three ticks to 58.9. Italy and Spain reported for the first time and both improved nearly a point from March to 60.7 and 57.7, respectively. Final services and composite PMI readings will be reported Wednesday. Germany reported strong March retail sales, up 7.7% m/m vs. 3.0% expected and 2.7% in February. Of note, eurozone retail sales will be reported Thursday and are expected to rise 1.5% m/m vs. 3.0% in February.
ECB net asset purchases for the week ending April 30 will be reported. Net purchases were EUR22.25 bln for the week ending April 23, up from a net EUR16.3 bln for the week ending April 16 and EUR17.1 bln for the week ending April 9. This was the highest weekly net purchase amount since June 2020 and so the accelerated pace remains in place. Of note, redemptions were EUR2.8 bln for the week ending April 23, leaving gross purchases at EUR25.0 bln vs. EUR28.4 bln the previous week. These are the highest gross purchases since June 2020 and also suggest that the ECB is quite serious about keeping yields down.
Yet eurozone yields are making new highs. The 10-year Bund yield is currently around -18 bp and is the highest since March 2020, while the 10-year BTP yield is currently around 93 bp and is the highest since September 2020. This despite accelerated asset purchases since the March ECB meeting. We think the ECB may have to accelerate its purchases even further if eurozone yields continue to climb. The accelerated pace should be maintained until at least the June 10 meeting, when the ECB will likely reassess its program. If yields continue to rise, then the accelerated pace is likely to be extended into Q3, which would be a dovish signal from the bank.
The 10-year U.S.-German spread is currently around 180 bp. This compares to the April 2 peak near 205 bp and is now barely above the 179 bp low posted on April 22. Much of the attention has been on the recent fall in U.S. rates, but as noted above, German rates have been steadily rising. We expect U.S. yields to eventually rise and German yields to stabilize and so this spread should move back in the dollar’s favor. Until then, however, the euro is likely to remain buoyant.
Turkey reported April CPI. Headline inflation came in at 17.14% y/y vs. 17.30% expected and 16.19% in March. This was the highest since May 2019 and moves further above the 3-7% target range. The central bank meets Thursday and is expected to keep rates at 19.00%. It will be under great pressure from Erdogan to cut rates as soon as possible. However, with the lira trading near record lows, a cut now would be inviting trouble and so steady rates seem prudent. After this week, the next policy meetings are June 17 and July 14, with both likely to be very much “live.”
Asia will be very quiet this week as the two largest economies are on extended holidays. Japan markets are closed until Thursday due to the Golden Week holiday, while China markets are closed until Thursday due to the Labor Day holiday. Renewed concerns about the economy coupled with a dovish BOJ have helped push USD/JPY higher in recent days. The pair has retraced about half of the March-April drop. A break of the 109.65 area is needed to set up a test of the March 31 high near 111.
Indonesia reported April CPI. Headline inflation came in at 1.42% y/y vs. 1.50% expected and 1.37% in March. It remains near the recent low of 1.32% in August and still well below the 2.5-4.5% target range. Consensus sees steady rates through 2021 with rising odds of a hike as we move into 2022. We concur. Foreign inflows have dried up in recent weeks and so further easing would be risky. Next central bank policy meeting is May 25 and rates are expected to remain steady at 3.5%.