Dollar Gains to Continue in Q2

April 05, 2021

Last week’s jobs data confirm our view that the US economy is gathering momentum; ISM services PMI will be today’s highlight; the US growth outlook remains very strong; Colombia reports March CPI
Weekly ECB asset purchases will be reported; Scottish politics are heating up and not in a good way for sterling; Turkey reported March CPI
Japan reported final March services and composite PMI readings; the BOJ should be pleased with developments after its March 18-19 meeting and policy review

The dollar should continue to power ahead. After trading at a new cycle high near 93.437 last week, DXY fell back to trade just below the 93 level. Despite this minor setback, the break above the November 11 high near 93.208 sets up a test of the November 4 high near 94.302. The euro remains heavy and continues to edge towards $1.17. We believe it is still on track to test the November low near $1.1605. Sterling has been outperforming but also feels heavy despite this current bounce. We believe it is still on track to test of the February 4 low near $1.3565. The rise in USD/JPY continues and last week’s break above the June 5 high near 109.85 sets up a test of the March 2020 high near 111.70.

AMERICAS

Last week’s jobs data confirm our view that the US economy is gathering momentum. NFP rose 916k in March, while the February gain was revised to 468k from 379k previously. With vaccinations and reopening picking up, the labor market should continue to improve in April and beyond. This underscores are long-standing call that the US economy and US dollar will continue to outperform in Q2 (and likely beyond).

ISM services PMI will be today’s highlight. It is expected at 59.0 vs. 55.3 in February. If so, it would be the highest since November 2018. Markit also reports final March services and composite PMI readings. The former is expected to rise to 60.2 from 60.0 preliminary, which should nudge the latter higher from 59.1 preliminary. February factory orders will also be reported and are expected to fall -0.5% m/m vs. a 2.6% gain in January.

The US growth outlook remains very strong. The Atlanta Fed’s GDPNow model suggests Q1 growth is 6.0% SAAR, while the New York Fed’s Nowcast model suggests Q1 and Q2 growth of 6.2% and 1.6% SAAR, respectively. Of note, Bloomberg consensus for Q1 is currently at 4.7% SAAR, picking up to 7.0% SAAR in Q2 and 6.9% in Q3. And this is before the next round of stimulus has been accounted for. The same consensus sees core PCE picking up to 2.1% y/y in Q2 from 1.5% in Q1 before edging back down to 1.8% in Q3 and 1.9% in Q4.

Colombia reports March CPI. Inflation is expected at 1.45% y/y vs. 1.56% in February. If so, it would be a new all-time low and still below the 2-4% target range. Next policy meeting is April 30 and no change is expected then. Central bank minutes will also be released today. Consensus sees potential for one last cut in Q2 and then steady rates through much of 2021, with odds of a hike rising as we move into Q4 and beyond. We concur. High oil prices should help the economy rebound quickly this year.

EUROPE/MIDDLE EAST/AFRICA

Weekly ECB asset purchases will be reported. The pace has finally started to pick up but this needs to be sustained in order to underscore the ECB’s resolve. Last week, ECB President Lagarde threw down the gauntlet, saying “They can test us as much as they want.” Gross purchases should remain close to EUR20 bln. Last week, they were EUR20.4 bln, down from the EUR21.9 bln the previous week that were the highest since early December. Redemptions were relatively small at EUR1.4 bln and so net purchases were EUR19 bln, down from the EUR21 bln the previous week that were the highest since early December. At this quicker pace, the ECB would use up the entire EUR1.85 trln PEPP envelope by February 2022. The ECB will publish the account of its March 10-11 meeting Thursday.

Scottish politics are heating up and not in a good way for sterling. The latest polls show Scottish nationalist parties may win a supermajority in the May 6 elections. First Minister Sturgeon’s Scottish National Party may win 65 seats, giving it a slim outright majority of one. Elsewhere, polls suggest the pro-independence Scottish Green Party may win 8 seats, while former leader Salmond’s Alba Party may win 6. This would give pro-independence parties 79 out of 129 seats in the Scottish Parliament, a supermajority that would put pressure on UK Prime Minister Johnson to approve a second independence referendum. With Scotland having narrowly voted against leaving the 310 year-old union with England back in 2014, Johnson has so far refused to consider another such vote.

Sterling continues to outperform but this could start to ease as the May election approaches. While the economic consequences of Scottish independence are likely to be limited, it is yet another potential headwind and source of uncertainty for the UK. This also brings up the question matter of which currency an independent Scotland will choose to adopt. As May 6 approaches, we suspect there will still be more questions than answers.

Turkey reported March CPI. Headline inflation came in close to consensus at 16.19% y/y vs. 15.61% in February, but core came in at 16.88% y/y vs. 16.30% consensus and 16.21% in February. More ominously, PPI rose 31.20% y/y vs. 28.90% expected and 27.09% in February and suggests rising pipeline price pressures. Next policy meeting is April 15. While a rate cut then seems likely, new central bank Governor Kavcioglu warned that tight policy is still needed. He will be under great pressure to cut but circumstances call for a hike. The best that markets can hope for is steady rates but this is by no means assured.

ASIA

Japan reported final March services and composite PMI readings. The former rose to 48.3 from 46.5 preliminary, while the latter rose to 49.9 from 48.3 preliminary. While Q1 was hurt by lockdowns, the economic outlook has already started to improve last month. We still expect another fiscal package over the summer as Suga tries to boost his flagging popularity ahead of fall elections.

The Bank of Japan should be pleased with developments after its March 18-19 meeting and policy review. Since then, the JGB curve has remained nearly unchanged while the yen has weakened 1.5% vs. the dollar. This despite the bank really doing nothing at all except invite JGB selling by widening its 10-year yield target band to 0% +/- 25 bp from +/- 20 bp previously. Some of this is pure luck, as the US curve has flattened and the dollar’s rally has intensified over the same period. At the same time, the Japanese economy is showing signs of life. For now, the BOJ should be content to sit back and let markets do their thing. Next policy meeting is April 26-27 and it is likely to deliver a dovish hold then in order to keep current market sentiment going.

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