Dollar Continues to Smile

June 17, 2024
  • The dollar smile remains in play; the market still doesn’t believe the Fed; Fed officials remain cautious; regional Fed surveys for June start rolling out
  • So far, ECB officials seem unconcerned with developments in France; ECB officials remain cautious about the next cut
  • China housing sector continues to weaken; China also reported mixed real sector data for May

The dollar is mostly firmer as the dollar smile carries over from last week. DXY is trading flat near 105.575 but remains on track to test the April-May highs near 106.50. The euro is trading lower near $1.07 as French bond spreads continue to widen out despite weekend assurance from Le Pen (see below), while sterling is trading lower near $1.2655 and USD/JPY is trading flat near 157.55. Recent data support our view that the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. The Fed sees the same and delivered a hawkish hold last week. Overall, recent developments underscore the widening economic and monetary policy divergences that support the U.S. dollar and that should continue this week. In addition, the dollar should also continue to gain from any risk off impulses emanating from France.

AMERICAS

The dollar smile remains in play. Price action last week saw the dollar gain on both the hawkish Fed and the risk off impulses emanating from Europe. Both of these drivers are likely to remain in play this week and so the dollar rally should continue. DXY traded Friday at the highest since May 2 and is on track to test the April-May highs near 106.50.

The market still doesn’t believe the Fed. The Fed now sees only one cut in 2024 but the market is still fully pricing in two. Of course, it will all depend on the data. June CPI (out July 11) and PCE (July 26) will come before the July 30-31 FOMC meeting. Another good month of inflation data then could put that meeting more in play, where the market currently sees around 10% odds of a cut. The Fed will then wait for July CPI (out August 14) and PCE (August 30) before deciding on a possible cut at the September 17-18 meeting, where the odds are now around 75%.

Fed officials remain cautious. Over the weekend, Kashkari said “We need to see more evidence to convince us that inflation is well on our way back down to 2%. We’re in a very good position right now to take our time, get more inflation data, get more data on the economy, on the labor market, before we make any decisions.” He added that “If there is just one rate cut this year, it would likely come toward the end of the year.” There are many Fed speakers this week and most are expected to toe the hawkish line that was maintained at last week’s FOMC meeting. Williams, Harker, and Cook speak today.

Regional Fed surveys for June start rolling out. Empire manufacturing survey kicks things off today and is expected at -11.3 vs. -15.6 in May. New York Fed services will be reported tomorrow and stood at 3.0 in May. Philly Fed manufacturing will be reported Thursday and is expected at 4.8 vs. 4.5 in May.

EUROPE/MIDDLE EAST/AFRICA

The political turmoil in France continues to hang over European financial markets. Polls show Le Pen’s far-right National Rally and the left wing New Popular Front are on course to be the two biggest political groups in the French National Assembly. Such a scenario has worsened France’s already poor fiscal outlook, as both parties support unfunded spending programs. The 10-year yield premium on French bonds over German bunds widened to a seven-year high, sparking contagion in eurozone peripheral government bonds. Even though Le Pen said over the weekend that she would work with President Macron, France is now trading wide of Portugal in the 10-year space and is nearing Spain.

So far, ECB officials seem unconcerned with developments in France. Chief Economist Lane said “What we’re seeing in the markets is, of course, a repricing. It’s not, you know, the world of disorderly market dynamics.” Lane reminded market participants of the ECB’s Transmission Protection Instrument (TPI) that was introduced in July 2022. The TPI is intended to enable the ECB to control eurozone sovereign spreads by purchasing government securities in the secondary market from member states experiencing a deterioration in financing conditions not warranted by country-specific fundamentals. While TPI is a powerful tool, it does not resolve uncertainty over France’s fiscal woes. To be eligible for TPI, an EU member state needs to pursue sound and sustainable fiscal and macroeconomic policies. Unfunded spending plans championed by France’s hard-right National Rally and the left wing New Popular Front (the two parties leading the French legislative election polls) don’t really make the cut.

ECB officials remain cautious about the next cut. Lane said every meeting is live but stressed that the bank won’t know about services inflation at the July meeting and needs to see more than a month of good data on services inflation. Lane added that a really big move in the euro exchange rate would matter for the bank’s CPI forecast. Vujcic said “In order to do more, we need to see more. Any prolongation of the inflation conversion toward the medium-term target weakens the case for an interest-rate cut, and vice versa.” Despite this, the market sees 70% odds of a cut in September and has nearly priced in another cut in December. Lagarde, Guindos, and Makhlouf also speak today.

ASIA

China housing sector continues to weaken. New home prices fell -4.3% y/y vs. -3.5% in April, while existing home prices fell -7.5% y/y vs. -6.8% in April. The latter saw the deepest plunges on record since data became available in 2009. The deepening slump is particularly disappointing after policymakers announced a support plan for the housing sector last month. Elsewhere, property investment came in a tick lower than expected at -10.1% YTD vs. -9.8% YTD in April.

China also reported mixed real sector data for May. IP came in at 5.6% y/y vs. 6.2% expected and 6.7% in April, retail sales came in at 3.7% y/y vs. 3.0% expected and 2.3% in April, and FAI came in two ticks lower than expected at 4.0% YTD vs. 4.2% in April. PBOC kept its 1-year MLF rate unchanged at 2.5%. Regardless, sustained consumption-led growth is unlikely in part because of the nation’s huge debt overhang and a burst property bubble.

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