Dollar Down But Not Out

May 28, 2024

Dollar Down But Not Out

  • We expect USD to resume its year-to-date uptrend.
  • Soft underlying inflation pressure in Japan suggests the bar for an aggressive BOJ tightening cycle is high.
  • BOE will look through the sharp slowdown in UK shop price inflation in May.

Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week

USD is down against most major currencies. Resilient global economic activity is supporting risk assets and undermining USD. In our view, USD has scope to resume its year-to-date uptrend. First, the May global PMI prints showed growth momentum has shifted back in favour of the US. Second, the favourable US macro backdrop justifies the Fed’s higher-for-longer policy rate narrative. Fed funds futures price-in an 80% probability of a first cut in November.

The US May Conference Board consumer confidence index is today’s main data release (3:00pm London). Headline is projected to decline to a 21-month low at 96.0 vs. 97.0 in April consistent with softer consumer spending activity. Nevertheless, positive real wage growth, rising house prices and a strong labour market suggest household spending will remain an important tailwind to US GDP growth.

EUR/USD is up near 1.0880 on USD weakness. ECB policymakers are generally in broad agreement for a June policy rate cut. Governing Council member Francois Villeroy de Galhau said yesterday a June rate cut is a “done deal” and a second cut in July shouldn’t be excluded. According to Villeroy, there is “significant room” to ease policy, adding the current market view on the terminal rate (2.80% over the next five years) is “not unreasonable”.

ECB Chief Economist Philip Lane is more balanced on the policy path beyond June. Lane emphasised a data-dependent approach and the “need to be restrictive for an extended period” because “there is still a significant backward-looking element to the inflation and wage process”. Interest rate futures place just 10% odds of a second ECB policy rate cut in July while a second cut in September is over 80% priced-in.

Indeed, the modest improvement in the Eurozone growth outlook and sticky inflation expectations suggest back-to-back ECB policy rate cuts are unlikely which offers EUR support. The German IFO business expectations index rose to a 13-month high at 90.4 in May, albeit the increase was less than expected (consensus: 90.8). Meanwhile, the ECB’s short- and medium-term inflation expectations measures remain well above the bank’s 2% target. The ECB’s April inflation expectations survey is released today (9:00am London).

GBP ignored cooler UK shop prices. UK BRC shop price inflation eased sharply to a 30-month low at 0.6% y/y in May (consensus: 1.0%) on lower non-food prices. Shop price disinflation are unlikely to convince the BOE to move early with policy rate cuts. The BOE is more concerned with high services inflation. Interest rate futures continue to price-in a first 25bps BOE policy rate cut in November.

USD/JPY is directionless just under 157.00. Japan’s PPI services inflation overshot expectations (actual: 2.8% y/y, consensus: 2.3%) and quickened at the fastest pace in over 30 years in April. Regardless, Japan underlying inflation is in a firm downtrend and suggests the bar for an aggressive Bank of Japan (BOJ) tightening cycle is high. The BOJ’s trimmed mean CPI dropped to a 22-month low at 1.8% y/y in April vs. 2.2% in March and the weighted median CPI fell to a 13-month low at 1.1% y/y in April vs. 1.3% in March.

AUD/USD edged higher overnight largely because of broad USD weakness. Australia retail sales growth was weak in April. Retail turnover rose 0.1% m/m (consensus: +0.2%) after a 0.4% decline in March. A major reason the RBA held the policy rate steady in May was to mitigate against the risk that consumer spending remains subdued for a more prolonged period. Encouragingly, stabilization in real disposable income points to a modest recovery in consumption growth. But so far, the recovery is unimpressive which will keep the RBA cautious and a headwind for AUD.

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