Dollar Firm Ahead of Key Data as BOJ Holds Steady

April 28, 2023

Win Thin

March PCE data will be the highlight; Q1 ECI will command more attention than usual; April Chicago PMI will also be closely watched; we got our first look at Q1 GDP; Colombia is expected to hike rates 25 bp to 13.25%.
Eurozone April CPI data started trickling out; ECB tightening expectations have eased a bit; eurozone Q1 GDP data were also reported
BOJ meeting ended with no change in policy settings; April Tokyo CPI data ran hot; the labor market appears to be softening; March retail sales, IP, and housing starts were also reported; Australia reported March private sector credit and Q1 PPI; China reports official April PMI readings Sunday local time

The dollar is firm ahead of key data. DXY is trading higher near 102, with the biggest gains seen against the yen after the BOJ left policy unchanged (see below). USD/JPY is trading at the highest since March 10 near 136 and the pair is on track to test the March 8 high near 138. The euro is trading lower just under $1.10 and sterling is trading lower near $1.2465. Recent data have been dollar-supportive but until rate cuts this year are finally priced out, the dollar is likely to remain vulnerable.

AMERICAS

March PCE data will be the highlight. Headline is expected at 0.1% m/m and 4.1% y/y vs. 0.3% and 5.0% in February, while core PCE is expected at 0.3% m/m and 4.6% y/y vs. 0.3% and 4.6% in February. After yesterday’s higher than expected Q1 core PCE reading of 4.9%, we see upside risks to the today’s data. Of note, the Cleveland Fed’s inflation Nowcasting model has headline at 0.08% m/m and 4.10% y/y and core PCE at 0.35% m/m and 4.58% y/y, both very close to consensus. There are no estimates for so-called Super Core PCE, which stood at 4.6% y/y in February. While a headline reading of 4.1% y/y would be the lowest since May 2021, much of that improvement is due to energy as the core measures remain stubbornly high. Personal income and spending will be reported at the same time and are expected at 0.2% m/m and -0.1% m/m, respectively.

Q1 Employment Cost Index will command more attention than usual. That is because markets are focused on the labor market and the Fed’s desired aim of cooling wage pressures. Consensus sees 1.1% q/q vs. 1.0% in Q4. If so, this would be the first pickup after three straight quarters of deceleration from the 1.4% q/q peak in Q1 2022. Of note, the y/y rate of 5.1% in Q4 was the highest on record dating back to 2001. Any further acceleration would of course be alarming.

Fed tightening expectations have picked up bit. WIRP suggests over 90% odds of 25 bp hike next Wednesday, up from 80% at the start of last week and 70% at the start of the week before that. We believe a hike next week is a done deal. There are about 10% odds of another 25 bp hike in June. Between the May 2-3 and June 13-14 meetings, the Fed will have digested two more job reports, two CPI/PPI reports, and one retail sales report. At this point, a pause in June may be the most likely outcome but it really will depend on how all that data come in. After all that, one cut is still priced in by year-end vs. two at the start of last week. In that regard, Powell has said that Fed officials “just don’t see” any rate cuts this year. We concur.

April Chicago PMI will also be closely watched. Headline is expected at 43.6 vs. 43.8 in March. However, we see upside risks after S&P Global preliminary PMIs came in stronger than expected last week. Manufacturing came in 50.4 vs. 49.0 expected and 49.2 in March while services came in at 53.7 vs. 51.5 expected and 52.6 in March. As a result, the composite rose to 53.5 vs. 51.2 expected and 52.3 in March and was the highest since May 2022. Of note, April ISM PMIs will be reported next week.

We got our first look at Q1 GDP. While the headline reading of 1.1% SAAR was below the 1.9% consensus, the details were solid. Private consumption rose 3.7% vs. 1.0% in Q4, while final sales (GDP ex-inventories) rose 3.4%. A big inventory drawdown subtracted -2.26% from overall growth. Usually, a big inventory drawdown for the quarter points to a rebuild in the next quarter, which would add to GDP growth. The big question is how much do firms rebuild inventories when it looks like demand is softening? Something to ponder. Of note, the Atlanta Fed GDPNow model’s final estimate was spot on. The model will start tracking Q2 with its first estimate today. Bloomberg consensus for Q2 is currently 0.3% SAAR, followed by -0.6% SAAR in Q3.

Colombia central bank is expected to hike rates 25 bp to 13.25%. Expectations shifted from a hold after the peso weakened sharply this week due to the sacking of Finance Minister Ocampo. However, it’s still almost a 50-50 proposition. However, at the last policy meeting March 30, the central bank hiked rates 25 bp to 13.0% and Governor Villar said inflation data would determine if the tightening cycle has ended. Since then, March CPI data showed both headline and core inflation accelerating to new cycle highs. As such, we believe it hikes today and we see risks that the tightening cycle may be extended if the peso continues to weaken.

EUROPE/MIDDLE EAST/AFRICA

Eurozone April CPI data started trickling out. France and Spain already reported while Germany reports later today. France’s EU Harmonised CPI came in at 6.9% y/y vs. 6.7% expected and actual in March, while Spain’s came in at 3.8% y/y vs. 4.1% expected and 3.1% in March. Germany’s is expected to remain steady at 7.8% y/y but German state data already reported point to some downside risks. Italy and eurozone-wide CPI will be reported next Tuesday. The readings so far suggest inflation is likely to be stickier than expected.

ECB tightening expectations have eased a bit. WIRP suggests less than 15% odds of a 50 bp hike next Thursday vs. 30% seen at the start of this week. After that, another 25 bp hike is still priced in for June 15 followed by over 90% odds of another hike September 14. There are no longer any odds of one final hike and so the peak policy rate is now seen near 3.75% vs. 3.75-4.0% at the start of this week and back to the 3.75% seen at the start of last week.

Eurozone Q1 GDP data were also reported. Headline came in a tick lower than expected at 0.1% q/q vs. a revised -0.1% (was 0.0%) in Q4, while the y/y rate came in a ticker lower than expected at 1.3% vs. 1.8% in Q4. Looking at the country breakdown, France came in as expected at 0.2%, Spain came in at 0.5% q/q vs. 0.3% expected, Germany came in at 0.0% q/q vs. 0.2% expected, and Italy came at 0.5% q/q vs. 0.2% expected. Of note, the downward revision to the Q4 headline was driven by weaker readings in France and Germany. Many analysts are touting the fact that the eurozone has avoided recession and yet we believe it’s too early to get very excited about the growth outlook. The ECB only started hiking rates in July 2022 and so the full impact of the 350 bp of tightening so far has yet to be felt. On top of that, 75-100 bp more tightening is priced in. Furthermore, data so far suggest little positive impact for the rest of the world from China reopening.

ASIA

Two-day Bank of Japan meeting ended with no change in policy settings. However, the bank dropped its forward guidance for interest rates and launched a review of its policies that will take 12-18 months to complete. Governor Ueda stressed that “We’re not starting the review with the aim of normalizing. But it’s not zero chance we begin normalizing during the review period.” New macro forecasts were released that show core inflation remaining at or below the 2% target through FY25, with the bank adding that it sees downside risks to the new FY25 forecast. All in all, we think the moves give the bank maximum flexibility to change policy as needed. For now, it seems the bank is being extra cautious on the real economy despite still-high inflation.

The FX market reacted as one would expect. The lack of any policy changes today saw USD/JPY jump nearly 2% to trade at the highest since March 10 near 136.20. The pair is on track to test the March 8 high near 138. That said, the rates market seems to see liftoff sooner rather than later now. WIRP suggests nearly 50% odds of liftoff at the next meeting June 16, rising to being almost fully priced in December 19. However, the subsequent tightening path is seen as very mild as the market is pricing in only 15 bp of tightening over the next 12 months followed by only 15 bp more over the subsequent 24 months. That is why we expect any knee-jerk drop in USD/JPY after liftoff to be fairly limited.

April Tokyo CPI data ran hot. Headline came in at 3.5% y/y vs. 3.3% expected and actual in March, while core (ex-fresh food) came in at 3.5% y/y vs. 3.2% expected and actual in March. This was despite ongoing energy subsidies. What’s worse, core ex-energy came in at 3.8% y/y vs. 3.5% expected and 3.4% in March. This was the highest since April 1982 and should be very concerning to policymakers. Yet it seems they are more concerned about soft real sector data.

The labor market appears to be softening. The unemployment rate jumped to 2.8% in March vs. 2.5% expected and 2.6% in February, while the job-to-applicant ratio fell to 1.32 when it was expected to remain steady at 1.34. If this softness continues, it will make it more difficult for wage growth to pick up as much as the BOJ desires. March cash earning data will be reported May 9 and are expected to show very limited gains.

March retail sales, IP, and housing starts were also reported. Sales came in at 7.2% y/y vs. 6.5% expected and 7.3% in February, while IP came in at -0.7% y/y vs. -1.2% expected and -0.5% in February. Lastly, housing starts came in at -3.2% y/y vs. -3.9% expected and -0.3% in February. Recent softness in the real sector data suggests downside risks to Q1 GDP, which will be reported May 17. As things stand, the BOJ cut its FY23 growth forecast to 1.4% but a weak Q1 reading would suggest even less momentum in the economy going into the new fiscal year.

Australia reported March private sector credit and Q1 PPI. PPI rose 5.2% y/y vs. 5.8% in Q4 and was the second straight quarterly deceleration to the slowest since Q1 2022. Elsewhere, credit growth slowed to 6.8% y/y vs. 7.6% in February and was the lowest since November 2021. Price pressures are easing even as lending activity slows. Next policy meeting is May 2 and WIRP suggests a hold is widely expected. A cut is no longer expected by year-end, as it was in early April but of course, it will all depend on the data. For now, the Australian economy has remained fairly robust despite the 350 bp of tightening seen so far since it began hiking in May 2022 but there are some signs of slowing. The market sees steady rates over the next 12 months followed by the start of an easing cycle over the subsequent 12 months, which sounds about right to us.

China reports official April PMI readings Sunday local time. Manufacturing is expected at 51.4 vs. 51.9 in March and non-manufacturing is expected at 57.0 vs. 58.2 in March. If so, the composite would likely fall by more than a point from 57.0 in March, with growth still largely driven by the services sector. The continued reliance on boosting domestic non-manufacturing activity rather than export-focused manufacturing activity is the major reason why other countries in the region have yet to feel much impact from China reopening.

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