Dollar Firm as Important Week Begins

June 03, 2024

Win Thin

The Fed is nowhere close to cutting rates; ISM manufacturing PMI for May will be the highlight; Q2 growth remains solid; Claudia Scheinbaum won the Mexican presidential election by a large margin
Eurozone reported final May manufacturing PMIs; Switzerland reported mixed May PMIs; Turkey May CPI ran very hot
Japan reported soft capital spending for Q1; Caixin reported firm May manufacturing PMI; iron ore continues to slide

The dollar is trading firm as a key week begins. Not only will we get important U.S. data for May, but both the BOC and ECB are expected to begin their easing cycles. We expect developments this week to underscore ongoing monetary policy and economic divergences that favor the dollar. DXY is trading higher near 104.740. The euro is trading lower near $1.0835 while sterling is trading lower near $1.2715. USD/JPY is trading back below 157 despite weaker than expected Q1 capital spending (see below). MXN is the worst performer in EM FX after Scheinbaum and her Morena party swept weekend elections (see below). We believe the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. Markets have taken back the dovish Fed easing expectations and yields have been steadily rising. As such, we look for the dollar recovery to continue. This week’s data could be a big help.

AMERICAS

The Fed is nowhere close to cutting rates. Despite the Fed’s media blackout, we got one last Fed comment from Kashkari in an interview from May 27 that was just published today. He said the Fed is likely to keep rates on hold for an “extended period of time” until incoming data convinces policymakers that inflation is on the way down. Unless there are any more unpublished basement tapes, there will be no more Fed speakers until Chair Powell’s post-decision press conference next Wednesday. Before the blackout, Fed officials all stayed on message about being patient and so the market still sees the first cut as most likely coming in November.

ISM manufacturing PMI for May will be the highlight. Headline is expected at 49.6 vs. 49.2 in April. Last week, the Chicago PMI continued to drop to multi-year lows. However, we put more weight on S&P Global PMIs, as manufacturing PMI rose to 50.9 in May vs. 50.0 in April. Keep an eye on prices paid, which is expected at 59.5 vs. 60.9 in April. That was the highest since June 2022 and so any further acceleration would be a big concern for the Fed. April construction spending and May vehicle sales will also be reported today.

Q2 growth remains solid. The Atlanta Fed’s GDPNow model is tracking Q2 growth at 2.7% SAAR and will be updated today after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q2 growth at 1.8% SAAR and will be updated Friday. It should also release its first estimate for Q3 growth Friday.

Claudia Scheinbaum won the Mexican presidential election by a large margin. This was widely expected. More importantly, her Morena party is poised to win control of both houses of congress. Sheinbaum has pledged to continue President Andrés Manuel López Obrador's agenda, but the prospect of no checks and balances has led to MXN weakness. With a supermajority in both houses of congress, Morena would be able to implement sweeping constitutional and economic reforms. Some of those, such as increased pension payouts and minimum wage hikes, could potentially lead to expensive social welfare spending. That said, we believe the fundamental backdrop remains positive for MXN. Mexico has one of the highest real interest rates within the EMFX universe, a stimulative fiscal stance, and boasts a favorable balance of payments backdrop (small current account deficit and large net FDI inflows).

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported final May manufacturing PMIs. Headline fell a tick from the preliminary to 47.3. Looking at the country breakdown, Germany was steady at 45.4 and France fell three ticks from the preliminary to 46.4. Italy and Spain report for the first time and theirs came in at 45.6 and 54.0, respectively. Services and composite PMIs will be reported Wednesday. Here too, Italy and Spain report for the first time and their composite PMIs are expected at 53.2 and 56.2, respectively.

Switzerland reported mixed May PMIs. Manufacturing came in at 46.4 vs. 44.0 expected and 41.4 in April, but services came in at 48.8 vs. 55.6 in April. Both have not been below 50 since March and argues for further SNB easing. At the last meeting March, the SNB started the easing cycle with a 25 bp cut to 1.5%. Next meeting is June 20, and the market is pricing in 50% odds of another rate cut then. We believe the SNB has scope to ease further next week as inflation remains subdued. May CPI will be reported tomorrow. Headline is expected to remain steady at 1.4% y/y, while core is expected to pick up a tick to 1.3% y/y.

Turkey May CPI ran very hot. Headline came in at 75.45% y/y vs. 74.80% expected and 69.80% in April, while core came in at 74.98% y/y vs. 74.45% expected and 75.81% in April. Headline was the highest since November 2022. At the last meeting May 23, the central bank kept rates steady at 50.0% but tightened liquidity by raising required reverse ratios for lira deposits and limiting the monthly growth of FX loans to 2%. The y/y inflation rate is expected to peak soon due to high base effects from last year, and so the market is pricing in the start of an easing cycle over the next three months. However, with m/m gains still accelerating, a rate cut so soon seems highly unlikely. Next policy meeting is June 27, and we see risks of a hawkish surprise.

ASIA

Japan reported soft capital spending for Q1. Spending came in at 6.8% y/y vs. 11.0% expected and 16.4% in Q4, while spending ex-software came in at 6.8% y/y vs. 8.4% expected and 11.7% in Q4. Elsewhere, company sales came in a tick lower than expected at 2.3% y/y vs. 4.2% in Q4, while company profits came in at 15.1% y/y vs. 8.3% expected and 13.0% in Q4. The slowdown in capital spending is hard to square with strong profits and is likely to be a further drag on revised Q1 GDP data due out next Monday, which came in at -0.5% q/q preliminary.

Caixin reported firm May manufacturing PMI. Headline came in a tick higher than expected at 51.7 vs. 51.4 in April and is the highest since June 2022. This contrasts with the official manufacturing PMI, which fell to 49.5 in May, the lowest since February. Caixin services and composite PMIs will be reported Wednesday. Services is expected to remain steady at 52.5.

Iron ore continues to slide. Markets seem to be putting more weight on the weak official PMI rather than the firm Caixin reading. Iron ore prices slid nearly 5% today and are down lover 10% from the May peak. This is negative for exporters such as Australia and Brazil. Copper is also down over 10% from its May peak as optimism regarding China’s housing sector support plan wears off, and rightfully so. This is negative for exporters such as Chile and Peru.

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