• U.S. yields are edging lower as risk-off impulses linger; Fed tightening expectations remain relatively robust; Fed manufacturing surveys for April will continue to roll out
  
• ECB hawks remain vocal; ECB tightening expectations have eased a bit, however; U.K. reported March public sector net borrowing; BOE tightening will hurt the fiscal outlook; Hungary is expected to hike the base rate 100 bp to 5.40%
  
• Japan announced measures meant to help consumers and businesses deal with higher inflation; Japan reported March labor market data; PBOC pledged to continue supporting the economy
  

The dollar is firm as risk-off impulses linger. Yen and Swissie are outperforming today while DXY is up for the fourth straight day and traded at a new cycle high today near 101.963. The March 2020 high near 103 remains our next target. The euro traded at a new cycle low today near $1.0675 and is nearing a test of the March 2020 low near $1.0635. Further losses are likely (see below). After trading at a new cycle high near 129.40 last week, USD/JPY has stalled out and is stuck near 127.70. Until the BOJ changes its ultra-dovish stance, we look for an eventual test of the 2002 high near 135.15. Sterling continues to underperform and traded at a new cycle low today just below $1.27. We look for a break of the September 2020 low near $1.2675 that would first set up a test of the $1.25 level and then the June 2020 low near $1.2250. Between lingering risk-off impulses and an eventual recovery in U.S. yields, we believe the dollar uptrend remains intact.

AMERICAS

U.S. yields are edging lower as risk-off impulses linger. The U.S. 10-year yield traded at a new cycle high of 2.98% last week but has since fallen to 2.79% currently. Similarly, the 2-year traded at a new cycle high near 2.78% last week but has since fallen to 2.60% currently. Asian and European equity markets are building on yesterday’s recovery in U.S. stocks but futures are now pointing to a lower U.S. open. Yet the dollar continues to firm despite the lower yields, which can be chalked up to the dollar smile theory that suggests the dollar will gain during periods of strong U.S. data as well as bouts of risk-off sentiment. DXY traded today at a new cycle high near 101.963 and we continue to target the March 2020 high near 103.

Fed tightening expectations remain relatively robust. WIRP suggests 50 bp hikes at the May 3-4 and June 14-15 meetings are fully priced in, with nearly 30% odds of a possible 75 bp move in June. Looking ahead, swaps market is pricing in 275 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%. While this almost meets our own call for a 3.5% terminal rate, we continue to see risks that the expected terminal rate moves even higher if inflation proves to be even more stubborn than expected. The media blackout ahead of the FOMC meeting is in effect and so there will be no Fed speakers until Chair Powell’s post-decision press conference the afternoon of May 4.

Fed manufacturing surveys for April will continue to roll out. Richmond reports today and is expected at 9 vs. 13 in March. Yesterday, the Dallas Fed came in at 1.1 vs. 5.0 expected and 8.7 in March. Before that, Empire came in at 24.6 vs. -11.8 in March and Philly Fed came in at 17.6 vs. 27.4 in March. Kansas City reports Thursday and is expected at 35 vs. 37 in March. Most signs point to continued strength in the manufacturing sector despite ongoing supply chain issues. Elsewhere, March Chicago Fed National Activity Index points to continued strength in the U.S. economy. It came in at 0.44 vs. 0.45 epx3ected but February was revised up to 0.54 vs. 0.51 previously. As a result, the 3-month average rose to 0.58 from 0.43 and is the highest since May 2021 and further above the -0.7 level that signals imminent recession. March durable goods orders (1.0% m/m expected), February S&P CoreLogic house prices, March new homes sales (-0.3% m/m expected), and April Conference Board consumer confidence (108.5 expected) will also be reported.

EUROPE/MIDDLE EAST/AFRICA

ECB hawks remain vocal. Kazaks said the bank has room for as many as three hikes this year, adding it should begin liftoff soon. He added that a hike in July is possible and “reasonable” and that ending APP in early July is “appropriate.” Kazaks said that the ECB should start with a 25 bp move but stressed that this pace is not final, suggesting a possibly larger move. Lastly, he said the ECB should eventually get rates to neutral, which he said ECB estimates at 1.0-1.5%. Kazaks is staking out the hawks position and they seem to have pulled the rest of the Governing Council over to a more hawkish stance, similar to what we saw here in the U.S. with Bullard and the FOMC. However, as Madame Lagarde has pointed out many times, the economic outlooks for the U.S. and eurozone are very different right now. April eurozone CPI data will be reported Friday and will be very important for shaping the ECB narrative ahead of the next meeting June 9.

ECB tightening expectations have eased a bit, however. WIRP suggests odds of liftoff June 9 are now around 20% now vs. 40% at the start of this week, while liftoff July 21 remains fully priced in. The swaps market is now pricing in 125 bp of tightening over the next 12 months vs. 150 bp at the start of this week, with another 75 bp of tightening priced in over the following 12 months that would see the deposit rate peak near 1.5%. This would put it close to what Kazaks implied but this still seems way too aggressive to us. De Cos and Villeroy speak today and it will be important to see if they have joined Guindos’ hawkish pivot. The euro remains heavy and traded today at a new cycle low near $1.0675. We look for a test of the March 2020 low near $1.0635. After that is the February 2017 low near $1.05 and then the January 2017 low near $1.0340.

U.K. reported March public sector net borrowing. Ex-banking groups came in at GBP18.1 bln vs. GBP19.8 bln expected and a revised GBP10.6 bln (was s. GBP13.1 bln) in February. For the entire FY21/22, PSNB ex-banking fell to GBP151.8 bln, less than half the GBP317.6 bln for FY20/21 but still the third largest reading since records began in 1947. Of note, debt servicing costs nearly doubled to a record GBP69.9 bln in FY21/22, while the budget deficit fell to -6.4% of GDP from -14.8% in FY20/21. Chancellor Sunak sought to defend his rather underwhelming budget for FY22/23, warning that “Public debt is at the highest levels since the 1960s and rising inflation is pushing up our debt interest costs, which mean we must manage public finances sustainably to avoid saddling future generations with further debt.”

Bank of England tightening will hurt the fiscal outlook. WIRP suggests another 25 bp hike to 1.0% is fully priced in for the next meeting May 5, while swaps market is pricing in 175 bp of tightening over the next 12 months vs. 200 bp at the start of this week that would see the policy rate peak near 2.5%. Such a rate path will of course add to the government’s debt burden, which in turn could force further fiscal tightening to offset it. On top of this, the BOE will start Quantitative Tightening (QT) after the policy rate hits 1.0%, which suggests the gilt market will remain under pressure. There are no BOE speakers scheduled for this week. Sterling continues to sink and traded yesterday at the lowest level since September 2020 near $1.27. Despite a modest bounce, further losses are likely and we first target the September 2020 low near $1.2675. After that is the July 2020 low near $1.2480 and then the June 2020 low near $1.2250.

National Bank of Hungary is expected to hike the base rate 100 bp to 5.40%. At the last meeting, the bank increased the pace of tightening to 100 bp from 50 bp previously and we expect it to maintain that pace for now. Inflation was 8.5% y/y in March, the highest since June 2007 and further above the 2-4% target range. The swaps market sees 150 bp of tightening over the next 12 months that would see the base rate peak near 6.0%. It is also expected to hike the 1-week deposit rate 30 bp to 6.45% at its weekly tender Thursday.

ASIA

Japan announced measures meant to help consumers and businesses deal with higher inflation. Key spending includes JPY1.5 trln yen to offset the impact of soaring oil prices, raising the limit on gasoline subsidies for oil refiners to 35 yen per liter from 25 previously, JPY1.3 trln to support small and mid-sized companies, JPY1.3 trln to aid low-income households that include cash handouts of 50,000 yen per child. The measures total JPY6.2 trln ($48.5 bln) and will be funded by a combination of an additional budget as well as existing reserves. The Cabinet Office said that once private sector contributions are included, the estimated size of the package rises to JPY13.2 trln. The government will reportedly push parliament to pass the extra budget in the current session so that they are in place before Upper House elections this summer.

Japan reported March labor market data. The unemployment rate was expected to remain steady at 2.7% but instead fell to 2.6%, while the job-to-applicant ratio rose a tick as expected to 1.22. Unemployment is the lowest in nearly years. With the labor market improving, it’s no surprise that March department store sales came in firm yesterday, rising 4.6% y/y vs. -0.7% in February. Retail sales data Thursday should also be firm and are expected at 1.0% m/m vs. -0.9% in February. However, we think it will be more important to see how wages behave, as the BOJ has recently added stronger wage growth as a prerequisite for tightening policy.

People’s Bank of China pledged to continue supporting the economy. The bank said it “will step up the prudent monetary policy’s support to the real economy, especially for industries and small businesses hit hard by the pandemic.” It added that it would promote the healthy and stable development of financial markets and provide a supportive monetary and financial environment, reiterating that it will keep liquidity ample. The pledge is really nothing and markets should be a little skeptical as earlier pledges have so far been followed by timid measures. Premier Li Keqiang warned at a State Council meeting Monday that “New downward pressure on the economy has increased.” Li added that policy should be implemented quickly through H! in order to stabilize jobs, inflation, and the economy. He has been one of the most vocal in calling for quick and aggressive stimulus but so far, little action has been taken.

Of note, the PBOC earlier this week cut the amount that banks need to keep in reserve for their foreign currency holdings. This was seen as an attempt to support the yuan by making more foreign currency available onshore. This measure along with the PBOC pledge to support the economy helped push USD/CNY back down below 6.50 today from yesterday’s cycle high near 6.5775 that nearly matched the March 2021 high near 6.5795. However, as long as the monetary policy divergences continue to widen here, the yuan should continue to weaken and we target the November 2020 high near 6.75.