Dollar Gets Limited Traction Ahead of the Weekend

May 20, 2022

Win Thin

We believe much of this week’s price action was driven by a short squeeze for the foreign currencies; we note more observers are getting concerned about U.S. recession risks; regional Fed manufacturing surveys for May have so far been weak

U.K. reported better than expected April retail sales; U.K. GfK consumer confidence came in weaker than expected; BOE Chief Economist Pill sounded hawkish; ECB consensus continues to move towards July liftoff

Japan reported April national CPI data; Australia goes to the polls Saturday; China’s commercial banks cut the 5-year Loan Prime Rate by 15 bp to 4.45%; Taiwan reported very weak April export orders

The dollar is getting some limited traction ahead of the weekend. DXY is trading near 102.838 and is just above yesterday’s low near 102.657. The euro is trading just below $1.06 and cable is trading just below $.125. USD/JPY is trading at 128 and is likely to take its near-term cues from risk sentiment. We believe much of the dollar selling this week has been position-driven (see below). Despite concerns about the economic outlook, we continue to believe that the fundamental story favors the dollar, mainly because the U.S. is simply in much better shape than the eurozone, U.K., and Japan. While it may be tempting to say otherwise due to recent price action where the greenback sold off during a risk off period, we believe the dollar smile remains intact and look for gains to eventually resume after this technically driven selloff ends.

AMERICAS

We believe much of this week’s price action was driven by a short squeeze for the foreign currencies. Long dollar positioning was getting stretched and in need of a correction. That is still happening and may have some room to go still. Euro bounce may get as far as the May 5 high near $1.0640 or even the key retracement objective from the April -May drop near $1.0710. Similarly, cable may test the May 4 high near $1.2640 or the equivalent retracement objective near $1.2735. For USD/JPY, a clean break below the April 27 low near 127 would set up a test of the April 14 low near 125. For us, it's hard to see the dollar losing much more ground than that. We think markets are getting way too negative on the U.S. economy (see below) and so we look to fade this bounce in the foreign currencies if we approach those April/May levels cited above.

From a fundamental perspective, we note more observers are getting concerned about U.S. recession risks. Such an outcome would rightfully harm the strong dollar story if it were to happen. While we acknowledge that the U.S. economy is slowing, that shouldn’t come as any surprise when both monetary and fiscal policy are tightening. Two of our favorite indicators for U.S. recession risk – the 3-month to 10-year yield curve and the 3-month average Chicago National Activity Index – show no signs of an imminent downturn. Other major economies are in much worse shape already.

Regional Fed manufacturing surveys for May have so far been weak. Yesterday, Philly Fed came in at 2.6 vs. 15.0 expected and 17.6 in April. Earlier in the week, Empire survey came in at -11.6 vs. 15.0 expected and 24.6 in April. The manufacturing sector continues to struggle with supply chain issues but we see underlying strength being maintained as we move towards H2. There are no U.S. data reports today.

EUROPE/MIDDLE EAST/AFRICA

U.K. reported better than expected April retail sales. Headline was expected at -0.3% m/m but instead rose 1.4% vs. a revised -1.2% (was -1.4%) in March, while ex-auto fuel was expected at -0.2% m/m but also rose 1.4% vs. a revised -0.9% (was -1.1%) in March. This is welcome news after last week’s real sector data came in largely weaker than expected. However, some of the details were not as upbeat. For instance, the headline gain was boosted by spending on alcohol, sweets, and tobacco, which the ONS suggested could be “possibly due to people staying in more to save money.” In addition, the y/y rate for ex-auto fuel fell to -6.1% from a revised -0.2% (was -0.6%) in March, which was the most since May 2020.

May U.K. GfK consumer confidence came in at -40 vs. -39 expected and -38 in April. This is the lowest on record dating back to 1974 and even lower than the depths of the Great Financial Crisis. GfK official said “Consumer confidence is now weaker than in the darkest days of the global banking crisis, the impact of Brexit on the economy, or the Covid shutdown. The outlook for consumer confidence is gloomy, and nothing on the economic horizon shows a reason for optimism any time soon.” Indeed, Chancellor Sunak said earlier this week that “I cannot pretend this will be easy. The next few months will be tough.”

Bank of England Chief Economist Pill sounded hawkish. He warned that “the balance of risk is tilted towards inflation proving stronger and more persistent than anticipated in that baseline.” The latest BOE forecasts see inflation at 10.2% in October. He added that “We still have some way to go in our monetary policy tightening, in order to make the return of inflation to target secure. Acting to achieve the 2% inflation target is now more important than ever.” While markets may not be happy with the likely recession, this is the sort of firm language (along with actual action) that is needed to help tame inflation and inflation expectations. Yet BOE tightening expectations remain stalled. WIRP suggests another 25 bp hike is priced in for the next meeting June 16. Looking ahead, the swaps market is still pricing in 150 bp of total tightening over the next 12 months that would see the policy rate peak near 2.50%, steady from the start of last week.

ECB consensus continues to move towards July liftoff. Visco said that while June is too early because that is when the ECB will end QE, “we will move after that -- after that, means perhaps July.” Liftoff July 21 remains fully priced in. However, the swaps market is now pricing in total tightening of only 200 bp that would lead to a peak deposit rate near 1.50% vs. 1.75% at the start of last week. Eurozone consumer confidence will be reported. It is expected at -21.5 vs. -22.0 in April.

ASIA

Japan reported April national CPI data. Headline came in as expected at 2.5% y/y vs. 1.2% in March, while core (ex-fresh food) came in a tick higher than expected at 2.1% y/y vs. 0.8% in March. This is the highest reading for core since March 2015. To illustrate the outsized impact of oil prices, core ex-energy rose only 0.8% y/y vs. -0.7% in March. The April 27-28 Bank of Japan meeting showed that policymakers remain unconcerned about inflation, which it still views as transitory. We maintain our view that monetary policy will be kept steady through the end of Governor Kuroda’s term next spring. It will be up to his successor to change policy.

Australia goes to the polls Saturday. The most recent Ipsos poll suggests opposition Labor ahead of the incumbent Liberal-National Coalition 53-47%. Labor’s polling lead has shrunk in recent weeks, while many recall the big polling miss for the 2019 election that saw the ruling coalition win despite being behind Labor in most opinion polls. A majority of 76 seats in the 151-seat parliament are needed to form a government. The impact of the outcome will most likely be felt the most in fiscal policy, as Shadow Treasurer Chalmers has promised greater spending if Labor returns to power.

China’s commercial banks cut the 5-year Loan Prime Rate by 15 bp to 4.45%. The 1-year rate was kept steady at 3.70% and both rates were expected to be cut 5 bp. This move comes after PBOC kept its 1-year MLF rate steady at 2.85% but then cut the mortgage rate for first-time buyers to as low as 4.4% vs. 4.6% previously. The central bank said that cut was aimed at supporting housing demand and will “promote the stable and healthy development of the property market.” The stimulus measures taken so far have been underwhelming given the depth of the slowdown underway.

Taiwan reported very weak April export orders. Orders were expected at 11.5% y/y but instead fell -5.5% vs. vs. 16.8% in March. This is the first contraction since February 2020 and the weakest since January 2020. Of note, the Taiwanese orders data generally gives a look at exports six months ahead. Regional data are starting to reflect the impact of the deeper than anticipated slowdown in mainland China, as its COVID Zero policy has led to lockdowns that have disrupted already damaged supply chains.

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