Dollar Rally Takes a Breather

May 30, 2024

Win Thin

Fed released its Beige Book report; Cleveland Fed picked Beth Hammack as its next president; we get a revision to Q1 GDP; Q2 growth remains robust
Eurozone May CPI data continue to roll out; Switzerland reported firm Q1 GDP data; SARB is expected to keep rates steady at 8.25%; early projections suggest the ANC has lost its parliamentary majority
Australia business investment remains an important growth tailwind; AUD is tracking iron ore prices lower; New Zealand’s new government announced a package of tax cuts in its first budget

The dollar recovery is taking a breather. After trading as high as 105.184 earlier today, DXY is trading back near 104.963. The euro is trading higher near $1.0815 after higher-than-expected Spain CPI reported (see below) while sterling is trading higher near $1.2715. USD/JPY is trading lower near 157 while CHF is the best performing major after strong than expected GDP reported (see below). Lastly, ZAR is the worst performing in EM after early projections showed a bigger than expected ANC election loss (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.

AMERICAS

Fed released its Beige Book report. As expected, there was a balanced tone in this report that will allow the Fed to take a wait and see approach with regards to easing. On overall economic activity: National economic activity continued to expand from early April to mid-May; however, conditions varied across industries and Districts. Most Districts reported slight or modest growth, while two noted no change in activity. Overall outlooks grew somewhat more pessimistic amid reports of rising uncertainty and greater downside risks. On labor markets: Employment rose at a slight pace overall. Eight Districts reported negligible to modest job gains, and the remaining four Districts reported no changes in employment. Wage growth remained mostly moderate, though some Districts reported more modest increases. On prices: Prices increased at a modest pace over the reporting period. Price growth is expected to continue at a modest pace in the near term.

Fed officials remain cautious. Yesterday, Bostic reiterated that “My outlook is that if things go according to what I expect - inflation goes slowly, the labor market slowly and orderly moves back into a sort of a weaker stance, but a stable-growth stance - I’m looking at the end of the year, the fourth quarter, as the time where we might actually think about and be prepared to reduce rates.” Williams and Logan speak today. Of note, the market sees zero odds of a cut in June, rising to 10% in July, 55% in September, and 75% in November, which is near the pre-May 1 FOMC lows.

The Cleveland Fed picked Beth Hammack as its next president. Hammack comes over from Goldman Sachs, where she has accumulated more than three decades of experience in finance, capital markets, and risk management. She will replace Loretta Mester, who is retiring June 30, and will be a voter on the FOMC after she takes up her post August 21. It will be very interesting to hear Hammack's views on the economy. While Hammack has extensive market experience from her time at GS, she only has a B.A. from Stanford. By comparison, Mester has a Ph.D. in economics from Princeton.

We get a revision to Q1 GDP. Growth is expected at 1.3% SAAR vs. 1.6% previously, with personal consumption expected to be marked down to 2.2% vs. 2.5% previously. Of course, this is old news as markets are already looking ahead to Q2 and Q3. Weekly claims, April advance goods balance, wholesale/retail inventories, and pending home sales will also be reported today.

Q2 growth remains robust. The Atlanta Fed’s GDPNow model estimates Q2 growth at 3.5% SAAR and the next update comes tomorrow after the data. Elsewhere, the New York Fed's Nowcast model estimates Q2 growth at 2.0% SAAR and the next update also comes tomorrow. Looking ahead, its first Q3 estimate comes out in early June.

EUROPE/MIDDLE EAST/AFRICA

Eurozone May CPI data continue to roll out. Spain‘s EU Harmonised inflation came in a tick higher than expected at 3.8% y/y vs. 3.4% in April. Yesterday, Germany’s EU Harmonised inflation came in a tick higher than expected at 2.8% y/y vs. 2.4% in April. France and Italy report tomorrow, and their EU Harmonised inflation readings are expected at 2.6% y/y and 0.7% y/y, respectively. Eurozone-wide CPI will also be reported tomorrow. Headline is expected to pick up a tick to 2.5% y/y while core is expected to remain steady at 2.7% y/y. We see some upside risks after the German and Spanish readings but believe that the June cut remains on track. Of note, Spain is one of the few eurozone countries to report core inflation, which came in as expected at 3.0% y/y vs. 2.9% in April.

Switzerland reported firm Q1 GDP data. Growth came in ticks higher than expected at 0.5% q/q vs. 0.3% in Q4, while the y/y rate came in at 0.6% vs. a revised 0.5% (was 0.6%) in Q4. Adjusted for sporting events, the economy grew 0.3% q/q in Q1. Private consumption and investment in equipment grew solidly, while net exports subtracted from growth. The KOF Economic Barometer points to soft growth ahead as the index fell in May towards its medium-term average level of 100. The swaps market sees 40% odds of another rate cut in June, while we believe the SNB has scope to cut rates then with core CPI at just 1.2% y/y in April.

South African Reserve Bank is expected to keep rates steady at 8.25%. At the last meeting March 27, the bank kept rates steady at 8.25% and Governor Kganyago said “Given extra inflation pressure, headline now reaches the target midpoint only at the end of 2025, later than previously expected. As a result, the policy rate in our baseline forecast also starts normalizing later.” Since then, inflation has slowed modestly to 5.2% y/y in April but remains near the top of the 3-6% target range. The market sees steady rates over the next six months followed by the start of an easing cycle over the subsequent six months. However, we believe much will depend on the uncertain political outlook.

Early projections suggest the ANC has lost its majority in parliament. The Council for Scientific and Industrial Research estimates that the ruling ANC only won 42% of the vote, down 15.5 ppt from the last election in 2019. Main opposition party Democratic Alliance is forecast to win 22.3%, while the Economic Freedom Fighters are seen winning 9%. Former President Zuma’s new breakaway uMkhonto weSizwe Party appears to have siphoned off votes from the ANC, as it is projected to win 12.8% of the vote. Of note, the President is chosen by the National Assembly, with only a simple majority (201) needed to win. The ANC will have to rely on a coalition partner for the first time and the uncertainty is hitting the rand.

ASIA

Australia business investment remains an important growth tailwind. Private capital expenditure (capex) 1.0% q/q in Q1 vs. 0.7% expected and a revised 0.9% (was 0.8%) in Q4. Capex was driven by non-mining industries. Moreover, expectations of planned capex for FY2023/24 and FY2024/25 were revised higher compared to three months ago. Q1 GDP data will be reported next Wednesday, and the strong capex reading suggests some upside risks to the expected 0.2% q/q growth.

AUD is tracking iron ore prices lower. Iron ore futures on the Dalian and SGX exchanges plunged to a two-week low on lower demand prospects from China. China’s State Council announced that it aims to cut the country’s energy consumption and carbon dioxide emissions per unit of GDP by about 2.5% and 3.9% in 2024, respectively.

New Zealand’s new government announced a package of tax cuts in its first budget. Finance Minister Willis said the tax package is worth NZD14.7 bln ($9 bln) over four years and targets low and middle-income households. For the most part, the package matched the campaign promises. However, the Treasury now projects the budget deficit to widen to -NZD13.4 bln in FY25 next year vs. -NZD6.1 bln seen in December. The budget is not seen returning to surplus until FY28, a year later than what was forecast in December. Looser fiscal policy suggests the RBNZ will be more reluctant to cut rates. Indeed, the market now sees only 75% of the first cut in November.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.