Dollar Recovers as U.S. Yields Rise

May 29, 2024

Win Thin

Rising U.S. yields are lending the dollar some support; Fed officials remain cautious; Fed releases its Beige Book report; Conference Board consumer confidence rose sharply in May; Banco de Mexico releases its quarterly inflation report
Eurozone starts reporting May CPI data; most ECB officials remain wary of cutting rates too quickly; eurozone retail sales data for April continue to roll out; South Africa elections are being held today
BOJ board member Adachi reiterated the bank’s cautious policy guidance; Australia April CPI ran hot; New Zealand reported a soft May ANZ business survey

The dollar is staging a modest recovery on the back of rising U.S. yields. After trading as low as 104.335 yesterday, poor 2- and 5-year auctions (see below) led to higher yields and helped DXY recover to trade near 104.732 today. The euro is trading lower near $1.0840 while sterling is trading lower near $1.2745. USD/JPY is trading flat near 157.25 despite dovish BOJ comments (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

Rising U.S. yields are lending the dollar some support. Weak demand for 2- and 5-year UST auctions yesterday suggests supply may be becoming an issue for the market. Hawkish comments from the Fed added to the selloff, as did the stronger than expected Conference Board consumer confidence reading for May. The 2-year yield flirted with the 5% area yesterday but has since retreated a bit, while the 10-year yield continues to edge higher to trade near 4.60%. Today, Treasury will auction $28 bln in 2-year floating rate notes and $44 bln in 7-year notes.

Fed officials remain cautious. Yesterday, Kashkari said “I don’t think anybody has totally taken rate increases off the table. I think the odds of us raising rates are quite low, but I don’t want to take anything off the table.” He noted that “Wage growth is still quite robust relative to ultimately what we think would be consistent with the 2% inflation target.” While this is nothing new from the noted Fed hawk, his comments added to the negative UST sentiment already in play. Williams and Bostic speak today. Of note, the market sees less than 75% odds of a November cut, which is right at the pre-May 1 FOMC lows.

Fed releases its Beige Book report. The April 17 Fed Beige Book pointed to a healthy U.S. economic backdrop but suggested that firms’ ability to pass cost increases on to consumers had weakened considerably. Since then, inflation has proven to be sticky even as some signs of softening have been seen in the labor market and consumption. We expect a balanced tone in this report that will allow the Fed to take a wait and see approach with regards to easing.

Conference Board consumer confidence rose sharply in May. Headline rose to 102.0 vs. 96.0 expected and a revised 97.5 (was 97.0) in April. This was the first rise since January and almost reverses last month's drop. Both present situation and expectations rose sharply from April. Conference Board chief economist Peterson said, “According to May’s write-in responses, consumers cited prices, especially for food and groceries, as having the greatest impact on their view of the US economy.” Last week, final University of Michigan consumer sentiment posted an unexpected bounce to 69.1 v. 67.4 preliminary. Rebounding consumer confidence measures support our view that consumption can continue to hold up.

Regional Fed surveys for May will wrap up today. Richmond Fed manufacturing and services will both be reported, along with Dallas Fed services. Yesterday, Dallas Fed manufacturing came in at -19.4 vs. -12.1 expected and -14.5 in April. May Chicago PMI will be reported Friday and is expected at 41.1 vs. 37.9 in April.

Banco de Mexico releases its quarterly inflation report. At its last policy meeting May 9, the bank left rates unchanged at 11.0% and raised its inflation forecasts. It saw end-2024 inflation at 4.0% vs. 3.6% previously and end-2025 at 3.0% vs. 3.1% previously. Since that meeting, inflation picked up in mid-May and so we expect this inflation report to maintain a hawkish tone. Next meeting is June 27, and the decision will depend on how inflation behaves in the coming weeks. The swaps market is pricing in 50 bp of easing over the next six months followed by another 50 bp over the subsequent six months.

EUROPE/MIDDLE EAST/AFRICA

Eurozone starts reporting May CPI data. Germany reports shortly and its EU Harmonised inflation is expected to pick up three ticks to 2.7% y/y. German state data reported earlier today point to modest downside risks to the national reading. Spain reports tomorrow and its EU Harmonised inflation is expected to pick up three ticks to 3.7% y/y. Spain is one of the few eurozone countries to report core inflation and it is expected to rise a tick to 3.0% y/y. France and Italy report Friday 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 Friday. 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. Eurozone disinflation is well on track and supports the case for the ECB to begin easing in June.

Most ECB officials remain wary of cutting rates too quickly. Kazaks warned that the bank shouldn’t switch to “autopilot” in terms of easing after the widely expected start of the cycle in June. Knot said that “policy rates will slowly but gradually move to less restrictive levels” but added that “the precise timing, speed and scale of easing” will remain data dependent. Villeroy speaks today.

Eurozone retail sales data for April continue to roll out. Spain retail sales came in at 0.3% y/y vs. a revised 0.9% (was 0.6%) in March. On Monday, France reported retail sales at 0.0% y/y vs. a revised 0.9% (was 0.3%) in March. Germany reports Friday and there are upside risks after German GfK consumer confidence came in today at -20.9 vs.-22.5 expected and a revised -24.0 (was -24.2) in May. Overall, the recent data support our view that the eurozone recovery will be shallow, which is no surprise since the downturn was also shallow.

South Africa elections are being held today. The results are expected to be announced three days after voting ends. Polls show the ruling African National Congress (ANC) is projected to lose its absolute majority for the first time since the end of apartheid but will probably win enough support to lead a coalition government with other parties. Over the long term, the trend in ZAR will be guided by how the next government tackles rising unemployment, stagnant growth, rampant corruption, and deteriorating public infrastructure.

ASIA

Bank of Japan board member Adachi reiterated the bank’s cautious policy guidance. Adachi warned that “we need to absolutely avoid premature rate increases, which could throw cold water on a chance for the Japanese economy to recover.” However, Adachi added that “A monetary policy response would be one option if the impact on the achievement of the price stability target is predicted in the event that prolonged excessive yen weakness is affecting inflation.” In our view, the BOJ is unlikely to tighten more aggressively than what is currently priced in since underlying inflation is in a firm downtrend. The swaps market sees 40 bp of tightening over the next year, followed by another 20 bp over the subsequent year and another 15 bp over the following year. This means Japan real yields will remain negative and should be a drag on JPY.

Australia April CPI ran hot. Headline came in at 3.6% y/y vs. 3.4% expected and 3.5% in March. This was the second straight month of acceleration to the highest since November and moves further above the 2-3% target range. Core inflation remains sticky above 4%. CPI excluding volatile items and holiday travel was steady at 4.1% y/y while trimmed mean CPI came in at 4.1% y/y vs. 4.0% in March. The hot CPI print suggests the RBA will not be in a rush to loosen policy.

New Zealand reported a soft May ANZ business survey. The Own Activity Outlook index fell to a ten-month low of 11.8 vs. 14.3 in April and is consistent with weaker growth. Inflation indicators are easing, with Cost Expectations, Pricing Intensions, and Inflation Expectations all down near multi-year lows. Sticky domestic inflation is a major reason the RBNZ discussed the possibility of increasing the policy rate last week. However, the market thinks otherwise and sees over 65% odds of a cut in November that becomes more than fully priced in for February.

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