• The relative story continues to push the dollar higher; Fed officials continue to sound cautious about cutting rates; financial conditions loosened last week after the Fed's dovish hold; Q2 growth remains robust; BOC releases its FSR; Mexico is expected to keep rates steady at 11.0%; Peru is expected to cut rates 25 bp to 5.75%; Brazil cut rates 25 bp to 10.5%, as expected
  
• ECB hawks continue to urge caution; BOE meeting ends shortly with a decision; Governor Bailey’s press conference will be key; BOE also releases its April DMP inflation survey; Poland is expected to keep rates steady at 5.75%
  
• BOJ released its Summary of Opinions for its April meeting; Japan reported weak March cash earnings data; China reported April trade data; Malaysia kept rates steady at 3.0%, as expected

The dollar recovery continues. DXY is trading higher for the third straight day near 105.639 and has retraced over half of this month’s drop. Break above the key retracement objective near 105.738 would set up a test of the May 1 high near 106.49. GBP is trading flat near $1.25 ahead of the BOE decision (see below), while the euro is trading lower near $1.0735. USD/JPY is trading higher near 156 despite hawkish BOJ summary of opinions and Ueda comments (see below). We believe the backdrop of persistent inflation and robust growth in the U.S. remains in place, which the data next week is expected to underscore. Meanwhile, developments in the rest of the world underscore the relative economic outperformance of the U.S. and are helping the dollar to recover.

AMERICAS

The relative story continues to push the dollar higher. Given the absence of any topline U.S. economic data, we chalk these gains up to developments in the rest of the world. With FX, it’s always about the relative story and here, other central banks have so far shown an unwillingness to be as hawkish as the Fed. First, the RBA delivered a neutral hold. Then, the Riksbank delivered a 25 bp cut, becoming the second major central bank to cut rates (after Switzerland). Who’s next? The BOE decision is due out shortly and market are positioned for a dovish hold. In EM, Brazil cut rates yesterday and Peru is expected to cut today. Despite the Fed’s dovish hold last week, it seems monetary policy divergences will continue to favor the dollar.

Fed officials continue to sound cautious about cutting rates. Collins said “The recent upward surprises to activity and inflation suggest the likely need to keep policy at its current level until we have greater confidence that inflation is moving sustainably toward 2%. The recent data lead me to believe this will take more time than previously thought.” Odds of a June cut remain steady at around 10%, but July odds are around 33% vs. 40% at the start of this week. September odds are around 85% vs. 90% at the start of this week, while a November cut remains fully priced in. Daly speaks today.

As one would expect, financial conditions loosened last week after the Fed's dovish hold. Due to revisions, conditions have loosened two straight weeks after four straight weeks of modest tightening. Indeed, these past two weeks have totally unwound the previous four weeks of tightening and so the Fed once again is at odds with itself. The Fed needs to let the market do the tightening for it, but this won't happen if Powell continues to send a dovish message.

No wonder Q2 growth remains robust. The Atlanta Fed’s GDPNow model is tracking Q2 growth at 4.2% SAAR and will be updated next Wednesday after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q2 growth at 2.2% SAAR and will be updated tomorrow. Its initial read for Q3 growth will be released in early June.

Bank of Canada releases its Financial System Review. Last year’s FSR pointed out that indicators of financial stress among households remain low but are rising. We suspect the upcoming FSR will highlight increasing pockets of strains amongst households considering that interest rates are higher versus a year ago. If so, it would reinforce the case for a BOC rate cut in June,

Banco de Mexico is expected to keep rates steady at 11.0%. At the last meeting March 21, the bank started the easing cycle with a 25 bp cut to 11.0%. The vote was 4-1, with Espinosa dissenting in favor of steady rates. Ahead of the decision, Mexico reports April CPI. Headline is expected at 4.63% y/y s. 4.42% in March, while core is expected at 4.38% y/y vs. 4.55% in March. If so, headline would accelerate for the second straight month and move further above the 2-4% target range. The swaps market is pricing in 50 bp of easing over the next six months followed by another 75 bp over the subsequent six months.

Peru central bank is expected to cut rates 25 bp to 5.75%. A handful of analysts polled by Bloomberg look for steady rates. At the last meeting April 11, the bank delivered a dovish surprise and cut rates 25 bp to 6.00% vs. an expected hold. It said that “inflation is projected to continue its downward trend and gradually converge towards the center of the target range in the coming months.” Since then, April inflation came in lower than expected at 2.42% y/y vs. 3.05% in March. By moving back into the 1-3% target range, this gives the bank a green light to cut rates again today.

Brazil COPOM cut rates 25 bp to 10.5%, as expected. However, the growing divide became clear with the 5-4 vote, the first split since August. All four of Lula’s appointees dissented in favor of a larger 50 bp cut. Of note, the bank stressed that “The Committee stresses that a credible fiscal policy, committed to debt sustainability, contributes to the anchoring of inflation expectations and to the reduction in the risk premia of financial assets, therefore impacting monetary policy.” The market is pricing in one more 25 bp cut over the next three months that would see the policy rate bottom near 10.25%.

EUROPE/MIDDLE EAST/AFRICA

The ECB hawks continue to urge caution. Holzmann said a June cut was possible but added that “I see no reason at all for us to cut key rates too much too quickly. Every step we take is dependent on the data available at that time. We will have a lot of new data and forecasts in September and December. However, that’s hardly the case in July.” Wunsch said “Significant risks remain around the trajectory of wage growth and inflation in wage-intensive services. Now is not the time to commit to a preset course of action.” He added that “one known unknown remains the role of the exchange rate and the risk of importing inflation.” The market is pricing in cuts in June, September, and December. Vujcic, Cipollone, and Guindos speak today.

Bank of England meeting ends shortly with a decision. The bank is widely expected to leave the policy rate at 5.25%. Markets are positioned for a dovish BOE policy guidance, as speculators have accumulated the most net short GBP futures positions since January 2023. The Monetary Policy Committee (MPC) vote split to keep rates on hold is expected to shift from 8-1 to 7-2, with Ramsden likely to join Dhingra in pressing for a rate cut. Last month, Ramsden emphasized he had “become more confident in the evidence that risks to persistence in domestic inflation pressures are receding” and that “the balance of domestic risks to the outlook for UK inflation is now tilted to the downside.” A dovish surprise would be if the vote favoring steady rates swings from 8-1 to 6-3. Recent comments by BOE Governor Bailey suggests the bar for him to support an immediate rate cut is low. According to Bailey the UK’s April inflation print “will show quite a strong drop” owing to the reduction in the energy price cap from April.

Governor Bailey’s press conference will be key. Recent comments by Bailey suggest the bar for him to support an immediate rate cut is low. According to Bailey the UK’s April inflation print “will show quite a strong drop” owing to the reduction in the energy price cap from April. When all is said and done, our base case is for the BOE to signal that the time for cutting the Bank Rate remains some way off, which would trigger a relief rally in GBP. Leading indicators point to a pickup in economic activity, while underlying inflation pressures (private sector regular pay growth and services CPI) are tracking higher than the BOE’s February projections. Chief Economist Pill speaks both today and tomorrow.

After the decision, the BOE releases its April Decision Maker Panel inflation survey. 1-year expectations are expected to fall a tick to 3.1%. However, both short- and medium-term expectations remain firmly above the 2% target, warranting cautious on the part of the BOE.

National Bank of Poland is expected to keep rates steady at 5.75%. At the last meeting April 4, the bank kept rates steady and said, “The Council judges that the current level of the NBP interest rates is conducive to meeting the NBP inflation target in the medium term.” In his post-meeting press conference, Governor Glapinski said no MPC members are talking about rate cuts in 2024. The market is pricing in 25 bp of rate cuts over the next three months, as inflation is running just under the 2.5% target. However, ongoing tension between the government and the central bank governor complicates the policy rate path projection.

ASIA

The Bank of Japan released its Summary of Opinions for its April meeting. Recall that the bank delivered a dovish hold at the April 25-26 meeting. Rate were kept steady but the BOJ’s updated macro forecasts remained consistent with a gradual and modest tightening cycle. That said, there seemed to be growing concern about its policy stance. One board member felt the rate path could be higher than what the market expects, while one was concerned about upside risks to the inflation outlook. One member felt a weak yen could lead to a rise in inflation, while one said the yen’s impact on inflation could speed up normalization of policy.

Governor Ueda warned again that a policy response might be needed if foreign exchange rates affect the inflation trend. Yet despite all of these hawkish signals, the market is still only pricing in around 50 bp of tightening over the next two years. Talk is cheap. We think the limits of jawboning (both on intervention and rate hikes) have been reached. If the BOJ really wants to put a floor under the yen, we think it would have to actually deliver rate hikes soon accompanied by FX intervention.

Japan reported weak March cash earnings data. Nominal earnings came in at 0.6% y/y vs. 1.4% expected and actual in February, while real earnings came in at -2.5% y/y vs. -1.4% expected and -1.8% in February. This was the weakest reading for real earnings since November and suggests very little in the way of wage pressures. The Bank of Japan is closely monitoring whether a virtuous cycle between wages and prices will intensify to gage the extent of its normalizing cycles. So far, low annual wage growth suggests the BOJ’s tightening process will be gradual.

China reported April trade data. Exports came in at 1.5% y/y vs. 1.3% expected and -7.5% in March, while imports came in at 8.4% y/y vs. 4.7% expected and -1.9% in March. While the recovery of both exports and imports from the March slump is welcome, we do not expect a robust export-led recovery in China. That is why it remains important to boost domestic consumption there.

Bank Negara Malaysia kept rates steady at 3.0%, as expected. The bank signaled that it is unlikely to shift to looser policy settings anytime soon despite low inflation of 1.8% y/y in March. First, it noted that “the latest indicators point towards higher economic activity in the first quarter of 2024.” Second, it forecast headline and core inflation to pick up over 2024 and average between 2.0-3.5% and 2.0-3.0%, respectively. Third, it warned “the ringgit currently does not reflect Malaysia's economic fundamentals and growth prospects.” The swaps market continues to price in steady rates over the next three years, with some risks of a rate hike over that time horizon.