Dollar Recovery Continues as Riksbank Cut Underscores Divergences

May 08, 2024

Win Thin

The dollar's resilience this week in the absence of any major data releases has been very surprising; Fed hawks are trying to push back; the neutral rate is worth discussing further; Brazil is expected to cut rates 25 bp to 10.50%
Eurozone countries reported soft March IP data; Riksbank cut rates 25 bp to 3.75%, as expected; Governor Thedeen sounded cautious
BOJ Governor Ueda tilted more hawkish; Finance Minister Suzuki continues to jawbone; Taiwan reported soft April trade data

The dollar recovery continues. DXY is trading higher near 105.503 after trading as low as 104.522 last week. It has retraced half of this month’s drop and a break above the next key retracement objective near 105.738 would set up a test of the May 1 high near 106.49. GBP is leading this move lower and tested the May 1 low near $1.2465 earlier today before recovering to $1.2490. The euro is trading flat near $1.0755. USD/JPY is trading higher near 155.35 despite Ueda comments (see below) as the impact of last week’s intervention fades. SEK is underperforming after the Riksbank started the easing cycle (see below). We believe the backdrop of persistent inflation and robust growth in the U.S. remains in place, which 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 dollar's resilience this week in the absence of any major data releases has been very surprising. Next week will be the true test, as we get April CPI, PPI, and retail sales data. We see upside risks to the data, which would certainly upset the current dovish Fed narrative. Indeed, there are already some cracks forming as Fed easing expectations have adjusted lower. Odds of a June cut remain steady at around 10%, but July odds are around 30% vs. 40% at the start of this week. September odds are around 80% vs. 90% at the start of this week, while a November cut remains fully priced in.

Fed hawks are trying to push back. Kashkari said, “The most likely scenario is we sit here for an extended period of time.” He noted that “If inflation starts to tick back down or we saw some marked weakening in the labor market then that might cause us to cut back on interest rates. Or if we get convinced eventually that inflation is embedded or entrenched now at 3% and that we need to go higher, we would do that if we needed to.” He stressed that "The bar to raising is quite high, but it is not infinite." Jefferson, Collins, and Cook speak today.

Kashkari also published an article on the Minneapolis Fed website. In it, he questioned whether Fed policy was restrictive given recent inflation data. Kashkari also noted that resilience in the housing data raises questions about the level of neutral rate, adding that he raised his estimate “modestly” to 2.5% vs. 2.0% previously. Kashkari's hawkish tone is not a big surprise but no matter what the hawks may say, they cannot erase the dovish narrative that Powell put forth last week.

The neutral rate is worth discussing further. Recall that in the March Dot Plots, the median for the long-term rate (a proxy for r*) rose to 2.562% vs. 2.5% previously. That median didn’t fully reflect the widening range of views: 1 Fed official saw r* at 2.375%, 8 saw 2.5%, 1 saw 2.625%, 1 saw 2.75%, 3 saw 3.0%, 1 saw 3.125%, 2 saw 3.5%, and 1 saw 3.75%. Back in March 2022, when the Fed started hiking, 1 Fed official saw r* at 2.0%, 6 saw 2.25%, 1 saw 2.375%, 5 saw 2.5%, and 2 saw 3.0% for a median of 2.375%. The longer the U.S. economy remains resilient, the more we expect the median r* to continue edging higher in future Dot Plots.

In related news, financial conditions remain quite loose. The Chicago Fed’s weekly measure will be reported today. Conditions likely loosened last week after the Fed’s dovish hold, as yields fell, equities rallied, and the dollar weakened. Before that, conditions had tightened five straight weeks, albeit modestly.

Q2 growth remains robust. The Atlanta Fed’s GDPNow model is tracking Q2 growth at 3.3% SAAR and will be updated today after the data. Wholesale trade sales and inventories are expected at 0.8% m/m and -0.4% m/m, respectively. Elsewhere, the New York Fed’s Nowcast model is tracking 2.2% SAAR and will be updated Friday. Its initial read for Q3 growth will be released in early June.

Brazil COPOM is expected to cut rates 25 bp to 10.50%. However, a third of the 33 analysts polled by Bloomberg look for a larger 50 bp move. At the last meeting March 20, it cut rates 50 bp to 10.75% and said, “the Committee members unanimously decided to communicate that, if the scenario evolves as expected, they anticipate a reduction of the same magnitude in the next meeting.” While recent BRL weakness should keep the central bank cautious, there are risks of a dovish surprise since Lula has stacked the bank with doves. The swaps market is pricing in a terminal rate of 10.25% over the next three months. April IPCA inflation will be reported Friday. Headline is expected at 3.66% y/y vs. 3.93% in March. If so, it would be the lowest since June 2023 and further within the 1.5-4.5% target range.

EUROPE/MIDDLE EAST/AFRICA

Eurozone countries reported soft March IP data. Germany and Spain reported today. German IP came in at -0.4% m/m vs. -0.7% expected and a revised 1.7% (was 2.1%) in February, while the y/y rate came in at -3.3% vs. -3.6% expected and a revised -5.3% (was -4.9%) in February. Spanish IP came in at -0.7% m/m vs. 0.7% in February, while the y/y rate came in at -1.2% vs. a revised 1.3% (was 1.5%) in February. Italy reports IP Friday and is expected at 0.3% m/m vs. 0.1% in February. Eurozone IP will be reported May 15.

Riksbank cut rates 25 bp to 3.75%, as expected. It justified the cut by noting that inflation is approaching the 2% target while economic activity is weak. Updated macro forecasts won’t be published until the June 20 meeting. However, the Riksbank underscored its dovish forward guidance by saying that “If this outlook still holds, the policy rate could be cut two more times during the second half of the year, in line with the March forecast.” However, the bank noted that “The risks that may cause inflation in Sweden to rise again are primarily linked to the strong US economy, the geopolitical tension and the krona exchange rate. The adjustment of monetary policy going forward should therefore be characterized by caution, with gradual cuts to the policy rate.”

Governor Thedeen sounded cautious. He said a June cut is unlikely under current circumstances, adding that SEK weakening is a concern that must be factored in. The market is pricing in 50 bp of rate cuts over the next six months followed by another 25 bp over the subsequent six months. SEK is underperforming across the board and monetary policy divergences between the Riksbank and the Fed should keep SEK under downside pressure in the next few months.

ASIA

Bank of Japan Governor Ueda tilted more hawkish. He warned there is a risk the weak yen could affect underlying inflation but added that so far that’s not the case. Ueda stressed that it would be appropriate to hike rates at a faster pace if upside risks to the inflation outlook rise. Despite these comments, the swaps market is still only pricing around 50 bp of tightening over the next two years. Until the monetary policy divergences with the Fed narrow, we expect the yen to continue weakening.

Meanwhile, Japan’s Finance Minister Suzuki continues to jawbone. He expressed strong concerns over the weak yen impact on prices and reiterated readiness to “take actions against excessive FX moves.” The Ministry of Finance (MOF) likely gave the green light for intervention on April 29 and May 1 and data that would disclose action is due out at end of May. USD/JPY continues to edge higher. The pair has now retraced nearly half of the intervention-induced drop from 160.15 to 151.85. Key retracement objectives ahead come in near 156 (50%) and 157 (62%).

Taiwan reported soft April trade data. Exports came in at 4.3% y/y vs. 9.9% expected and 18.9% in March, while imports came in at 6.6% y/y vs. 7.7% expected and 7.1% in March. Exports to the U.S. jumped 81.6% y/y, while exports to China slumped -1.1% y/y. That mix tells us a lot about where global growth is being generated.

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