Dollar Soft Ahead of CPI Data

May 11, 2022

Market expectations for Fed tightening have cooled a bit; April U.S. CPI data takes center stage; the heavy slate of UST issuance continues; Brazil reports April IPCA inflation

ECB President Lagarde all but signed off on July liftoff; Brexit is back in the headlines; BOE tightening expectations have fallen; CZK is underperforming due to concerns about monetary policy

Market sentiment during the Asian session recovered as China’s virus numbers improved; China April CPI and PPI data were higher than expected; Malaysia delivered a hawkish surprise with a 25 bp hike to 2.0%The dollar is soft ahead of key CPI data.  

DXY is trading near 103.60 after failing again yesterday to break above 104.  We look for an eventual break above Monday’s cycle high near 104.187.  The euro remains stuck near $1.0550 despite Lagarde comments (see below) and we continue to target the January 2017 near $1.0340.  USD/JPY is back below 130 due to lack of any follow-through after setting a new cycle high Monday near 131.35.  We continue to target the January 2002 high near 135.15.  Sterling is steady near $1.2350 after it traded Monday at a new cycle low $1.2260.  With Brexit back in the headlines (see below), we look for a break below the June 2020 low near $1.2250, which would set up a test of the May 2020 low near $1.2075. With U.S. yields likely to rise again, the dollar should resume its climb after this period of consolidation.

AMERICAS

Market expectations for Fed tightening have cooled a bit.  The swaps market now sees a terminal Fed Funds rate of around 3.0%, down from 3.75% last week.  In turn, the 2-year UST yield has fallen to around 2.58% from a peak near 2.85% last week.  Bostic speaks today. Yesterday, Bostic said that he favors 50 bp hikes at the next 2-3 meetings but added that it’s important to monitor how the economy responds.  Last week, Barkin did his job and put 75 bp back on the table, adding that he want to hike rates “as fast as feasible.”  Yesterday, Mester echoed that message by saying “We don’t rule out 75 forever.  I don’t want to rule anything out. When we get to that point in the second half of the year, if we don’t have inflation moving down we may have to speed up.”  We expect other Fed officials to fall in line with this more hawkish stance this week.  

April U.S. CPI data takes center stage.   Headline is expected at 8.1% y/y vs. 8.5% in March, while core is expected at 6.0% y/y vs. 6.5% in March.  Keep an eye on the m/m gains to slow from 1.2% and 0.3% in March, respectively.  PPI will be reported tomorrow.  Headline is expected at 10.7% y/y vs. 11.2% in March, while core is expected at 8.9% y/y vs. 9.2% in March.  Here too, keep an eye on the m/m gains to slow from 1.4% and 1.0% in March, respectively.  That said, we note that most April CPI data from both DM and EM have been upside surprises.  While any improvement in the inflation numbers would be welcome, we are a long ways off from the 2% target for core PCE and so the data would do nothing to deter the Fed from hiking rates aggressively at the coming meetings.  

The heavy slate of UST issuance continues.  $36 bln of 10-year notes will be sold today.  At the last auction, indirect bidders took up 64.3%, the bid/cover ratio was 2.43, and the high yield was 2.72%.  Yesterday, $45 bln of 3-year notes saw strong demand.  Indirect bidders took up 62.0% vs. 53.4% at the previous auction, the bid/cover ratio was 2.59 vs. 2.48, and the high yield was 2.809% vs. 2.738%.  $22 bln of 30-year bonds will be sold tomorrow.  April budget statement will come out today.  

Brazil reports April IPCA inflation.  Headline is expected at 12.07% y/y vs. 11.30% in March.  If so, it would be the highest since October 2003 and further above the 2-5% target range.  COPOM just delivered the expected 100 bp hike to 12.75% last week and signaled a smaller hike at the next policy meeting June 15.  The swaps market is pricing in another 100 bp of tightening over the next 6 months that would see the policy rate peak near 13.75%. 

EUROPE/MIDDLE EAST/AFRICA

ECB President all but signed off on July liftoff.  She said “The first rate hike, informed by the ECB’s forward guidance on the interest rates, will take place some time after the end of net asset purchases.  We have not yet precisely defined the notion of ‘some time,’ but I have been very clear that this could mean a period of only a few weeks.”  She has been cagey in the past about what some time really means but it has now become clear that the ECB is likely to announce an end to QE June 15 and then hike rates July 27.  Yet the swaps market is now pricing in only 140 bp of tightening over the next 12 months followed by another 50 bp of tightening priced in over the following 12 months that would see the deposit rate peak near 1.50% vs. 1.75% at the start of this week.   Nagel, Lagarde, Vasle, Knot, Centeno, Buch, Muller, and Schnabel all speak today and most are likely to fall in line with July liftoff.  Brexit is back in the headlines.   

U.K. officials are once again threatening unilateral action in Northern Ireland.  Foreign Secretary Truss, who become chief Brexit negotiator after Frost resigned last year, warned that the government “will not shy away from taking action to stabilize the situation in Northern Ireland if solutions cannot be found.”  Reports suggest Truss has drafted legislation to enable the U.K. to scrap large parts of the Brexit deal unilaterally, which would remove the need for checks on goods being sent from Britain to Northern Ireland and allow the U.K. to disregard EU rules.  Top EU Brexit negotiator Sefcovic warned that “renegotiation is not an option” but he and Truss are set to meet again Thursday.   The U.K. continues to play a weak hand badly, as a trade war with the EU couldn’t come at a worse time with the economy already sliding towards recession.  We suspect the EU will call the bluff and is yet another reason to remain negative on sterling.

Bank of England tightening expectations have fallen.  While WIRP suggests another 25 bp hike is priced in for the next meeting June 16, the swaps market is now only pricing in 125 bp of total tightening over the next 12 months that would see the policy rate peak near 2.25% vs. 2.50% at the start of the week.  The monthly data dump begins tomorrow, with most indicators expected to show a continued loss of momentum as Q1 ended.

The koruna is underperforming due to concerns about Czech monetary policy.  As reported earlier this week, Czech President Zeman did indeed name current broad member Alex Michl to be the next Governor of the Czech National Bank.  Michl is considered one of the most dovish at the bank and has voted against every one of the bank’s hikes during the current tightening cycle.  Other reports suggest Zeman will also appoint more doves to upcoming vacancies on the board.  Governor Rusnok will chair only the next meeting June 22 before his term ends in July.  Michl confirmed that he will propose keeping rates steady at his first meeting in August, which underscores the notion that the markets are right to be concerned about his appointment.  

ASIA

Market sentiment during the Asian session recovered as China’s virus numbers improved.  Shanghai reported a 51% drop in new infections Tuesday, with zero cases from community spread.  Officials have said that three days of no community transmission are needed before movement restriction are lifted.  For now, it appears that the draconian containment measures of COVID Zero are working in Shanghai.  In Beijing, community spread continues despite strict work from home orders as well as a ban on dining at restaurants.  Stay tuned.  

China April CPI and PPI data were higher than expected.  CPI came in at 2.1% y/y vs. 1.9% expected and 1.4% in March, while PPI came in at 8.0% y/y vs. 7.8% expected and 8.3% in March.  Headline inflation is the highest since November but still well below the 3% target for this year.  At this point, policymakers are focused on boosting growth, not fighting inflation.   However, despite pledges to stimulate the economy, the measures announced so far have been minimal.  PBOC will set its 1-yaer MLF rate sometime over the next week and consensus sees a 5 bp cut to 2.80%.  A handful look for 10-15 bp cuts but even then, the moves would still be modest. 

Bank Negara Malaysia delivered a hawkish surprise with a 25 bp hike to 2.0%.  It noted that “Inflationary pressures have increased sharply due to a rise in commodity prices, strained supply chains and strong demand conditions, particularly in the US.”  The bank added that growth is on firmer footing, driven by both stronger domestic demand amid sustained export growth.  CPI rose 2.2% y/y in March and has been decelerating steadily from the 3.3% peak in November.  While the central bank does not have an explicit inflation target, falling price pressures led most (including us) to believe it would remain on hold until the July 6 meeting, especially given the growth risks coming from the mainland China slowdown. That said, we do not expect an aggressive tightening cycle ahead and a hike in July will depend in large part how the economy is faring.

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