Dollar Soft Ahead of Retail Sales Data

May 16, 2023

Win Thin

The debt ceiling drama continues ahead of a planned meeting today; Fed officials continue to beat the hawkish drum; the data highlight will be April retail sales; Canada reports April CPI
Germany ZEW survey for May came in soft; the U.K. reported mixed labor market data
RBA released the minutes of its May 2 meeting; China reported soft April IP and retail sales

The dollar is trading soft ahead of retail sales data. DXY is trading lower for the second straight day near 102.27 after the recent rally took it as high as 102.75 yesterday. We believe it is on track to eventually test of the early April high near 103.058. The euro is trading higher near $1.09 but we believe it remains on track to test the April 10 low near $1.0830. Sterling is trading slightly higher near $1.2535 but we believe it remains on track to test the May 2 low near $1.2435. USD/JPY rally ran out of steam near 136.30 yesterday and is trading near 135.85 today. We look for continued gains and a clean break above 136.15 is needed to set up a test of the May 2 high near 137.75. Banking sector concerns and dovish market pricing for Fed policy have been the two major negative headwinds on the dollar. While regional bank stocks remain vulnerable, the recent data suggest low risks of systemic problems and so we believe the dollar has likely put in a near-term bottom. However, we need significant repricing of Fed policy in order to see the next big leg higher for the greenback.

AMERICAS

The debt ceiling drama continues ahead of a planned meeting today. House Speaker McCarthy said “We are nowhere near reaching a conclusion,” adding that ongoing staff negotiations are “not productive at all.” This is a different tone from earlier reports suggest that the delayed high level talks were due to progress at the staff level. Treasury Secretary Yellen warned that “time is running out” while McCarthy said “We only have so many days left to deal with this.”

Fed officials continue to beat the hawkish drum. Yesterday, Kashkari warned that “The labor market is still hot, and we have not seen much softening in the labor market. So, that tells me that we have a long way to go before we get inflation back down.” He added “We at the Federal Reserve probably have more work to do on our end to try to bring inflation back down. Most importantly, we should not be fooled by a few months of positive data. We are still well in excess of our 2% inflation target, and we need to finish the job.” Yet Fed easing expectations continue to run high. At the start of last week, the swaps market was pricing in a Fed Funds range between 4.0-4.25% in 12 months. Now, it's seen around 3.75% in 12 months with three cuts still priced in by year-end. Fed officials are likely to continue pushing back against this dovish take. Mester, Barr, Williams, Logan, Goolsbee, and Bostic all speak today.

The data highlight will be April retail sales. Headline is expected at 0.8% m/m vs. a revised -0.6% (was -1.0%) in March, while ex-autos is expected at 0.4% m/m vs. a revised -0.4% (was -0.8%) in March. The so-called control group used for GDP calculations is expected at 0.3% m/m vs. -0.3% in March. In late April, the Census Bureau reported its annual revisions to the retail sales data. The Atlanta Fed’s GDPNow model is currently tracking 2.7% SAAR growth for Q2, steady from the previous reading and up from the initial 1.7% reading and 1.1% in Q1. Next model update comes today after the data. Bloomberg consensus currently sees Q2 at 0.1% SAAR and Q3 at -0.6% SAAR.

Regional Fed surveys for May will continue rolling out. New York Fed services index will be reported. Yesterday, Empire manufacturing survey came in very weak at -31.8 vs. -3.9 expected and 10.8 in April. April IP will also be reported today and is expected flat m/m vs. 0.4% in March. The manufacturing is slowing but that is a global phenomenon, as services sector strength is proving to underpin growth all around the world. NAHB housing index and March business inventories will also be reported today.

Canada reports April CPI. Headline is expected to fall two ticks to 4.1% y/y, while both core trim and median are expected to fall three ticks to 4.1% and 4.3%, respectively. Bank of Canada expectations remain dovish. While it seems that the tightening cycle is over, we disagree with market expectations for a cut by year-end, though that is an improvement over the two that were priced in last week.

EUROPE/MIDDLE EAST/AFRICA

Germany ZEW survey for May came in soft. Expectations came at -10.7 vs. -5.0 expected and 4.1 in April, while current situation came in at -34.8 vs. -37.0 expected and -32.5 in April. The drop in the survey readings is not that surprising given recent weakness in the hard data. We cannot get excited about the eurozone outlook when its largest economy continues to struggle. Of course, China reopening has done little for the global economy.

ECB expectations have steadied. WIRP suggests a 25 bp hike is priced in for June 15 and about 60% for July 27. One last 25 bp hike is priced in for September 14 and so the market so far does not believe the hawks that are pushing for three straight hikes. The split between the hawks and the doves clearly remains in place but it feels like the doves have taken control of the narrative, at least for now. Stournaras said “We are close to the end, Whether it will be one more hike, two more hikes, I can’t say, that will depend on the forecasts for inflation, the forecasts for financial conditions in the euro zone.” Lagarde speaks later today.

The U.K. reported mixed labor market data. Unemployment was expected to remain steady but instead rose a tick to 3.9% for the three months ended in March and is the highest since January 2022. Average weekly earnings came in steady at 5.8% y/y while earnings ex-bonus picked up a tick to 6.7% y/y. Looking ahead, payrolled employees came in at -136k for April. This was the first drop since February 2021 and the largest one since May 2020, which suggests further softness ahead in the labor market.

Bank of England expectations have steadied. A 25 bp hike is nearly 75% priced in for June 22 and another 25 bp hike is about 75% priced in for September 21. Inflation remains stubbornly high and so the market now sees the terminal rate peaking between 4.75-5.0% vs. 5.0% at the start of this week and 4.75% before last week’s meeting.

ASIA

Reserve Bank of Australia released the minutes of its May 2 meeting. At that meeting , it delivered a hawkish surprise and hiked rates 25 bp to 3.85% vs. an expected hold. The minutes show that the bank discussed the case to pausing a second straight month but that “Members noted that, although this was consistent with the bank’s mandate and objectives, it left little room for upside risks to inflation given that inflation would have been above the target for around four years by that time.” In addition, “Members also agreed that further increases may still be required, but that this would depend on how the economy and inflation evolve.” The bank felt that strong April data supported the decision to hike, which really does mean that it’s now data dependent. Next meeting is June 6 and no change is expected then. WIRP suggests odds of another 25 bp hike top out around 40% for September 5, with an easing cycle now seen for early 2024 vs. late 2023 previously. We concur.

China reported soft April IP and retail sales. IP is came in at 5.6% y/y vs. 10.9% expected and 3.9% in March, while sales came in at 18.4% y/y vs. 21.9% expected and 10.6% in March. We called the reading soft despite the steep y/y increases because they are due largely to low base effects as the economy struggled under Covid Zero policies last year. Right now, China is facing deflation risks and weak growth that calls for more stimulus, but recent reports of an exploding debt/GDP ratio warrant some caution on the part of policymakers. For instance, property investment came in at -6.2% YTD, suggesting a reluctance to pump up that sector again. Either way, further yuan weakness is likely and the 7 level is key for USD/CNY. It is the 62% retracement objective of the November-January drop and a break above would set up a test of the November 1 high near 7.3275. There is also a gap from the reopening announcement near 7 as well.

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