Dollar Soft Ahead of Retail Sales Data

April 15, 2024

Win Thin

A semblance of calm has returned to the markets; Fed easing expectations continue to adjust; highlight will be March retail sales; Q1 growth remains robust
ECB officials continue to stake out their positions; eurozone reported February IP; Israel reports March CPI
Reports suggest the BOJ may put less emphasis on inflation when setting policy; Japan reported February core machine orders; RBNZ released an updated research report on its estimates of r*; PBOC kept its key 1-year MLF rate steady at 2.50%, as expected

The dollar is trading softer ahead of retail sales data. DXY is trading lower near 105.91 after trading Friday at a new cycle near 106.109. it is on track to test the November 1 high near 107.113. The euro is trading higher near $1.0655 but the clean break below $1.0755 sets up a test of the November 1 low near $1.0515. Elsewhere, sterling is trading higher near $1.2490. USD/JPY traded at a new cycle high near 154 on dovish BOJ reports (see below) but the upside has been slowed by continued jawboning and intervention concerns. The dollar rally should continue as data confirm persistent inflation and robust growth in the U.S. The U.S. data continue to come in mostly firmer and should keep upward pressure on U.S. yields. We believe that while market easing expectations have adjusted violently after CPI, there is still room to go. When the market finally capitulates on the Fed, the dollar should gain further.

AMERICAS

A semblance of calm has returned to the markets. Reaction has so far been muted following Iran’s missile strikes on Israel over the weekend. With limited damage inflicted, markets are signaling that Israeli retaliation is the likely path forward and that the regional conflict will not widen. Crude oil prices are lower on the day, gold is trading modestly higher, equity markets are rising, and U.S. Treasury yields are up. The yen, Swiss franc, and the dollar are all underperforming today as the safe haven bid evaporates. However, the greenback still supported by a hawkish Fed and so the rally should continue as interest rate differentials continue to move in its favor.

Fed easing expectations continue to adjust. Odds of a June cut have fallen to 25% vs. 60% last week, while odds of a July cut have fallen below 60% vs. fully priced in last week. The market now sees the first cut coming in September and only 75% odds that we get a second cut in December. After some softening in tone ahead of the CPI data, Fed officials rightfully turned more cautious. Logan, Williams, and Daly speak today. Yields at the short end of the U.S. curve continue to rise on revised Fed expectation, while yields at the long end continue to rise on elevated inflation risks. This rise was interrupted Friday by some safe haven bid stemming from Iran-Israel tensions. However, both ends have resumed rising and should give further fuel to the dollar rally.

Highlight will be March retail sales. Headline is expected at 0.4% m/m vs. 0.6% in February, while ex-autos is expected at 0.5% m/m vs. 0.3% in February. The so-called control group used for GDP calculations is expected at 0.4% m/m vs. 0.0% in February. Overall, consumer spending remains resilient, supported by robust demand for labor and positive real wage growth.

Q1 growth remains robust. Official data will be out next week with consensus currently at 2.0% SAAR. The New York Fed’s Nowcast model is tracking Q1 growth at 2.2% SAAR and Q2 growth at 2.6% SAAR and is updated every Friday. Elsewhere, the Atlanta Fed’s GDPNow model is tracking Q1 growth at 2.4% SAAR and will be updated Monday after the data. We think this all boils down to the U.S. labor market. As long as jobs are being created, both consumption and growth will remain strong, and firms will be able to pass on higher costs to consumers. When all is said and done, we suspect the Fed will discover that disinflation will stall out without significant weakening of the labor market. Stay tuned.

Housing data will be closely watched. April NAHB housing market index will be reported today and is expected to remain steady at 51. March building permits and housing starts will be reported tomorrow and are expected at -0.9% m/m and -2.6% m/m, respectively. March existing home sales will be reported Thursday and are expected at -4.1% m/m vs. 9.5% in February.

Regional Fed surveys for April start rolling out. Empire manufacturing survey kicks things off today and is expected at -5.0 vs. -20.9 in March. New York Fed services index will be reported tomorrow. Philly Fed manufacturing index will be reported Thursday and is expected at 2.3 vs. 3.2 in March. February IP will also be reported tomorrow and is expected at 0.4% m/m vs. 0.1% in January.

EUROPE/MIDDLE EAST/AFRICA

ECB officials continue to stake out their positions. Simkus said today that “I see a higher than 50% chance there will be more than three cuts this year. I see a higher than zero chance that an interest rate cut may follow also in July. The July decision will be important in setting the trajectory.” This view is very close to current market pricing, which sees three cuts along with nearly 40% odds of a fourth one. Reports suggest the doves are trying to set the table for back-to-back cuts in June and July. We expect the hawks and the doves to continue battling for control of the narrative. Chief Economist Lane and de Cos speak later today.

Eurozone reported February IP. It came in as expected at 0.8% m/m vs. a revised -3.0% (was -3.2%) in January. However, the y/y came in at -6.4% vs. -5.5% expected and a revised -6.6% (was -6.7%) in January. The recovery remains spotty.

Israel reports March CPI. Headline is expected to rise a tick to 2.6% y/y. If so, it would be the first acceleration since August but would still remain within the 1-3% target range. The Bank of Israel last week left rates steady at 4.5%. It sees the policy rate at 3.75% in Q1 2025, which is lower than market pricing for a terminal rate between 4.0-4.25%. Next meeting is May 27, and no change is expected then. Uncertainty is running high after Iran’s weekend missile attack. Much will depend on whether Israel retaliates.

ASIA

Reports suggest the Bank of Japan may put less emphasis on inflation when setting policy. This comes after reports last week that the bank is likely to raise its core inflation forecast for FY24. If true, this could imply greater tolerance for inflation overshoot of the 2% target, limit scope for BOJ tightening and further weigh on JPY. Indeed, USD/JPY is breaking higher. The pair traded at a new cycle high just below 154.00. The uptrend is intact because we anticipate a gradual BOJ tightening process. The market continues to price in only around 50 bp of tightening over the next three years. Until these expectations shift, monetary policy divergences with the Fed will likely keep upward pressure on USD/JPY. However, ongoing threat of intervention should cushion the yen’s slide. Finance Minister Suzuki warned again that he’s watching FX moves closely.

Japan reported February core machine orders. Orders came in at -1.8% y/y vs. -6.0% expected and -10.9% in January. This was the strongest since December and complements the improvement in machine tool orders.

The RBNZ released an updated research report on its estimates of r*. According to the study, the long-term (10 years or more) nominal neutral rate is around 2.5% (unchanged from past estimates). The short-term (1-2 years) nominal neutral rate is higher at around 3.9%. With the Official Cash Rate at 5.5%, monetary policy is tight and weighing on economic activity. Indeed, New Zealand’s services PMI fell to a 47.5 in March, the lowest since January 2002 and indicative of a contraction in the service sector. The market is pricing the first rate cut in October with 75% odds of a second cut in November.

People’s Bank of China kept its key 1-year MLF rate steady at 2.50%, as expected. However, it drained liquidity for the second straight month, this time to the tune of a net CNY70 bln. This suggests the bank will remain cautious about easing even though the big batch of data tomorrow is likely to show that the recovery remains spotty.

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