The dollar remains under pressure despite the better than expected jobs report. DXY is trading lower near 98.919 as Friday’s gains are proving hard to sustain. At the root of our weaker dollar outlook lies in ongoing uncertainty regarding U.S. tariff and fiscal policies that is undermining confidence in the greenback. Eventually, that uncertainty will filter into the labor market (and beyond). The euro is trading higher near $1.1420. We expect a test and eventual break above the April high near $1.1575, which would set up a test of the late October 2021 high near $1.17. Sterling is trading higher near $1.3570 and is just below the new cycle high near $1.3615 set last week. We believe it is on track to test the January 2022 high near $1.3750. Elsewhere, USD/JPY is trading lower near 144.15 after testing and failing to break above the 145 level. For now, the 140-145 range seems safe. Inflation data and a heavy UST auction schedule this week will keep the market on its toes. Those auctions could get sloppy and put further pressure on the greenback. Stay tuned.
AMERICAS
The May jobs report suggests we will get another month of solid economic data. As we have noted throughout this economic cycle, the labor market remains key. As long as jobs are being created, incomes rise and consumption will continue to drive economic growth. This has been seen in retail sales and personal spending data through April. May retail sales will be reported next Tuesday. There will be headwinds from other sectors of the economy, but private domestic demand should remain solid as we move into H2.
Indeed, growth remains firm. The Atlanta Fed’s GDPNow model is tracking Q2 growth at 3.8% SAAR, with personal consumption seen rising 2.6% SAAR. It will be updated today after the April wholesale inventories and trade sales data. Elsewhere, the New York Fed’s Nowcast model is tracking Q2 growth at 2.3% SAAR and Q3 growth at 2.4% SAAR. Both readings will be updated Friday.
The Fed media blackout remains in effect this week. While the data have been a bit mixed, the overall picture supports the prevailing Fed view that it can be patient. The market sees no chance of a cut next week, only around 15% odds of a cut in July, and around 70% odds of a cut in September. A cut is not fully priced in until the October meeting. Furthermore, the swaps market is pricing in around 75 bp of total easing over the next 12 months. The Fed outlook will be tested by this week’s inflation readings.
Indeed, May inflation data come into focus. New York Fed inflation expectations will be reported today. In April, 1-year inflation expectations were unchanged at 3.6% while 3-year expectations rose two ticks to 3.2%, the highest reading since July 2022. In contrast, 5-year expectations fell two ticks to 2.7%, matching the December 2024 low. Still-elevated inflation expectations support the Fed’s intention to remain cautious about cutting. CPI will be reported Wednesday, followed by PPI Thursday.
With inflation and inflation expectations likely to pick up, long-end yields should edge higher. With the Fed on hold for the foreseeable future, the short end remains anchored and so the bear-steepening trade should continue. However, this steepening is likely to be contained, as the 10-year yield has seen strong resistance in the 4.5-4.6% area. Likewise, the 30-year yield has seen strong resistance in the 5.0-5.1% area. Appetite for USTs will be tested with heavy supply this week. Treasury auctions $58 bln of 3-year notes tomorrow, $39 bln of 3-year notes Wednesday, and $22 bln of 30-year bonds Thursday.
Mexico reports May CPI data. Headline is expected at 4.38% y/y vs. 3.93% in April, while core is expected at 4.03% y/y vs. 3.93% in April. If so, headline would be the highest since November and back above the 2-4% target range. At the last meeting May 15, Banco de Mexico cut rates 50 bp for the third straight meeting to 8.5% and added that “The Board estimates that looking ahead it could continue calibrating the monetary policy stance and consider adjusting it in similar magnitudes.” The decision was unanimous and so the bank seems determined to continue cutting rates despite upside risks to inflation. Next policy meeting is June 26 and another 50 bp cut to 8.0% seems likely.
EUROPE/MIDDLE EAST/AFRICA
European Central Bank officials are sounding more hawkish. GC member Kazimir said the bank is “nearly or already” at the end of its easing cycle, adding that it would be a mistake to neglect upside inflation risks. Recall that after last week’s 25 bp cut, reports emerged that ECB officials are considering a pause at the July meeting. It appears Kazimir is in this group. Given this forward guidance, the market is pricing in only 15% odds of a cut next month. However, the swaps market is still pricing in another 50 bp of easing over the next 12 months that would see the policy rate bottom near 1.5%. Other officials may also push back against this dovish market pricing. Elderson and Escriva also speak today.
ASIA
Japan Q1 GDP growth was revised up. Overall, the economy was stagnant q/q vs. -0.2% preliminary, while contracting -0.2% SAAR vs. -0.7% preliminary. The revision was largely due to inventories, which contributed 0.6 ppt to headline growth vs, 0.3 ppt preliminary. As such, we do not think the revision moves the dial on Bank of Japan policy and should underscore its cautious approach to tightening. No change in rates is expected at next week’s policy meeting, though there will be a debate about a modest change to the pace of its bond-buying. The swaps market is still pricing in 25 bp of tightening over the next 12 months.
Japan also reported April current account data. The adjusted surplus came in at JPY2.307 trln vs. JPY2.589 trln expected and JPY2.723 trln in March. However, the investment flows will be of more interest. The April data showed that Japan investors remained net sellers of U.S. bonds (-JPY1.071 trln) after four straight months of net buying. Japan investors stayed net sellers of both Australian bonds (-JPY177 bln) and Canadian bonds (-JPY17 bln) for the fourth straight month. Investors became net sellers of Italian bonds (-JPY201 bln) after three straight months of net buying. Overall, Japan investors stayed total net sellers of foreign bonds (-JPY1.977 trln) after two straight months of net buying. Still, we believe it’s still too early to say that Japan investors have stopped chasing higher yields abroad.
RBNZ Chief Economist Conway delivered dovish comments over the weekend. Conway stressed that “underlying inflation continues to ease” and that “the labor market’s a bit softer” than the unemployment rate suggests. Nevertheless, the RBNZ signaled at its last meeting May 28 that the easing cycle is on pause for the time being. Governor Hawkesby stressed then that “when we next meet in July a further cut in the OCR is not a done deal. We’re really more in a phase where we are taking considered steps, data dependent.” The swaps market sees 20% odds of a July rate cut and 25 bp of total easing over the next 12 months that would see the policy rate bottom at 3.00%.
China reported mixed CPI and PPI data. CPI came in a tick higher than expected at -0.1% y/y and was steady from April, while PPI came in a tick lower than expected at -3.3% y/y vs. -2.7% in April. Overall, China’s economy is still struggling to escape a deflationary spiral, in large part because consumption spending is too weak. China's consumption-to-GDP ratio is very low at around 40%, which is due to a combination high household savings, low household income levels, and high levels of household debt. Expect further stimulus measures in the coming weeks. May money and loan data will be reported sometime this week.
Elsewhere, China reported soft May trade data. Exports came in at 4.8% y/y vs. 6.0% expected and 8.1% in April, while imports came in at -3.4% y/y vs. -0.8% expected and -0.2% in April. Exports to the U.S. fell -34.4% y/y, while imports from the U.S. fell -17.9% y/y. The trade surplus still rose to $103.22 bln vs. $96.18 bln expected and was the largest since January. However, the surplus with the U.S. fell to $18.0 bln vs. $20.5 bln in April.
U.S.-China trade talks began another round of trade talks in London today. Reports suggest rare earths will be the main focus. Over the weekend, China confirmed that it had approved some applications for rare earths exports under its new program of tighter control. We expect no major breakthroughs this week; some sort of understanding on rare earths simply keeps the status quo in place with regards to tariffs.
