Dollar Soft as Market Squares Up Ahead of Holiday Weekend

May 24, 2024

Win Thin

Fed officials remain very cautious about easing prematurely; Fed Governor Waller will speak about r*; S&P Global preliminary May PMIs rose sharply; the relative growth story is back in play; Canada reports March retail sales
ECB officials continue to send a cautious message; U.K. reported weak April retail sales
Japan reported softer April national CPI and April department store sales; RBNZ Assistant Governor Silk reinforced the hawkish message

The dollar is giving back some of its gains ahead of the long holiday weekend in the U.S. After trading above 105 level on hawkish FOMC minutes and strong PMIs (see below), DXY is trading lower today near 104.853 as the market squares up ahead of the holiday weekend. The euro is trading higher near $1.0840 while sterling is trading higher near $1.2720 despite soft U.K. retail sales (see below). Lastly, USD/JPY is trading flat near 157 despite softer CPI data (see below). We believe the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. Markets have already started to take back the dovish Fed easing expectations and so we look for the dollar recovery to continue.

AMERICAS

Fed officials remain very cautious about easing prematurely. Bostic said “The sensitivity to our policy rate - the constraint and the degree of constraint that we’re going to put on - is going to be a lot less. I would expect this to last a lot longer than you might expect.” He added that “A goal that I think is quite important is to move in one direction only - so not cut and then have to raise and then cut and then raise - because I think that creates policy uncertainty.” Bostic has said that he expects only one cut in 2024, towards year-end. The market seems to agree, as odds of a cut are only 60% in September and 85% in November before becoming fully priced in for December. It’s clear that the market remains unconvinced that the Fed will pivot earlier than previously anticipated.

Fed Governor Waller will speak about r*, the neutral rate. Many Fed officials have commented on their uncertainty about the degree of monetary restrictiveness in part because the longer-run equilibrium interest rate (r*) may be higher than previously thought. Recall that in the March Dot Plots, the median for the longer-term rate (a proxy for r*) rose to 2.562% vs. 2.5% previously. The range of views was wide: 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%. It will be interesting to see where Waller fits on that spectrum but as one of the Fed’s leading hawks, we suspect he is near the upper end.

This is not just a U.S. debate. At this week’s policy meeting, the RBNZ revised up its estimate for r* to 2.75% from 2.50% previously. At the April 10 meeting, the BOC revised up its estimate for r* to a range of 2.25-3.25% vs. 2-3% previously. However, that was based in large part on the exact same revision to its U.S. r* estimate, noting that "Because Canada is a small open economy, its neutral rate of interest is influenced by global economic conditions. The Bank uses an estimate of the neutral rate for the United States as a proxy for the global neutral interest rate.”

S&P Global preliminary May PMIs rose sharply. Manufacturing came in at 50.9 vs. 49.9 expected and 50.0 in April, services came in at 54.4 vs. 51.2 expected and 51.3 in April, and the composite came in at 54.4 vs. 51.2 expected and 51.3 in April. The composite was the highest since April 2022 and suggests the economy is picking up again. Chicago PMI will be reported next Friday but ISM PMIs won’t be reported until the first week of June.

The relative growth story is back in play. For comparison's sake, the eurozone composite PMI rose to a 12-month high of 52.3 and the U.K. composite PMI fell to a 2-month low of 52.8. Japan’s composite rose to 10-month high of 52.4. All three are well below the U.S. composite reading of 54.4.

Indeed, U.S. Q2 growth remains robust. The New York Fed’s Nowcast model is tracking 1.9% SAAR and will be updated today. Its initial read for Q3 growth will be released in early June. Elsewhere, the Atlanta Fed’s GDPNow model is tracking Q2 growth at 3.6% SAAR and will also be updated today after the data. April durable goods orders are expected at -0.8% m/m vs. 0.9% in March.

April Chicago Fed National Activity Index is worth discussing. Recall that a positive reading means the economy is growing above trend. Headline came in at -0.23 vs. 0.13 expected and a revised -0.04 (was 0.15) in March. As a result, the 3-month moving average still rose to 0.01 and is the first positive reading since October 2022. It's also further away from the -0.7 threshold that signals recession.

Weekly jobless claims are also worth discussing. That’s because initial claims were for the BLS survey week containing the 12th of the month. These came in at 215k vs. 220k expected and a revised 223k (was 222k) the previous week, while the 4-week moving average rose to 220k vs. 218k the previous week. Continuing claims are reported with a one-week lag and came in at 1.794 mln vs. 1.793 mln expected and a revised 1.756 mln (was 1.794 mln) the previous week. Bloomberg consensus for May NFP stands at 180k vs. 175k in April while its whisper number stands at 191k.

Canada reports March retail sales. Headline is expected at -0.1% m/m vs. -0.1% in February and ex-autos is expected at 0.3% m/m vs. -0.3% in February. Of note, Statistics Canada’s advanced retail indicator suggests sales were unchanged in March. Poor retail sales activity would reinforce the case for a Bank of Canada rate cut in June and further weigh on CAD. The market has raised the odds of a June cut to nearly 70% following Tuesday’s soft Canada April CPI print vs. 45% at the start of this week.

EUROPE/MIDDLE EAST/AFRICA

ECB officials continue to send a cautious message. Schnabel said “I would caution against moving too quickly because there is a risk of cutting interest rates too fast. And we should definitely avoid that.” Nagel said the likelihood of a June cut is “winning traction” and added that wage growth will slow in the coming months. The market is pricing in a June cut, but the odds of cuts in September and December have fallen to 65-70% after being fully priced in last week. Vasle, Muller, de Cos, and Centeno all speak today.

U.K. reported weak April retail sales. Headline came in at -2.3% m/m vs. -0.5% expected and a revised -0.2% (was 0.0%) in March, while sales ex-auto fuel came in at -2.0% m/m vs. -0.8% expected and a revised -0.6% (was -0.3%) in March. Poor weather was a major factor behind the weak readings and perhaps explains the muted GBP reaction. Going forward, we expect consumer spending to recover, underpinned in part by positive real wage growth. The market is pricing in the first 25 bp rate cut in November vs. August at the start of this week.

ASIA

Japan reported softer April national CPI. Headline came in a tick higher than expected at 2.5% y/y vs. 2.7% in March, core (ex-fresh food) came in as expected at 2.2% y/y vs. 2.6% in March, and core ex-energy came in as expected at 2.4% y/y vs. 2.9% in March. Core is the lowest since January and nearing the 2% target. The bar remains high for an aggressive BOJ tightening cycle. The swaps market is pricing in only 70 bp of rate hikes over the next three years and this remains a drag on JPY.

Japan also reported April department store sales. Sales came in at 8.9% y/y vs. 9.9% in March and have slowed two straight months. Next Friday, April retail sales will be reported and are expected at 1.9% y/y vs. 1.2% in March.

RBNZ Assistant Governor Silk reinforced the hawkish message. She said the bank is “absolutely” prepared to hike rates if necessary. Meanwhile, there is a bright spot for New Zealand’s sluggish household spending outlook. The ANZ-Roy Morgan consumer confidence index improved to 84.9 in May vs. 82.1 in April, though it remains at historical weak levels. NZD continues to power forward versus AUD following the RBNZ’s hawkish hold earlier this week.

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