Dollar Soft as Post-BOC Boost Fades

June 08, 2023

Win Thin

BOC is being viewed as the canary in a coal mine; the fact that RBA and BOC unexpectedly hiked rates this week is noteworthy; BOC delivered a hawkish surprise and hiked rates 25 bp to 4.75%; Mexico reports May CPI; Peru is expected to keep rates steady at 7.75%
Eurozone GDP contracted in Q1; ECB tightening will weigh on growth in Q2 and Q3; German firms see a weak outlook in China
Japan reported firm final Q1 GDP data; April current account data are worth discussing; Australia reported soft April trade data; India kept rates steady at 6.5%, as expected

The dollar is trading softer as its post-BOC boost fades. After the BOC surprise boosted Fed tightening expectations and the dollar, the absence of any top tier economic data or Fed speakers is causing the greenback to drift lower for the second straight day. DXY is trading lower near 103.862 but we still look for a retest of last Wednesday’s cycle high near 104.699 and then the mid-March high near 105.103. The euro is trading higher near $1.0730 but we still look for a retest of last Wednesday’s low near $1.0635 and then the mid-March low near $1.0515. Sterling is trading higher near $1.2465 but we still look for a test of the late May low near $1.2310. USD/JPY is trading lower near 139.75 but we still look for a test of the late May high near 141. The headwinds on the dollar (banking sector weakness, debt ceiling battle) have been resolved even as the tailwinds (strong economy and robust labor market) pick up. We look for the post-NFP rally to continue as markets continue to underestimate the risks of Fed tightening (see below).

AMERICAS

The Bank of Canada is being viewed as the canary in a coal mine, it seems. After the hawkish surprise north of the border yesterday (see below), Fed tightening expectations have risen along with UST yields. Indeed, the BOC has done what NFP couldn't last Friday and that's to push the 2-year yield back near 4.60%. WIRP suggests odds of a hike next week are around 35% vs. 20% before the BOC, and those odds rise to around 85% in July vs. 70% before the BOC. More importantly, WIRP suggests only 15% odds of a rate cut by year-end vs. nearly 50% before the BOC. There has been quite a bit of Fed repricing in recent weeks but more needs to be done.

The fact that RBA and BOC unexpectedly hiked rates this week is noteworthy. Both economies remain resilient despite aggressive monetary tightening , while inflation remains stubbornly high and labor markets remain stubbornly tight. One can say the same about the U.S. and perhaps the U.K. as well, whilst the eurozone is in a slightly weaker position (see below). We see risks of a hawkish surprise from the Fed next week despite talk of a skip, but it will really depend on the CPI data Tuesday. We also see upside risks for Fed and BOE tightening ahead, while the ECB seems to be nearing the end of its tightening cycle this summer. Japan is its own animal right now, with the BOJ still on hold despite solid growth and high inflation.

Only minor data will be reported. Weekly jobless claims, April wholesale trade sales and inventories, and Q1 change in household net worth will be reported. Initial claims are expected at 235k vs. 232k last week, while continuing claims are expected at 1.802 mln vs. 1.795 mln last week. For now, most indicators suggest the labor market remains quite robust and so we expect another solid jobs reports for June. Of note, the Atlanta Fed’s GDPNow model is currently tracking 2.2% SAAR growth in Q2, up from 2.0% previously. Next model update will come today after the data.

Bank of Canada delivered a hawkish surprise and hiked rates 25 bp to 4.75%. That said, it wasn’t a total surprise as nearly a fifth of the analysts polled by Bloomberg saw a 25 bp hike while WIRP suggested nearly 45% odds of a hike. The bank noted “Overall, excess demand in the economy looks to be more persistent than anticipated.” It added that “Monetary policy was not sufficiently restrictive to bring supply and demand into balance and return inflation sustainably to the 2% target,” citing what it called an “accumulation of evidence.” Lastly, the bank stressed “Concerns have increased that CPI inflation could get stuck materially above the 2% target.” There was no forward guidance given, which suggests the bank joins many others in becoming data-dependent. That said, WIRP suggests nearly 70% odds of another hike July 12 and is fully priced in for September 6. Odds of another hike after that top out near 55% December 6 and so a BOC rate cut by year-end is now totally priced out. Updated macro forecasts will be released at the July meeting. Today, Deputy Governor Beaudry speaks and will likely provide a more thorough explanation of the decision.

Mexico reports May CPI. Headline is expected at 5.88% y/y vs. 6.25% in April, while core is expected at 7.38% y/y vs. 7.67% in April. If so, headline would be the lowest since August 2021 but still well above the 2-4% target range. Minutes to the May 18 meeting showed that after holding rates steady at 11.25%, the bank felt that “In order to achieve an orderly and sustained convergence of headline inflation to the 3% target, it considers that it will be necessary to maintain the reference rate at its current level for an extended period.” Next policy meeting is June 22 and no change is expected then. Governor Rodriguez said last week that the bank will hold rates for at least two meetings. The next meetings are June 22, August 10, and September 28. While Rodriquez ruled out June and August for any policy changes, Deputy Governor Espinosa added that a rate cut was unlikely in September. That leaves November 9 and December 14. The swaps market sees steady rates for the next three months followed by the start of an easing cycle over the subsequent three months, which is consistent this latest forward guidance.

Peru central bank is expected to keep rates steady at 7.75%. Rates have been kept steady since the last 25 bp hike in January. At the last meeting May 11, the bank reiterated that inflation would fall to 3% by year-end but would not rule out further hikes if needed. The market is pricing in the start of an easing cycle in Q3.

EUROPE/MIDDLE EAST/AFRICA

Eurozone GDP contracted in Q1. Revised data show the q/q rate at -0.1% vs. 0.1% preliminary. With Q4 also coming in at -0.1% q/q, the eurozone suffered back to back quarterly contractions for the first time since the depths of the pandemic. Germany contracted for the second straight quarter. Italy and Spain were the major drivers of eurozone growth in Q1 but data there have softened. Of note, Bloomberg consensus sees q/q growth at 0.1% in Q2, 0.2% in Q3, and 0.2% in Q4.

ECB tightening will weigh on growth in Q2 and Q3. WIRP suggests a 25 hike is priced in June 15, followed by another 25 bp hike July 17. The odds of one last hike top out near 25% October 26. Updated macro forecasts will be released next week and its 2023 and 2024 growth forecasts are likely to be revised down closer to the World Bank’s new forecasts of 0.4% and 1.3%, respectively. The ECB’s March forecasts, which are close to the OECD’s new forecasts of 0.9% and 1.5%, seem too optimistic in light of further slowing in the major eurozone economies.

German firms see a weak outlook in China. Over half of the firms surveyed by the German Chamber of Commerce in China expect conditions to either worsen or remain unchanged for their industries. Almost a third of the respondents expect profits to decline by more than 5% in 2023, up 10 percentage points from last year. The Chamber warned that “The slower-than-expected market development, as well as ongoing geopolitical tensions, have dashed hopes for a quick improvement in the business environment.” Similar to what we’ve seen in the Asian exporters, recent German data have shown little positive impact from China reopening.

ASIA

Japan reported firm final Q1 GDP data. Growth was revised up to 0.7% q/q vs. 0.5% expected and 0.4% preliminary, with the SAAR rate rising to 2.9% vs. 1.9% expected and 1.6% preliminary. The upgrade was due largely to business spending being revised up to 1.4% q/q vs. 0.9% preliminary. In addition, inventory contribution to growth was revised up to 0.4 percentage points vs. 0.1 preliminary. Of note, Bloomberg consensus sees SAAR growth slowing to 1.4% in Q2, 1.0% in Q3, and 0.9% in Q4.

April current account data are worth discussing. The adjusted surplus came in at JPY1.9 trln vs. JPY1.4 trln expected and JPY1.0 trln in March. However, the investment flows will be of most interest. The April data showed that Japan investors turned net sellers of U.S. bonds (JPY2.0 trln) after three straight months of net buying. Japan investors remained net buyers (JPY310 bln) of Australian bonds for the second straight month after eight straight months of net selling, and also remained net sellers of Canadian bonds (-JPY5 bln) for the fourth straight month and for fourteen of the past fifteen months. Investors remained net buyers of Italian bonds (JPY36 bln). Overall, Japan investors were total net sellers of foreign bonds (-JPY1.1trln) after three straight months of net buying. With signs growing that the BOJ is on hold for now, we expect investors to resume chasing higher yields abroad and that’s yen-negative.

Australia reported soft April trade data. Exports came in at -5% m/m vs. 4% in March while imports came in at 2% m/m vs. a revised 4% (was 2%) in March. In y/y terms, the 3.2% reading for exports was the weakest since March 2021. Of note, exports of metal ores and minerals fell -10.4% in April, which underscores the limited impact so far of China reopening on the regional exporters. On the other hand, imports rose 8.5% y/y and was the strongest since January, suggesting consumption remains strong.

Reserve Bank of India kept rates steady at 6.5%, as expected. The decision was unanimous but the bank flagged risks of further tightening by keeping its bias towards “removal of accommodation” by a 5-1 vote. Governor Das stressed “Close and continued vigil on the evolving inflation outlook is absolutely necessary, especially as the monsoon outlook and the impact of El Nino remain uncertain. The continuation of the stance of withdrawal of accommodation should be seen from this perspective.” Das repeated his statement from the last hold that the decision remains a “pause, not a pivot.” The market says otherwise and is pricing in no more hikes and a potential easing cycle over the next 6 months.

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