Dollar Soft as Risk Sentiment Improves

April 26, 2023

Win Thin

The U.S. House of Representatives could vote on Speaker McCarthy’s debt ceiling bill today; Fed tightening expectations have eased a bit; regional Fed surveys for April continue to come in soft; minor data will be reported today; BOC releases the summary of its March deliberations
Germany reported firm May GfK consumer confidence; ECB tightening expectations have steadied; Riksbank hiked rates 50 bp to 3.5%, as expected; Hungary delivered a dovish hold
Australia reported soft March and Q1 CPI data; the AUD technical picture is not good; mainland equity markets have given back the entirety of the post-reopening rally

The dollar is firm as risk off impulses ease. Strong earnings reports from the big tech companies last night have helped improve market sentiment. DXY is trading lower near 101.269 and has given back nearly all of yesterday’s gains. The euro is trading higher near $1.1060 and sterling is trading higher near $1.2485. USD/JPY is trading heavy near 133.50 despite the improved risk sentiment. AUD is underperforming after soft CPI data (see below). Recent data have been dollar-supportive and we are finally seeing a reaction in U.S. yields. Until rate cuts this year are finally priced out, the dollar is likely to remain vulnerable.

AMERICAS

The U.S. House of Representatives could vote on Speaker McCarthy’s debt ceiling bill today. Last night, the bill cleared the House Rules Committee by a 9-4 vote, setting the table for a full vote soon. McCarthy committed to a vote sometime this week but refused to say whether he’s secured enough support from his fellow Republicans to pass it. He cannot lose more than four lawmakers from his own party if no Democrats vote for it. Of note, Representative Norman of the so-called House Freedom Caucus said yesterday that he believes there are four lawmakers in his group that are “leaning no” but we believe their opposition may simply be hardball negotiating tactics. That said, McCarthy continued to tell lawmakers last night that he would not make any changes to the text. If the bill fails, it would basically destroy the Republicans’ negotiating position in any talks with their Democratic counterparts in Congress as well as the White House. It also would likely delay the start of actual talks on raising the debt ceiling. Rising concerns about a potential technical default due to a failure to raise the debt ceiling has seen investors pile into 1-month T-bills, driving the yield sharply lower before recovering slightly today.

Fed tightening expectations have eased up bit. WIRP suggests over 80% odds of 25 bp hike at the May 2-3 meeting, down from 90% at the start of this week and back to the 80% seen at the start of last week and 70% at the start of the week before that. We believe a hike next week is a done deal. There are no longer any odds of another 25 bp hike in June, down from about 15% at the start of this week. Between the May 2-3 and June 13-14 meetings, the Fed will have digested two more job reports, two CPI/PPI reports, and one retail sales report. At this point, a pause in June might just be the most likely outcome but it really will depend on how all that data come in. After all that, two cuts are now priced in by year-end vs. one at the start of this week and back to two seen at the start of last week. In that regard, Powell has said that Fed officials “just don’t see” any rate cuts this year. We concur.

Regional Fed surveys for April continue to come in soft. Yesterday, Richmond Fed manufacturing came in at -10 vs. -8 expected and -5 in March. Overall, they have been on the weak side as Dallas Fed manufacturing index came in -23.4 vs. -12.0 expected and -15.7 in March, Philly Fed came in at -31.3 vs. -19.3 expected and -23.2 in March, and Empire survey came in at 10.8 vs. -18.0 expected and -24.6 in March. Kansas City Fed manufacturing index will be reported tomorrow and is expected at -2 vs. 0 in March.

Minor data will be reported today. March wholesale (0.1% m/m expected) and retail (0.2% m/m expected) inventories, advance goods trade (-$90.0 bln expected), and durable goods orders (0.7% m/m expected) will all be reported. All of these are inputs to the Atlanta Fed’s GDPNow model, which is currently tracking Q1 growth at 2.5% SAAR. Next and final model update for Q1 will come today after the data. After that, the model will start tracking Q2. We get our first look at Q1 GDP tomorrow. Consensus currently is at 2.0% SAAR vs. 2.6% in Q4. The mix of Q1 growth will be important. In Q4, the bulk of growth came from inventories and helped offset the slowdown in personal consumption and net exports.

Bank of Canada releases the summary of its March deliberations. At the April 12 meeting, the bank kept rates steady at 4.5% for the second straight meeting but pushed back against any notions of early easing by noting “Governing Council continues to assess whether monetary policy is sufficiently restrictive to relieve price pressures and remains prepared to raise the policy rate further if needed to return inflation to the 2% target.” Recent data have come in solid, raising the possibility that this pause may turn out to be temporary. Like the Fed, it will really depend on the data going forward. Next BOC policy meeting is June 7 and another hold is expected. Looking ahead, the market is now pricing two cuts by year-end vs. one at the start of this week, either of which we believe is very unlikely.

Banco de Mexico Governor Rodriguez said it will consider ending its tightening cycle at the next policy meeting. She noted that “We will be evaluating in the next decision, on May 18, these factors and will be discussing whether it’s the moment to stop the increase in rates. We still have to have the discussion with the members of the board.” With inflation continuing to fall, the bank now seems likely to keep rates steady then. Mexico just reported mid-April CPI this week, with headline coming in at 6.24% y/y vs. 6.58% end-March and core coming in at 7.75% y/y vs. 8.03% end-March. Market is now pricing in steady rates over the next six months, followed by 175 bp of easing cycle over the subsequent six months. This easing path seems overly aggressive but it will all depend on how the data come in.

EUROPE/MIDDLE EAST/AFRICA

Germany reported firm May GfK consumer confidence. It came in at -25.7 vs. -28.0 expected and a revised -29.3 (was -29.5 in April). This was the highest since last April and mirrors the steady rise in business confidence. That said, we still cannot get excited about the eurozone economic outlook. Germany in particular is very dependent on China as an export destination and the impact of the reopening on the rest of the world has so far been insignificant.

ECB tightening expectations have steadied. The next policy meeting is May 4 and WIRP suggests nearly 30% odds of a 50 bp hike then. After that, another 25 bp hike is priced in for June 15 followed by another 25 bp hike in September or October and nothing after that, which would take the deposit rate up to 3.75% vs. 3.75-4.0%% seen at the start of this week and back to 3.75% at the start of last week and 3.50% at the start of the week before that.

Riksbank hiked rates 50 bp to 3.5%, as expected. However, there were two dissents in favor of a smaller 25 bp move. The bank noted that “It is important for confidence in the inflation target that inflation falls clearly this year. To ensure that this happens, the policy rate needs to be raised further.” Forward guidance shifted more hawkish as the policy rate is seen peaking at 3.65% in Q2 2024 vs. 3.33% in Q4 2024 in the February forecasts and staying there through Q2 2025 before falling by Q2 2026. However, that path suggests only one more 25 bp hike and that has been taken by the markets as too dovish, with EUR/SEK up nearly 1% on the day and approaching the March cycle high near 11.4815. Regarding the exchange rate, the Riksbank said “The krona has not been a decisive factor behind the substantial rise in inflation, but it has contributed to somewhat higher inflation. A stronger krona would be desirable.” Looking ahead, WIRP suggests odds of another 50 bp hike June 29 at nearly 30%, down from 50% at the start of this week.

National Bank of Hungary delivered a dovish hold. While it kept the base rate unchanged at 13.0%, it lowered the top of its rates corridor (the overnight collateralized loan rate) to 20.5% vs. 25.0% previously, which the bank has said would be the first step towards easing. Furthermore, the bank said that its risk perceptions regarding inflation have “improved significantly” and expects inflation to fall at an “accelerating pace” in H2. When asked when the benchmark 1-day deposit rate (now at 18.0%) might converge with the base rate, Deputy Governor Virag said this fall was “a realistic path.” With a 500 bp difference, this suggests easing could begin as early as May of June, assuming the easing path is cautious. Thus, Hungary joins Poland and Czech in the dovish camp and will most likely ease prematurely even as CPI is running at 25.2% y/y. For now, markets are giving CEE central banks the benefit of the doubt when they should instead be calling them out.

ASIA

Australia reported soft March and Q1 CPI data. March headline came in at 6.3% y/y vs. 6.5% expected and 6.8% in February, the lowest monthly reading since May 2022 but still well above the 2-3% target range. For Q1, headline came in at 7.0% y/y vs. 6.9% expected and 7.8% in Q4 while trimmed mean came in at 6.6% y/y vs. 6.7% expected and 6.9% in Q4. Q1 PPI will be reported Friday. Next policy meeting is May 2 and WIRP suggests nearly 25% odds of a 25 bp hike. These odds have risen to nearly 75% for August 1 vs. zero chance after its pause in early April. Of course, it will all depend on the data but if price pressures continue to ease, this current pause may turn out to mark the end of the tightening cycle. That said, the Australian economy has remained fairly robust despite the 350 bp of tightening seen so far since it began hiking in May 2022.

The technical picture is not good. AUD is underperforming today and trading lower after breaking below the daily trendline drawn off the October low yesterday. Next up is the March low near 0.6565 but a break below that opens up a test of that October cycle low near 0.6170. Iron ore and coal prices continue to sink as China reopening disappoints; this negative terms of trade shock can only add to AUD headwinds. In another sign of disappointment, mainland equity markets have given back the entirety of the post-reopening rally. So have regional stocks as well as EM as whole.

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