• Markets continue to reprice the Fed; Fed tightening expectations have risen; U.S. yields are rising again; April jobs data will be the highlight; Canada also reports April jobs data; Chile delivered a hawkish surprise yesterday.
  
• Markets are still digesting the BOE’s disastrous decision; updated macro forecasts contained the worst of all worlds; ECB officials continue to tilt hawkish; ECB tightening expectations have picked up; Germany reported very weak March IP
  
• April Tokyo CPI came in hot; RBA released its Statement of Monetary Policy; the Statement contained updated forecasts; it's hard to get excited about AUD when China is slowing much more than anticipated
  

The dollar is softer ahead of the jobs report. DXY traded earlier today at a new cycle higher near 104.061 but has since edged lower to around 103.203. We continue to look for a test of the December 2002 high near 107.30. The euro got a little boost from hawkish ECB comments (see below) but is likely to have trouble making a clean break above $1.06. it should eventually test last week’s cycle low near $1.0470 and then the January 2017 low near $1.0340. USD/JPY remains stuck near 130 but it should soon test last week’s cycle high near 131.25. We continue to look for a test of the 2002 high near 135.15. Sterling continues to suffer from the BOE’s disastrous decision and traded at a new cycle low near $1.2275 today before recovering to $1.2375 currently. We look for a break below the June 2020 low near $1.2250 that would set up a test of the May 2020 low near $1.2075. However, we think cable may eventually test the March 2020 low near $1.1410. Between lingering risk-off impulses and the recovery in U.S. yields, we believe the dollar uptrend remains intact. Any profit-taking in the dollar should be viewed as a buying opportunity.

AMERICAS

Markets continue to reprice the Fed. After Wednesday's relief rally, it seems the equity market is now focusing on the Fed’s aggressive tightening cycle. The bond market also seems to be taking the Fed seriously for now. There are some stories floating around that the bond market has lost confidence in the Fed but we respectfully disagree. The 10-year breakeven inflation rate is stuck around 2.86% and the U.S. yield curve continues to steepen. That seems to be showing faith that the Fed can limit inflation without causing a recession. Also, the real 10-year is at a cycle high 0.21%, which means policy is finally getting restrictive. The FX market is also showing faith in the Fed as the dollar is stronger now than before the FOMC.

Fed tightening expectations have risen. WIRP suggests 50 bp hikes are fully priced in for June, July, and September, followed by 25 bp hikes in November, December, and February. The swaps market is now pricing in a peak policy rate of 3.75% over the next 12 months. Fed speakers will start fanning out to spread the word. Williams, Bostic, Bullard, Waller, and Daly all speak today.

U.S. yields are rising again. The 10-year yield traded yesterday at a new cycle high near 3.11%, the highest since November 2018. It is currently around 3.08% and nearing that month’s high near 3.26%. The 2-year yield is lagging a bit, trading around 2.73% currently after making a new cycle high Wednesday near 2.85%, the highest since November 2018 and nearing that month’s high near 2.97%. The uptrend in yields is likely to continue as U.S. inflation continues to run hot and the Fed continues its aggressive tightening cycle. This should support the dollar.

April jobs data will be the highlight. The data will draw some market attention but with the U.S. pretty much at full employment, it no longer has that much impact on Fed policy. That said, consensus stands at 380k vs. 431k in March, with the unemployment rate expected to fall a tick to a new cycle low of 3.5%. Average hourly earnings are expected to ease a tick to 5.5% y/y, while average weekly hours are expected to rise a tick to 34.7. There are risks of a downside miss given all the clues, but it would have no policy implications. March consumer credit ($25.0 bln expected) will also be reported.

Canada also reports April jobs data. A gain of 40k jobs is expected vs. 72.5k in March, while the unemployment rate is expected to fall a tick to 5.2%. If so, it would be another all-time low. With the economy pretty much at full employment, it’s full speed ahead for the Bank of Canada. WIRP suggests a 50 bp hike to 1.0% is full priced in for the next meeting June 1. Looking ahead, the swaps market is pricing in 225 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%. April Ivey PMI will also be reported.

Chile central bank delivered a hawkish surprise yesterday. In a unanimous vote, it hiked rates 125 bp to 8.25% vs. 100 bp expected. The bank said recent inflation trends have been worse than expected, due to energy and food prices as well as the weak peso and supply chain issues. The swaps market is now pricing in another 200 bp of tightening over the next 3 months that would see the policy rate peak near 10.25%, up from 8.75% at the start of this week. April CPI data will be reported today and headline is expected at 10.1% y/y vs. 9.4% in March. if so, it would be the highest since September 1994 and further above the 2-4% target range. We see upside risks here after the bank’s hawkish surprise.

EUROPE/MIDDLE EAST/AFRICA

Markets are still digesting the Bank of England’s disastrous decision. While the 25 bp hike was widely expected, the mixed messaging has taken a toll on the bank’s credibility. With two MPC members opposing forward guidance of further tightening and three in favor of a 50 bp hike, the bank issued a rather weak statement that “most members judged that some degree of further tightening in monetary policy might still be appropriate in coming months.” There are so many vague qualifiers in that statement to render it meaningless. If nothing else, we expect volatility in U.K. asset markets to remain high as the bank’s weak sauce efforts at communication are falling flat. That means there will be more surprises ahead that will likely catch many investors wrong-footed. Of note, the bank said that it has asked staff to work on a strategy for outright asset sales. An update will come at the August meeting, allowing policymakers “to make a decision at a subsequent meeting on whether to commence sales.”

The updated macro forecasts contained the worst of all worlds. That is, double digit inflation is forecast for this year, to be followed by recession next year. The only good news may be that a mild recession does what BOE tightening so far has not and that is to tame inflation. The forecasts suggest the BOE thinks it can engineer a soft-ish landing but of course, we see risks of a hard one instead given all the headwinds building on the U.K. economy. Governor Bailey said that “I recognize the hardship this will cause people in the U.K., particularly those on lower incomes. The biggest driver is the real-income shock, which is coming from the change in the terms of trade, coming particularly from energy prices.”

ECB officials continue to tilt hawkish. Villeroy said today with regards to the deposit rate that “Barring unforeseen new shocks, I would think it reasonable to have entered positive territory by the end of this year.” He is considered moderate to dovish and so his pivot is noteworthy. On the other hand, it’s not surprising that noted hawks Rehn and Wunsch are singing the same tune. Some doves remain unconvinced, as Panetta warned that the eurozone economy is “de facto stagnating” and that it would be imprudent for the ECB to hike without first seeing Q2 GDP data scheduled for July 29.

ECB tightening expectations have picked up. WIRP suggests odds of liftoff June 9 are now back over 40% vs. 30% at the start of this week, while liftoff July 21 remains fully priced in. The swaps market is now pricing in 155 bp of tightening over the next 12 months, with another 60 bp of tightening priced in over the subsequent 12 months that would see the deposit rate peak near 1.65% vs. 1.5% at the start of this week. This still seems too aggressive to us given that 1) eurozone inflation may be peaking and 2) the risks to growth are mounting.

Germany reported very weak March IP. It was expected at -1.3% m/m but instead plunged -3.9% vs. a revised 0.1% (was 0.2%) in February. The y/y rate came in at -3.5% vs. a revised 3.1% (was 3.2%) in February. Yesterday’s factory orders shocker (-4.7% m/m and -3.1% y/y) suggests little relief on the horizon for the manufacturing sector here. Germany is the engine of the eurozone economy and recent signs point to continued weakness in Q2 after both barely grew at all (0.2% q/q) in Q1.

ASIA

April Tokyo CPI came in hot. Headline rose 2.5% y/y vs. 2.3% expected and 1.3% in March, while core (ex-fresh food) came in at 1.9% y/y vs. 1.8% expected and 0.8% in March. The core reading is the highest since March 2015. Of note, core ex-energy came in at 0.8% y/y vs. 0.6% expected and -0.4% in March. While these readings are at multi-year highs, much of the jump is due to the cut in mobile phone rates last year that has led to low base effects. Policymakers are looking through it as well as the energy component and have signaled steady policy for the time being. National CPI data will be reported May 20 and there are clearly upside risks.

Reserve Bank of Australia released its Statement of Monetary Policy. The bank stressed that “The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead. The Board will continue to closely monitor the incoming information and evolving balance of risks as it assesses the timing and extent of future interest rate increases.” It noted that “Inflation in Australia remains lower than in many other advanced economies, but it has picked up faster and to a higher level than previously expected. The outlook for inflation is also materially higher than envisaged three months ago.”

The Statement contained updated forecasts. As the RBA surprised with a 25 bp hike this week, it’s no surprise that inflation forecasts were raised and unemployment forecasts were lowered. However, with China slowing significantly, we were surprised that the growth forecasts were not marked down. Still, RBA tightening expectations continue to rise. WIRP suggests a 25 bp hike at the June 7 meeting is fully priced in, while a 50 bp move July 5 followed by several more hikes of that magnitude are pretty much priced in. The swaps market is pricing in 315 bp of tightening over the next 12 months that would see the policy rate peak near 3.5%, steady from the start of this week and up from 3.25% at the start of last week.

It's hard for us to get excited about AUD when China is slowing much more than anticipated. The AUD rally this week fizzled out near .7265, just ahead of the 200- day moving average near .7285 as well as a major retracement objective from the mid-April drop near .7295. With the USD rally back on track, we think AUD lost its best chance to break these key levels. Going the other way, break below .7120 sets up a test of the May 2 cycle low near .7030.