Euro Bid Despite ECB Rift

May 24, 2022

U.S. yields have fallen sharply from the early May peaks; April Chicago Fed National Activity Index came in close to consensus; regional Fed manufacturing surveys will continue to roll out; Mexico reports mid-May CPI; Brazil reports mid-May IPCA inflation

Reports suggest some ECB hawks were unhappy with President Lagarde’s forward  guidance yesterday; Lagarde pushed back today; eurozone reported solid preliminary May PMI readings; U.K. reported weak preliminary May PMI readings; Russia eased key capital controls as the ruble continues to gain

Japan reported firm preliminary May PMI readings and April department store sales; Australia reported weak preliminary May PMI readings; U.S. officials remain non-committal regarding tariffs on China; Indonesia kept rates steady at 3.50%, as expected

The dollar remains under pressure.  DXY is down for the second straight day and traded below 102, the lowest since April 26.  Key level to watch is 101.80 as a break below would set up a test of the April 21 low near 99.818.  We still view this move lower as a correction within the longer-term dollar rally but we continue to be surprised at how far the dollar has fallen from the early May peak.  The euro is trading at the highest since April 26 just above $1.07 despite a growing rift at the ECB (see below).  Here, a clean break above $1.0710 sets up a test of the April 21 high near $1.0935.  USD/JPY remains heavy near 127.50 as risk sentiment is worsening again.  Sterling is trading back near $1.25 after being unable to break above $1.26, with weak PMI readings weighing on it.  If risk off sentiment continues to worsen, we would expect the dollar to start catching a bid.


U.S. yields have fallen sharply from the early May peaks.  The 10-year yield is currently trading near 2.81% vs. the May 9 peak near 3.20%,while the 2-year yield is trading near 2.58% vs. the May 4 peak near 2.85%.  Part of this drop has been the return of periodic risk-off impulses, but we feel a large part of it reflets concerns about the economic outlook due to some soft survey data.  However, we note that jobs and retail sales data have remained firm.  Our two favorite indicators – the 3-month to 10- year yield curve and the Chicago Fed National Activity – suggest recession fears are overblown.  While the slop of the curve has fallen to 178 bp from the 231 bp peak in early May, it remains far from inversion.  Likewise, the Chicago Fed NAI (see below) also remains far from recessionary readings.  We believe that U.S. yields will resume rising as risk off impulses ebb and that should help the dollar in the coming days.   

April Chicago Fed National Activity Index came in close to consensus.  Because it is a good predictor of economic downturns, this series should command more and more attention as the Fed tightens.  Headline came in at 0.47 , slightly lower than the expected 0.50 but still a solid reading.  A positive number means above-trend growth, while a negative one means below-trend growth.  Of note, the 3-month average fell to 0.48 from a revised 0.49 (was 0.58), which keeps it well above the -0.7 level that signals recession.   

Regional Fed manufacturing surveys will continue to roll out.  Richmond Fed is expected at 10 vs. 14 in April.  Kansas City reports Thursday and is expected at 18 vs. 25 in April.  Last week, Empire came in at -11.6 vs. 24.6 in April and Philly Fed came in at 2.6 vs. 17.6 in April.  Preliminary May S&P Global (formerly Markit) PMI readings will also be reported today. Manufacturing is expected at 57.7 vs. 59.2 in April, services is expected at 55.2 vs. 55.6 in April, and the composite is expected at 55.7 vs. 56.0 in April.  April new home sales will also be reported and are expected at -1.7% m/m vs. -8.6% in March.  Powell speaks today.   

Mexico reports mid-May CPI.  Headline is expected at 7.57% y/y vs. 7.72% in mid-April.  If so, it would be the first deceleration since January but still well above the 2-4% target range.  Banco de Mexico releases its minutes Thursday.  At the May 12 meeting, it hiked the expected 50 bp to 7.0%.  However, it hinted at larger hikes ahead as it noted “Given the growing complexity in the environment for inflation and its expectations, taking more forceful measures to attain the inflation target may be considered.”  The vote was 4-1, with Deputy Governor Espinosa dissenting in favor of a 75 bp hike.   Deputy Governor Heath may have joined her as he said he was surprised  that so few analysts are looking for 75 bp at the next policy meeting June 23.  If inflation does slow, however, another 50 bp hike to 7.5% seems to be the likely outcome.  The swaps market is pricing in 250 bp of tightening over the next 12 months that would see the policy rate peak near 9.5%.   

Brazil reports mid-May IPCA inflation.  Inflation is expected at 12.04% y/y vs. 12.03% in mid-April.  If so, it would remain well above the 2-5% target range.  COPOM hiked the expected 100 bp to 12.75% at the last meeting May 4 and hinted that the pace would continue to slow.  Next meeting is June 15 and the CDI market is pricing in a 50 bp hike to 13.25% followed by a final 25 bp hike to 13.5% at the August 3 meeting.  This lines up with the swaps market pricing as well.  The real has taken advantage of recent dollar softness and is trading at the strongest level since late April.  For USD/BRL, a break below 4.8375 would set up a test of the April 20 low near 4.6095. 


Reports suggest some ECB hawks were unhappy with President Lagarde’s forward  guidance yesterday.  Recall she said the bank is likely to exit negative rates by the end of Q3, which would seem to suggest liftoff July 21 with a 25 bp hike followed by another 25 bp September 8 that results in a zero deposit rate.  The hawks are reportedly unhappy because this would seem to take a larger 50 bp hike off the table for now.  Though we never thought this was a serious option for the ECB, we feel that it’s always better for policymakers to keep all options on the table.  We said the same thing when Powell seemed to take 75 bp off the table.  That said, we remain unimpressed by unnamed ECB officials that seek to undermine Lagarde’s message.

Lagarde pushed back today.  She stressed that the ECB won’t be rushed into tightening.  Specifically, she said “I don’t think that we’re in a situation of surging demand at the moment.  It’s definitely an inflation that is fueled by the supply side of the economy. In that situation, we have to move in the right direction, obviously, but we don’t have to rush and we don’t have to panic.”  Villeroy added his support, noting that “A 50 bp hike is not part of the consensus at this point, I am clear.  Interest rate hikes will be gradual.”  Villeroy speaks again today. As it is, market pricing for ECB tightening remains unaffected by this debate.  The swaps market is still pricing in a terminal policy rate of 1.5%.   

Eurozone reported solid preliminary May PMI readings.  Manufacturing came in at 54.4 vs. 54.7 expected and 55.5 in April, services came in at 56.3 vs. 57.4 expected and 57.7 in April, and the composite came in at 54.9 vs. 55.1 expected and 55.8 in April.  Looking at the country breakdown, the German composite came in at 54.6 vs. 53.9 expected and 54.3 in April and the French composite came in at 57.1 vs. 56.9 expected and 57.6 in April.  Italy and Spain will be reported with the final May readings next week.  May French business confidence was also reported steady at 106 vs. 105 expected.  The eurozone economy  has far proven to be more resilient than expected as the Ukraine crisis drags on, which is probably giving policymakers more confidence to begin withdrawing stimulus. 

U.K. reported weak preliminary May PMI readings.  Manufacturing came in at 54.6 vs. 55.0 expected and 55.8 in April, services came in at 51.8 vs. 57.0 expected and 58.9 in April, and the composite came in at 51.8 vs. 56.5 expected and 58.2 in April.  This is the lowest composite reading since February 2021 and suggests that the consumer is buckling under the weight of higher prices and higher payroll taxes.  CBI also reported its May distributive trades survey.  Total reported sales came in at 13 vs. 3 in April, while retailing reported sales came in at -1 vs. -30 expected and -35 in April.  Lastly, the government also reported its April public sector net borrowing.  Ex-banking groups came in at GBP18.6 bln vs. GBP18.9 bln expected and a revised GBP14.7 bln (was GBP18.1 bln) in March.

Sterling took a hit from the weak PMI readings.  After testing the $1.26 area this week, cable has fallen back to trade near $1.25.  A break below $1.2325 is needed to set up a test of the May 13 low near $1.2155.  Sterling weakness comes despite unchanged Bank of England tightening expectations.  WIRP suggests another 25 bp hike is priced in for the next meeting June 16, while the swaps market is still pricing in 150 bp of total tightening over the next 12 months that would see the policy rate peak near 2.50%, steady from the start of this week.  

Russia eased key capital controls as the ruble continues to gain.  Exporters are now required to sell 50% of their FX proceeds vs. 80% previously.  The Finance Ministry said the change was due to “the stabilization of the exchange rate and the reaching of adequate levels of foreign-currency liquidity on the domestic market.”  The ruble has strengthened further today.  However, until foreigners are allowed to sell their Russian assets and repatriate the proceeds, the exchange rate has no meaning. 


Japan reported firm preliminary May PMI readings and April department store sales.  Manufacturing came in at 53.2 vs. 53.5 in April, services came in at 51.7 vs. 50.7 in April, and the composite came in at 51.4 vs. 51.1 in April.  This was the highest reading for the composite since December, before lockdowns led to a couple of sub-50 readings in January and February.  Elsewhere, sales rose 19.0% y/y vs. 4.6% in March.  While the economy is clearly recovering, policymakers are showing no signs of removing stimulus.  Next Bank of Japan meeting is June 16-17 and all settings are expected to remain steady. 

Australia reported weak preliminary May PMI readings. Manufacturing came in at 55.3 vs. 58.8 in April, services came in at 53.0 vs. 56.1 in April, and the composite came in at 52.5 vs. 55.9 in April.  The composite reading was the lowest since January, when the economy was struggling from lockdowns.  We suspect that the weak May readings largely reflect the start of the negative spillover from the slowing mainland Chinese economy.  AUD tested the 62% retracement objective of the May drop near .71 but so far was unable to make a clean break above, which would set up a test of the early May high near .7265.  Concerns about China are likely to remain a headwind for AUD near-term, however. 

U.S. officials remain non-committal regarding tariffs on China.  USTR Tai stressed that the U.S. must be “strategic” when it comes to a decision on whether to remove those tariffs.  Specifically, Tai said “With respect to the tariffs, our approach as with everything in this relationship, is to be strategic.  We have to keep our eye on the ball in terms of how to effectively realign the US-China trade and economic relationship.”  She added that “All options are on the table in terms of how we address our short-term economic needs, but our eye must be on the ball with respect to the medium and long term needs for the United States to realign this economic and trade relationship.”  As we noted yesterday, having those tariffs in place gave the U.S. some leverage over China.  If the Biden administration does consider the move, we suspect it would be along the lines of a temporary suspension as the U.S. is unlikely to give up that leverage.  

Bank Indonesia kept rates steady at 3.50%, as expected.  However, raised reserve requirements to 9% starting in September vs. 6.5% previously planned.  Governor Warjiyo said the move would remove IDR110 trln ($7.5 bln) of liquidity from the banking system and comes on top of the planned IDR200 trln rupiah reduction from the steps announced back in January.   Headline inflation accelerated to 3.47% y/y in April, the highest since December 2017 and in the top half of the 2-4% target range.  With no liftoff this week, we think it is very likely come at the next meeting June 23.  

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