Euro Boosted by PMIs and Wage Growth

May 23, 2024

Win Thin

FOMC minutes tilted hawkish; financial conditions continue to loosen; S&P Global preliminary May PMIs will be the highlight; April Chicago Fed NAI will also be important; Chile is expected to cut rates 50 bp to 6.0%; Mexico reports mid-May CPI
Eurozone reported solid preliminary May PMIs; ECB Q1 negotiated wage data ran hot; U.K. Prime Minister Sunak has called general elections for July 4; U.K. reported soft preliminary May PMIs; Turkey is expected to keep rates steady at 50.0%
Japan reported solid preliminary May PMIs; Australia reported softer preliminary May PMIs; New Zealand reported firm Q1 retail sales; Korea kept rates steady at 3.5%, as expected

The dollar is giving back some of its recent gains ahead of S&P Global PMIs. After testing the 105 level on hawkish FOMC minutes (see below), DXY is trading lower 104.738. The euro is trading higher near $1.0845 after firm eurozone PMIs and hot Q1 negotiated wage growth (see below), while sterling is trading flat near $1.2725 after soft U.K. PMIs (see below). Reports of U.K. general election called for July 4 had little market impact. Lastly, USD/JPY is trading lower near 156.70 after solid PMIs (see below). Despite last week’s data, we believe the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. Markets have already taken back Fed easing expectations and so we look for the dollar recovery to continue.

AMERICAS

FOMC minutes tilted hawkish. With regards to inflation, “Participants noted disappointing readings on inflation over the first quarter and indicators pointing to strong economic momentum, and/ assessed that it would take longer than previously anticipated for them to gain greater confidence that inflation was moving sustainably toward 2%.” With regards to policy, “Although monetary policy was seen as restrictive, many participants commented on their uncertainty about the degree of restrictiveness.” Also, “Participants discussed maintaining the current restrictive policy stance for longer should inflation not show signs of moving sustainably toward 2% or reducing policy restraint in the event of an unexpected weakening in labor market conditions. Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate.”

The hawkish tilt was not a huge surprise given how cautious Fed officials have been since the May 1 decision. Despite the cautious statement and minutes, Powell still delivered a very dovish press conference that day, which makes us think that he went rogue. The market sees 5% odds of a cut in June, rising to 20% in July and 70% in September. These odds are back to where they were before last week’s soft data and so it’s clear that the market remains unconvinced that the Fed will pivot earlier than previously anticipated. Bostic speaks today.

Financial conditions continue to loosen. The Chicago Fed’s measure has loosened five straight weeks through Friday May 17 and are the loosest since November 2021. This simply does not square with ongoing Fed comments that policy is restrictive.

S&P Global preliminary May PMIs will be the highlight. Manufacturing is expected at 49.9, services is expected at 51.2, and the composite is expected at 51.2, which would all be down a tick from April. Chicago PMI will be reported next week but ISM PMIs won’t be reported until the first week of June.

April Chicago Fed National Activity Index will also be important. Recall that a positive reading means the economy is growing above trend. Headline is expected at 0.13 vs. 0.15 in March. If so, the 3-month moving average would rise to 0.12 vs. -0.19 in March and would be the highest since September 2022 and move further above the -0.7 threshold that signals recession.

Weekly jobless claims will hold some interest. That’s because initial claims will be for the BLS survey week containing the 12th of the month and these are expected at 220k vs. 222k the previous week. Continuing claims are reported with a one-week lag and are expected at 1.793 mln vs. 1.794 mln the previous week. Bloomberg consensus for May NFP stands at 203k vs. 175k in April while its whisper number stands at 191k.

Regional Fed surveys for May will continue to roll out. Kansas City manufacturing is expected at -7 vs. -8 in April. Kansas City services will be reported tomorrow.

Housing sector data will remain in focus. April new home sales are expected at -2.2% m/m vs. 8.8% in March. Yesterday, existing home sales came in at -1.9% m/m vs. 0.8% expected and a revised -3.7% (was -4.3%) in March.

Chile central bank is expected to cut rates 50 bp to 6.0%. At the last meeting April 2, the bank cut rates 75 bp but signaled caution ahead as it raised its end-2024 inflation forecast to 3.8% vs. 2.9% previously and raised its 2024 growth forecast to 2-3% vs. 1.25-2.25% previously. The swaps market is pricing in 175 bp of total easing over the next 12 months that would see the policy rate bottom around 4.75%.

Mexico reports mid-May CPI. Headline is expected at 4.75% vs. 4.67% previously, while core is expected at 4.31% y/y vs. 4.34% previously. If so, headline would be the highest since January and move further above the 2-4% target range. Next policy meeting is June 27 and if price pressures continue to rise, another hold seems likely. Banco de Mexico also releases its minutes today. At the May 9 meeting, the bank kept rates steady at 11.0% after starting the easing cycle with a 25 bp cut at the March 21 meeting. The swaps market is pricing in 100 bp of total easing over the next 12 months.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported solid preliminary May PMIs. Headline manufacturing came in at 47.4 vs. 46.1 expected and 45.7 in April, services came in at 53.3 vs. 53.6 expected and 53.3 in April, and the composite came in at 52.3 vs. 52.0 expected and 51.7 in April. This was the highest composite reading since May 2023. Looking at the country breakdown, the German composite came in at 52.2 vs. 51.0 expected and 50.6 in April and was driven by a big jump in manufacturing to 45.4 vs. 42.5 in April. However, the French composite came in at 49.1 vs. 51.0 expected and 50.5 in April and was driven by a big drop in services to 49.4 vs. 51.3 in April. Italy and Spain will be reported with the final PMI readings in early June. Overall, the eurozone PMIs points to improving growth momentum, tempering expectations of additional ECB policy rate cuts beyond June.

European Central Bank Q1 negotiated wage data ran hot. Wage growth picked up to 4.7% y/y vs. 4.5% in Q4 and matches the record high set in Q3. The data are disappointing and lead to greater uncertainty on the extent of rate cuts beyond June. Odds for September and December cuts have fallen to 75% after being fully priced in last week. However, we note that the forward-looking ECB wage growth tracker and other leading indicators for wage pressures (like the Indeed wage tracker and ECB surveys) suggest that negotiated wage pressures are moderating.

U.K. Prime Minister Sunak has called general elections for July 4. Most observers (us included) expected Sunak to wait until the fall, when the economy would be on firmer footing and the BOE had already started cutting rates. We don't really understand the strategy for calling elections so early. That said, we don't see much market impact as it seems pretty clear that the Tories are headed for a trouncing. The only question is, how bad the beatdown will be. According to a Bloomberg survey of investors, a Labour-led government would be the best result for stocks and the pound.

U.K. reported soft preliminary May PMIs. Manufacturing came in at 51.3 vs. 49.5 expected and 49.1 in April, services came in at 52.9 vs. 54.7 expected and 55.0 in April, and the composite came in at 52.8 vs. 54.0 expected and 54.1 in April. Slower U.K. growth momentum versus improving growth traction in the eurozone is a near-term headwind for GBP against EUR.

Turkey central bank is expected to keep rates steady at 50.0%. At the last meeting April 25, the bank left rates steady at 50.0%. With inflation still accelerating, we see some risks of a hawkish surprise this week. In April, headline CPI quickened to 69.80% y/y vs. 68.50% in March and core CPI surged to a new high of 75.81% vs. 75.21% in March. The swaps market is pricing in steady rates over the next three months, followed by the start of an easing cycle over the subsequent months. All told, 17.50 ppt of cuts are priced in over the next twelve months.

ASIA

Japan reported solid preliminary May PMIs. Manufacturing came in at 50.5 vs. 49.6 in April, services came in at 53.6 vs. 54.3 in April, and the composite rose a tick to 52.4. The composite has risen three straight months to the highest since August 2023. After Japan’s economy contracted 0.5% in Q1, the PMIs so far in Q2 offer some signs of renewed growth. However, a modest BOJ tightening cycle is still priced in.

Australia reported softer preliminary May PMIs. Manufacturing came in steady at 49.6, services fell half a point to 53.1, and the composite fell to 52.6 vs. 53.0 in April. The composite has fallen two straight months from the March peak of 53.3 but remains firmly in expansionary territory. Meanwhile, consumer inflation expectations over the next 12 months dropped to 4.1% in May, the lowest since August 2021. The swaps market sees steady rates over the next six months, followed by the start of an easing cycle over the subsequent six months.

New Zealand reported firm Q1 retail sales. Sales came in at 0.5% q/q vs. -0.3% expected and a revised -1.8% (was -1.9%) in Q4. This was the first positive reading since Q4 2021. Nonetheless, the deterioration in consumer confidence is not consistent with a sustained recovery in household spending. The ANZ-Roy Morgan consumer confidence index fell in April to an eleven-month low at 82.1 in April. The reading for May will be released tomorrow. The swaps market sees steady rates over the next three months, followed by the start of an easing cycle over the subsequent three months.

Bank of Korea kept rates steady at 3.5%, as expected. The bank raised its 2024 growth forecast to 2.5% vs. 2.1% previously but maintained its inflation forecast at 2.6%. Governor Rhee noted that “We thought the big change in the growth forecast would have a huge impact on inflation, but it wasn’t big enough to change the inflation outlook. That’s big news for us.” Rhee added that “Uncertainties over the timing of a rate cut have grown. If there is confidence that inflation stabilizes, the task of normalizing the rate level would need to be started.” The swaps market still sees steady rates over the next six months, followed by the start of an easing cycle over the subsequent six months.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.