- U.S. yields are edging higher as risk-off impulses ease; higher U.S. rates and periodic bouts of risk-off impulses are only part of the strong dollar narrative; March core PCE reading will be important; we believe the Q1 GDP reading was a quirk that will not impact Fed policy; Fed tightening expectations remain relatively robust; Colombia is expected to hike rates 100 bp to 6.0%
- Eurozone inflation may be topping out; ECB tightening expectations have fallen a bit; eurozone Q1 GDP data were also reported
- China’s Politburo pledged to boost stimulus and contain the latest COVID outbreak; Caixin April China manufacturing and official PMI readings will be reported Saturday morning local time
The dollar is softer ahead of the weekend. DXY is down after six straight up days and traded yesterday at the highest level since January 2017 just below 104 before easing back to around 103 today. We continue to target the November 2002 high near 107. The euro traded at a new cycle low today near $1.0470 but has rebounded to almost $1.06 today. We still look for a test of the January 2017 low near $1.0340. After a period of consolidation, USD/JPY has resumed its march higher. With the help of a dovish BOJ, the pair traded yesterday at a new high above 131 but has since eased to around 130. We continue to look for a test of the 2002 high near 135.15. Sterling traded at a new cycle low yesterday near $1.2410 but has since rebounded to near $1.26. We still target the June 2020 low near $1.2250 and then the May 2020 low near $1.2075. Between lingering risk-off impulses and an eventual recovery in U.S. yields, we believe the dollar uptrend remains intact.
U.S. yields are edging higher as risk-off impulses ease. The U.S. 10-year yield traded as low as 2.71% this week but has since risen to 2.88% currently. Similarly, the 2-year traded as low as 2.47% this week but has since risen to 2.69% currently. Global equity markets are recovering, though U.S. futures are pointing to a modestly lower open. The dollar is softer today but should continue to firm along with the higher yields. This can of course be chalked up to the dollar smile theory that suggests the dollar will gain during periods of strong U.S. data and rising U.S. rates as well as bouts of risk-off sentiment.
Higher U.S. rates and periodic bouts of risk-off impulses are only part of the strong dollar narrative. Price action this week underscore that FX is always a relative story and here, developments in the rest of the world are also playing a big role in recent dollar gains. To wit: 1) ultra-dovish BOJ is negative for the yen, 2) eurozone energy risks are negative for the euro, 3) signs of eurozone inflation topping are also negative for the euro, 4) U.K. economy heading for recession is negative for sterling, and 5) China lockdowns are negative for the yuan. All of these also play a part in central bank and interest rate divergences and are the other side of the coin to the hawkish Fed. It’s hard to call a dollar top when the rest of the world is still deteriorating.
The March core PCE reading will be important. It is expected to ease a tick to 5.3% y/y but we see upside risks given CPI and PPI data already reported for March. If so, expect another leg higher in U.S. rates. Personal income and spending will be reported at the same time and are expected at 0.4% m/m and 0.6% m/m, respectively. April Chicago PMI will be reported and is expected at 62.0 vs. 62.9 in March. Yesterday, Kansas City Fed manufacturing index came in at 25 vs. 35 expected and 37 in March. Q1 Employment Cost Index and final April University of Michigan consumer sentiment will also be reported.
We believe the Q1 GDP reading was a quirk. Except perhaps for housing, virtually all other indicators point to continued strength in the economy. Indeed, the y/y rate is still a respectable 3.6% vs. 5.5% in Q4. Consumption and investment grew but were offset by weakness in inventories and net exports. Inventories are likely still being distorted by supply chain issues but a rundown in Q1 that subtracts from growth should be followed by a build in Q2 that adds to growth. Exports? Well, the Ukraine crisis is probably playing all sorts of tricks here and so we don't want to read too much into it. This is only one quarter, let's not get carried away with the "R" word. The Atlanta Fed’s GDPNow model will provide its initial estimate for Q2 GDP today. Of note, Bloomberg consensus for Q2 is currently at 3.0% SAAR.
This data will do nothing - we repeat, nothing - to impact Fed policy. WIRP agrees, with 50 bp in May and June still fully priced in with over 40% odds of a 75 bp move (which we think is unlikely). The swaps market is still pricing in 275 bp of hikes over the next 12 months and expected terminal rate of 3.25% remains in place. While this almost meets our own call for a 3.5% terminal rate, we continue to see risks that the expected terminal rate moves even higher if inflation proves to be even more stubborn than expected. The media blackout ahead of the FOMC meeting is in effect and so there will be no Fed speakers until Chair Powell’s post-decision press conference the afternoon of May 4.
Colombia central bank is expected to hike rates 100 bp to 6.0%. At the January meeting, the bank increased the pace of tightening to 100 bp from 50 bp previously but then delivered a dovish surprise at the March 31 with another 100 bp hike to 5.0% vs. 150 bp expected. We expect it to maintain the 100 bp pace for now. Inflation was 8.53% y/y in March, the highest since July 2016 and further above the 2-4% target range. The swaps market sees 450 bp of tightening over the next 12 months that would see the policy rate peak near 9.5%.
Eurozone inflation may be topping out. April eurozone headline CPI came in as expected at 7.5% vs. 7.4% in March, while core came in at 3.5% y/y vs. 3.2% expected and 2.9% in March. While it is way too early to celebrate, the data suggest there may be less pressure on the ECB to tighten in June. Looking at the country breakdown, France’s EU Harmonized headline inflation came in at 5.4% y/y vs. 5.1% expected and actual in March, while Italy’s came in at 6.6% y/y vs. 6.5% expected and 6.8% in March. Yesterday, Spain’s EU Harmonized headline inflation came in at 8.3% y/y vs. 9.0% expected and 9.8% in March and Germany’s came in at 7.8% y/y vs. 7.6% expected and actual in March.
ECB tightening expectations have fallen a bit. WIRP suggests odds of liftoff June 9 are now less than 30% vs. 40% at the start of this week, while liftoff July 21 remains fully priced in. The swaps market is now pricing in 150 bp of tightening over the next 12 months, with another 50 bp of tightening priced in over the following 12 months that would see the deposit rate peak near 1.5%vs. 1.75% seen at the start of this week. While this still seems too aggressive to us, at least markets are recognizing that 1) eurozone inflation may be peaking and 2) the risks to growth are mounting. De Cos speaks today.
Eurozone Q1 GDP data were also reported. Eurozone GDP grew the expected 0.2% q/q and 5.0% y/y vs. 0.3% and a revised 4.7% (was 4.6%) in Q4, respectively. The y/y gain was boosted by a low base from 2021. Looking ahead, a high base from 2021 will likely lead to a much lower y/y rate in Q2. Looking at the country breakdown, Italy contracted, France stagnated, and Germany and Spain grew modestly. France also reported weak March consumer spending at -1.3% m/m vs. -0.2% expected and a revised 0.9% (was 0.8%) in February, while Spain also reported weak retail sales at -4.2% y/y vs. 1.4% expected and 0.9% in February. Data suggest the eurozone was slowing in March and so it moved into Q2 with a clear loss of momentum. Indeed, while we expect the U.S. to rebound in Q2, we have far less conviction that the eurozone can do so as well, especially in light of the looming energy crunch.
China’s Politburo pledged to boost stimulus and contain the latest COVID outbreak. It issued a sweeping set of promises that sound great but are light on details. To wit: “Covid must be contained and the economy must be stabilized” ; “We should waste no time in planning more policy tools and enhance the strength of adjustment in due course” ; Authorities should “strive to achieve full year economic and social development goals”; guaranteed “supply chains in key sectors” ; pledged to “positively respond” to demands from companies for a smoother business operating environment. Yet the two main goals – boosting the economy and limiting COVID – are contradictory given Xi’s COVID Zero approach. We await more details but we’d fade any market optimism coming from China.
Caixin April China manufacturing and official PMI readings will be reported Saturday morning local time. Caixin manufacturing PMI is expected at 47.0 vs. 48.1 in March, while official manufacturing is expected at 47.3 vs. 49.5 in March. Official non-manufacturing PMI is expected at 46.0 vs. 48.4 in March, which should drag the official composite down by at least two points from 48.8 in March. This should move it closer to the Caixin composite reading of 43.9 in March. We remain disappointed with the timid policy response so far to the intensifying slowdown that threatens the growth target this year of “around 5.5%.” Lockdowns remain in place and so the data are likely to worsen in May as well.