U.S. yields are rising again; Fed Chair Powell added to the hawkish Fed chorus; Fed tightening expectations remain relatively robust; S&P Global (formerly Markit) preliminary April PMI readings will be the highlight; Canada highlight is February retail sales data; Mexico reports mid-April CPI data
ECB President Lagarde offered a more nuanced view of the state of affairs than the hawks; yet ECB tightening expectations continue to pick up; eurozone preliminary April PMI readings came in firm; U.K. reported weak March retail sales data
Reports suggest U.S. and Japan officials discussed the possibility of coordinated FX intervention; the boilerplate G-7 communique on FX markets is rather unremarkable; we downplay imminent risk of FX intervention; Japan reported March national CPI; PBOC Governor Yi is tilting more to the hawkish side; the yuan should continue to weaken
The dollar continues to benefit from rising U.S. yields. DXY is up for the second straight day and traded at a new cycle high near 101.068. After this correction, the March 2020 high near 103 remains our next target. The euro is back testing $1.08 after it traded yesterday at the highest level since April 11 near $1.0935. We still look for a test of last week’s new cycle low near $1.0760 and a break below would set up a test of the March 2020 low near $1.0635. After trading at a new cycle high near 129.40 Wednesday, USD/JPY has stalled out and is stuck near 128.30 as jawboning continues to intensify (see below). Until the BOJ changes its ultra-dovish stance, we look for an eventual test of the 2002 high near 135.15. Sterling is underperforming on weak economic data (see below) and tested the November 2020 low near $1.2855. We look for an eventual break that sets up a test of the September 2020 low near $1.2675. Between the likely return of risk-off impulses and still-rising U.S. yields, we believe the dollar uptrend has resumed after this recent correction.
U.S. yields are rising again. The U.S. 10-year yield traded at 2.97% today, just shy of the 2.98% cycle high from Wednesday. We believe it remains on track to test the October 2018 high near 3.26%. Elsewhere, the 2-year traded at a new cycle high near 2.77% today and we believe it remains on track to test the November 2018 high near 2.97%. The 2-year differential with Japan is at a new cycle high near 280 bp but the differential with Germany has stalled out near 248 bp as markets ratchet up ECB tightening expectations (see below).
Fed Chair Powell added to the hawkish Fed chorus. He said a 50 bp hike is on the table in May and that there is merit in “front-end loading” its tightening cycle. Echoing other Fed officials, he said that the Fed won’t count on supply side healing to help inflation, implying that the Fed is now more focused on the demand side of the equation. He noted some tightening in financial conditions, adding that the bond market is not looking like a safe place to be. Elsewhere, Bullard noted that inflation expectations are threatening to become unhinged, adding that the Fed has hiked 75 bp before without the world coming to an end. He admitted the Fed is behind the curve but “isn’t as far behind the curve as you think we are.” That said, Bullard also reiterated that he favored the Fed Funds rate at 3.5% based on a modified Taylor Rule. In related news, Chicago Fed President Evans announced he will retire in early 2023. The regional Fed presidents are chosen by each bank’s board, not by President Biden. At midnight tonight, the media blackout ahead of the FOMC meeting takes effect and there will be no Fed speakers until Chair Powell’s post-decision press conference the afternoon of May 4.
Fed tightening expectations remain relatively robust. WIRP suggests 50 bp hikes at the May 3-4 and June 14-15 meetings are fully priced in, with odds of possible 75 bp moves creeping into low but positive territory. Looking ahead, swaps market is pricing in nearly 300 bp of tightening over the next 12 months that would see the policy rate peak near 3.5%, up from 3.25% at the start of last week. While the 3.5% meets our own call for the 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.
S&P Global (formerly Markit) preliminary April PMI readings will be the highlight. Manufacturing is expected at 58.0 vs. 58.8 in March, services is expected to remain steady at 58.0, and the composite PMI is expected at 57.9 vs. 57.7 in March. ISM PMI readings will be reported the week after next. Philly Fed was reported yesterday at 17.6 vs. 21.4 expected and 27.4 in March, while Empire Survey was reported last week at 24.6 vs. 1.0 in March. Data suggest that the manufacturing sector had solid momentum is we moved into Q2.
Canada highlight is February retail sales data. Headline is expected at -0.5% m/m, while sales ex-autos are expected at 0.1% m/m. Last week, the Bank of Canada delivered the expected 50 bp hike and maintained an extremely hawkish tone. Since then, Governor Macklem said he could not rule out even larger hikes ahead. WIRP suggests a 50 bp hike at the next meeting June 1 is fully priced in, with nearly 40% odds of a 75 bp move. Looking ahead, swaps market sees the policy rate peaking near 3.5% over the next 24 months, up from 3.0% at the start of last week.
Mexico reports mid-April CPI data. Headline inflation is expected at 7.51% y/y vs. 7.29% in mid-March. If so, inflation would continue to move above the 2-4% target range. Banco de Mexico delivered the expected 50 bp hike to 6.5% in March. Minutes showed a range of views on further tightening but suggested there is a consensus to continue hiking rates at the current 50 bp pace. Next policy meeting is May 12 and another 50 bp hike to 7.0% seems likely. Swaps market sees the policy rate peaking near 9.25% over the next 12 months.
European Central Bank President Lagarde offered a more nuanced view of the state of affairs than the hawks. She noted that Europe’s recovery is being stalled to a certain degree, with risks skewed to the downside for growth. Lagarde noted that the eurozone and U.S. economies are moving at a different pace and that inflation must be addressed in a gradual way. She acknowledged that the June meeting is key for the end of APP and determining the potential rate path. Lastly, she noted that ECB policy is about normalization, not tightening.
Yet ECB tightening expectations continue to pick up. WIRP suggests odds of liftoff June 9 are only around 30% now vs. nearly 60% at the start of last week, but liftoff July 21 remains fully priced in. Swaps market is now pricing in nearly 60 bp of tightening over the next 6 months that would take the deposit rate into positive territory. Looking further ahead, the market is pricing in nearly 150 bp of tightening over the next 12 months vs. 125 bp at the start of this week and another 75 bp of tightening priced in over the following 12 months. This still seems way too aggressive to us. Lagarde speaks again today and is likely to maintain her more measured approach.
Eurozone preliminary April PMI readings came in firm. Headline manufacturing came in at 55.3 vs. 54.9 expected and 56.5 in March, services came in at 57.7 vs. 55.0 expected and 55.6 in March, and the composite PMI came in at 55.8 vs. 53.9 expected and 54.9 in March. Looking at the country breakdown, the German composite came in at 54.5 vs. 54.1 expected and 55.1 in March while the French composite came in at 57.5 vs. 55.0 expected and 56.3 in March. The firm readings are a pleasant surprise but we find it difficult to believe these readings will hold up as the Ukraine crisis shows no signs of abating. Final April PMI readings will be reported the week of May 2.
U.K. reported weak March retail sales data. Headline sales came in at -1.4% m/m vs. -0.3% expected and a revised -0.5% (was -0.3%) in February, while sales ex-auto fuel came in at -1.1% m/m vs. -0.4% expected and a revised -0.9% (was -0.7%) in February. Preliminary April PMI readings were also reported. Manufacturing came in at 55.3 vs. 54.0 expected and 55.2 in March, services came in at 58.3 vs. 60.0 expected and 62.6 in March, and the composite PMI came in at 57.6 vs. 58.7 expected and 60.9 in March. It’s clear from today’s data that the economy was already slowing before we moved into Q2, which will bring even greater headwinds that include hikes in payroll taxes and the cap on household energy costs.
Bank of England tightening expectations remain steady. WIRP suggests another 25 bp hike to 1.0% is fully priced in for the next meeting May 5, while swaps market is pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 2.75%. Despite BOE tightening, sterling continues to sink under the weight of softer data and traded today at a new low for this move near $1.2860, just above the November 2020 low near $1.2855. Further losses are likely and a break below that low would target the September 2020 low near $1.2675.
Reports suggest Finance Minister Suzuki discussed the possibility of coordinated FX intervention with Treasury Secretary Yellen. The report described the tone on the U.S. side as one of “positive consideration.” Elsewhere, Suzuki acknowledged that he discussed recent abrupt moves in the yen with Yellen and that the two agreed to uphold existing FX agreements. Suzuki declined to comment on whether the two spoke about FX intervention, adding that the talks focused more on the state of their respective economies rather than focusing on FX concerns. He added “We discussed existing Group of Seven thinking on foreign exchange. We’ll respond based on that agreement.”
The boilerplate G-7 communique on FX markets is rather unremarkable. Past ones have gone something like this: ““We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange rate markets closely, and cooperate as appropriate.” However, the G-7 sometimes slips in a second paragraph that references a hot button topic of the time, such as China’s highly managed yuan regime of the past.
We downplay imminent risk of FX intervention. So far, the weak yen has had limited spill over into other markets. The Nikkei 225 is right in the middle of recent trading ranges, while JGB yields are little changed, anchored by the Bank of Japan’s Yield Curve Control. Outside of FX, global financial markets appear to be paying very little attention to the yen’s downward slide. Until the BOJ changes its ultra-dovish stance, the monetary policy divergence argues for continued yen weakness and intervention would likely have little lasting impact.
Japan reported March national CPI. Headline came in as expected at 1.2% y/y vs. 0.9% in February, while core (ex-fresh food) came in as expected at 0.8% y/y vs. 0.6% in February. Of note, CPI ex-fresh food and energy came in a tick higher than expected at -0.7% y/y vs. -1.0% in March. Reports suggest the Bank of Japan will probably raise its FY22 projection for core inflation to 1.5-1.9% vs. 1.1% seen in January. The BOJ will also probably cut its FY22 growth forecast from 3.8% seen in January. However, officials stressed that there is no need to tighten policy as the impact from high oil prices is seen as temporary. As these forecasts will be part of the Outlook Report for the upcoming April 27-28 meeting, the tone of these remarks suggest the bank will reaffirm its current policy stance. In turn, this argues for continued yen weakness.
The economy continues to recover as pandemic restrictions are lifted. Preliminary April PMI readings were also reported. Manufacturing came in at 53.4 vs. 54.1 in March, services came in at 50.5 vs. 49.4 in March, and composite came in at 50.9 vs. 50.3 in March. Australia also reported preliminary April PMI readings. Manufacturing came in at 57.9 vs. 57.7 in March, services came in at 56.6 vs. 55.6 in March, and composite came in at 56.2 vs. 55.1 in March.
People’s Bank of China Governor Yi is tilting more to the hawkish side. He stressed the importance of keeping inflation under control in two separate speeches and pledged more targeted measures to support small businesses. Specifically, Yi reiterated that “policy is to maintain price stability.” He later emphasized that “China’s monetary policy’s primary objectives are stable prices and stable employment.” Yi said that monetary policy is in a “comfortable range” and is helping to support the economy but noted that “We also stand ready to support small and medium enterprises with more instruments if needed.” This cautious approach helps explain why the PBOC has recently confounded market expectations for more aggressive easing. Yet other official comments have focused on the need for more stimulus and so there appears to be a potential split developing amongst senior officials. When all is said and done, however, we believe the PBOC will eventually deliver more monetary and fiscal stimulus.
The yuan should continue to weaken. With all the focus on the move in USD/JPY, it's easy to overlook the fact that USD/CNY is trading at the highest level since August 2021 just below 6.50 and is nearing the August 2021 high near 6.5045 and then the July 2021 high near 6.5120. Looking ahead, the next target would be the March 2021 high near 6.5795. With monetary policy divergence with the Fed set to widen, we think this yuan move still has legs. Note that US-China spreads continue to move in the dollar’s favor, with the 2-year spread at levels not seen since 2010.