Will USD Rally Get Turbocharged?

March 15, 2024

Will USD Rally Get Turbocharged?

  • Higher US consumer inflation expectations can further curtail money market expectations of Fed funds rate cuts this year and turbocharge USD higher.
  • JPY got whipsawed following the significantly higher trade union wage hikes.
  • ECB policymakers continue to telegraph a June policy rate cut.

USD and 10-year Treasury yields are consolidating yesterday’s solid gains. The gains were triggered by more signs the progress on US inflation may be stalling, suggesting the Fed can be patient before loosening policy. Fed funds futures have trimmed the probability of a June rate cut (56% versus 66% on Monday) but still imply roughly 75bps of easing this year.

The less volatile US core PPI (excludes food, energy & trade services) rose 0.1pts to 2.8% y/y in February, indicating companies are not absorbing higher input prices. The pick-up in PPI inflation comes on the heels of the US February CPI report which showed core inflation sticky around 4% y/y and the New York Fed’s consumer survey pointing to an increase in medium/long-term inflation expectations.

The US retail sales report was disappointing as the control group (which exclude cars, gas, food services, and building materials and feeds into the GDP calculation) was flat in February following a 0.3% decline in January. Nonetheless, we don’t expect US consumer spending to rollover because real wage growth remains positive, and the labour market is resilient. Indeed, total nonfarm payroll employment continues to rise at an above average clip and jobless claims are historically low.

Overall, we see scope for Fed funds rate expectations to adjust higher in favour of a firmer USD because underlying US price pressures are still high, and the economic growth outlook is encouraging. The risk to our bullish USD view is the Fed dismissing the latest high inflation readings as noise and power forward with a dovish stance. This would lead to lower US real interest rates and undermine USD against most major currencies.

The US data highlights today are the: February import and export price indexes (12:30pm London), February industrial production (1:15pm London), and March University of Michigan consumer sentiment index (2:00pm London). The US terms of trade (export/import prices), a general measure of a country’s wealth, has been in a downtrend for the past year and is a long-term headwind for USD. Industrial production is expected to stagnate in February but the ISM manufacturing index points to a contraction.

Regardless, the March University of Michigan consumer sentiment index will likely generate more financial market volatility. The headline index is projected to improve by 0.2pts to 77.1 consistent with an encouraging household spending outlook. Importantly, one-year ahead expectations for inflation is anticipated to rise by 0.1pts to 3.1% (this measure has oscillated around 3% since December 2023) and inflation expectations over the next five-to-ten years is projected to remain at 2.9% for a 4th consecutive month. Higher inflation expectations can further curtail money market expectations of Fed funds rate cuts in 2024 and turbocharge USD higher.

JPY got whipsawed following the significantly higher trade union wage hikes. Japan’s Rengo, the largest trade union, agreed on total pay increases averaging 5.28% in 2024. This is up from 3.8% in 2023 and higher than the 4.1% rise expected by a Bloomberg survey of economists. The probability implied by interest rate futures (OIS) of a 10bps Bank of Japan (BOJ) policy rate hike next week rose briefly to a high around 70% before settling back down around 60%. In our view, Japan’s improving inflation backdrop and soft economic activity suggest the BOJ is unlikely to normalise the policy rate by more than is currently priced-in over 2024 (25bps total rate hikes). As such, USD/JPY will likely remain well supported above its 200-day moving average (146.39).

EUR/USD is holding under 1.0900. ECB policymakers continue to telegraph a June policy rate cut (fully priced-in). Governing Council member Olli Rehn noted this morning the ECB “will be able to gradually start taking its foot off the monetary-policy brake when the summer nears”.

GBP/USD remains heavy around 1.2740. The UK February BOE/Ipsos inflation attitudes survey is the domestic focus (9:30am London). The Bank of England will continue to monitor measures of short and longer-term inflation expectations to ensure they ease closer to the 2% target.

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