Dollar to snap 5-week losing streak?
Disappointing data from the US yesterday fuelled year-end US rate-cut bets once again, which softened US dollar demand. Softer jobless claims, weak manufacturing activity and a fall in prices paid weighed on the dollar. However, strong bank earnings this week have helped to firm up a Federal Reserve (Fed) hike next month and the dollar index looks set to achieve its first weekly rise in five.
Recurring US unemployment benefit claims jumped to the highest level since November 2021, indicating some softening in the labour market. While this data can be volatile from week to week, the pickup in continuing claims adds to signs that the labour market is beginning to lose momentum. In addition, separate data showed a gauge of manufacturing activity in the Philadelphia area plunged in April to the lowest level since May 2020 amid weak demand, and indicators of prices paid and received also fell to their lowest levels in three years. This is adding to growing recession fears in the US, keeping rate-cut bets alive, which has been the main catalyst for the dollar depreciation since late last year. Next up, we have flash PMIs throughout the day, which will provide more detail on the health of economic activity and the scope of recession risks in several major economies.
The US dollar index has pulled back 11% from its peak last year, but remains historically strong, meaning there is certainty room for more downside this year. However, if we witness a spike in volatility from the current low levels in equity, bond, and FX markets, this could fuel safe haven demand back into the dollar in the short-term.
UK morale highest in over a year
UK consumer confidence and retail sales data dropped in this morning and highlights how the UK economy has been dealing with higher interest rates and persistent double-digit inflation. Consumer morale jumped to its highest level since February last year whilst retail sales fell more than forecast. Sterling remains unfazed, trading within a 1-cent range over the past three trading days versus the dollar and euro.
This week’s hotter than expected UK wage and inflation data has raised expectations that the Bank of England (BoE) will deliver another 25-basis point rate rise at the May meeting. Meanwhile, terminal rate pricing signals that the bank rate could reach 5% by November. This high inflation regime, coupled with increasing vulnerability to higher rates due to variable mortgage rate exposure, doesn’t bode well for the UK economy. Moreover, it may take the UK longer to achieve positive real rates if inflation remains much higher than its G7 peers. This should weigh on the value of the pound. However, despite these risks, the GfK consumer confidence indicator rose to -30 in April, exceeding market expectations as Britons took a more positive view of their finances and the health of the wider economy. Retail sales dropped in March though, after consumers splashed their cash during the two months prior.
The current tug-of-war between US and UK rate expectations is likely to keep GBP/USD anchored near current levels. The $1.25 level remains an area of stiff resistance and although some calls for $1.30 are growing louder, there is an increased risk that sterling will be susceptible to another dovish BoE hike given how quickly rate expectations have risen this week.
Inflation to keep ECB hawkish
The minutes of the European Central Bank’s (ECB) March meeting confirmed that had it not been for the banking sector turbulence last month, the central bank would have more convincingly signalled additional tightening ahead. Banking worries have since receded and inflation remains sticky. This could result in a more hawkish ECB, raising rates several more time , though this depends on the incoming data.
Back when the ECB raised interest rates by 50 basis points at that March meeting, it said the outlook was too uncertain to commit to more, but several policymakers saw risks to the inflation outlook “as tilted to the upside over the entire horizon”. Another rate hike at the May meeting looks like a done deal, but the size of the move remains open and could be influenced by the flash estimate for April inflation, the Q2 bank lending survey and the March credit number, which are all published just days ahead of the ECB’s decision and could inject volatility into markets as a result. Diverging rate differentials continue to be a prime driver of FX right now rather than the economic surprise differential which has favoured the US since the start of this year. EUR/USD appears to have decoupled from this correlation and is rising with narrowing US-EZ rate spreads instead.
After seven successive weekly gains, EUR/USD has been running out of steam near the $1.10 threshold though. A period of relative inertia may take hold until the key central bank meetings in May provide more guidance on the monetary policy outlook.
FX volatility eases ahead of CB decisions
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: Apr 17-21
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.