Written by Convera’s Market Insights team
Making sense of the dollar weakness
Boris Kovacevic – Global Macro Strategist
A stronger than expected US producer price index did little to nothing to change the overall strong sentiment driving investors into risk sensitive assets. Equity markets built on their gains from last week as the European Stoxx 600 reached another all-time high and as the US dollar fell for a second day in a row. US Treasury yields fell across the board as Fed Chair Jerome Powell played down the higher-than-expected PPI print. Inflation remains in focus with US CPI coming up today.
Both the headline and core producer price index increased by 0.5% on a monthly basis in April and have therefore risen in all but one month this year. The annual rise of the index excluding food and energy that had bottomed at 1.8% in December reached a new 8-month high at 2.4% in April. While a hot print on the surface, it failed to rattle markets for three reasons. 1) The correlation between the PPI and following CPI print has been non-significant since the pandemic, 2) some of the components going into the important PCE report the Fed is eagerly watching seem to be cancelling each other out and 3) Fed Chair Jerome Powell did not seem bothered by the rise in producer prices in his speech yesterday. Still, the PPI print and Monday’s rise in inflation expectations (NY Fed) put emphasis on today’s consumer price index, which is expected to come in at 0.3%, a monthly rise inconsistent with the 2-percent target. A separate release is expected to show US retail sales losing some steam in April (0.4%), after having risen by 0.9% and 0.7% in the two previous months.
This week’s weakness of the US dollar is a bit surprising but not hard to explain. Sentiment continues to be positive as central banks are expected to ease policy this year, supporting global equities. Second, we have noted the dollar’s asymmetric reaction function, with the Greenback reacting more on negative than on positive data surprises. Thirdly, investors still price in inflation coming down eventually, clearly displaying the markets bias towards disinflation and the Fed cutting. We still have seven Fed speakers coming up this week and with CPI and retail sales closely watched, volatility should be higher than usual till the close on Friday.
Becoming obvious the BoE wants to cut
Boris Kovacevic – Global Macro Strategist
The pound expanded on its gains from Monday as the global equity rally continued and investors ignored comments from a Bank of England official calling for rate cuts. The FTSE 100 pushed higher as well and is now up 10% since the beginning of March, outshining its peers in the US (2%) and Europe (4%). GBP/USD has bounced off the $1.25 level last week and ended the day just shy of $1.27 yesterday, the strongest daily close since the middle of April. Macro and inflation data have continued surprising to the upside in the United Kingdom.
Still, the expected fall of consumer inflation to 2% and dovish comments from a plethora of British policy makers have made it hard for the pound to rise substantially. Just yesterday, the BoE’s chief economist Huw Pill voiced his opinion on a possible rate cut this summer. As he was not one of the two members voting for a rate cut in the May meeting, his comments seem to hold a lot of weight for investors believing policy easing could come as soon as June.
The lack of further data releases this week for the United Kingdom make the pound sensitive to US data. Fed pricing continues to dominate overall FX price action and with CPI, retail sales and initial jobless claims coming up, there will be plenty to digest.
Euro tests 100-day barrier
Ruta Prieskienyte – FX Strategist
The euro had its best day in over a week, climbing to a near 5-week high of $1.0826, amid cooling demand for greenback despite stubborn US PPI deepening uncertainty over Fed rate cut trajectory. Both major European stock indices closed the day flat, as investors turn their attention to the April US CPI print for more clarity.
Domestically, the latest ZEW survey report confirmed that the worst of the bloc’s downturn is now behind us. The German ZEW investor sentiment gauge jumped to 47.1 in May, as real incomes climbed, domestic consumption improved, and export demand recovered. The measure rose for a tenth consecutive month and to the highest level since February 2022. Nevertheless, the ZEW’s current component remains depressed despite improving for a third consecutive month, highlighting the risk to growth in the near term as the industrial sector struggles to shake off its downturn. The improving expectations continue to be bolstered by the prospect of a June ECB rate cut. Speaking at the Annual FBA meeting alongside Fed’s Powell, ECB’s Knot reaffirmed that the next meeting in June may be the right time to start lowering borrowing costs, reinforcing expectations that monetary easing is imminent.
EUR/USD broke above its 200-day SMA as hotter expected US PPI report injected much needed volatility in an otherwise subdued trading environment, with the pair already eyeing its 100-day SMA around $1.0826. Option implied volatility for overnight tenure shot up to 12.25% – a 6-month high. Another above expectation reading could see euro bulls race towards $1.0900, a convincing sign that EUR/USD has broken out of a bearish trend since the beginning of March. Market participants are positioning for a stronger euro, with 1-week EUR/USD risk reversals most bullish since February as investors are betting softer US inflation will bring the outlook for monetary policy on both sides of the Atlantic closer in sync. Against this backdrop, hedge funds have reduced their shorts on the euro by around 40% over the past month, according to the latest CFTC data. At the time of writing, the swap implied probability of an ECB rate cut next month stood steady around 95%, with 68bps cuts priced in by-year end vs Fed’s 54bps.
CAD volatility at multi-week highs
Ruta Prieskienyte – FX Strategist
The Canadian dollar could be in for a sizable move against the Greenback following the release of today’s US CPI data. Implied volatility on overnight options for the pair, which captures today’s event risk, rose to 11.13% – a 1-month high, before paring the advance. The 1-week 25-delta risk reversals in USD/CAD narrowed to 21 bps, the most bearish dollar sentiment since the beginning of April. Having said that, the 10-delta flies on the same tenor trade at 0.18 vol and suggest that a sizable move in either direction is likely to meet a fading interest.
USD/CAD has depreciated for the past 5 consecutive trading session and is currently situated near a 1 ½ week low of $1.3626. From technical perspective, the pair is resting at its 50-day SMA and a break below could see the Canadian dollar test the 200-day SMA level situated at $1.3567.
Looking at today’s calendar, Canadian housing starts and manufacturing sales reports are both due today, but are likely to be ignored in favour of the US developments.
DXY slips below 105 amid Powell comments
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 13-17
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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.
