Written by Convera’s Market Insights team
Dollar faces crucial inflation test
George Vessey – Lead FX Strategist
The US inflation report is a big risk event for financial markets today. The last three reports have shown both the headline and core readings surprise on the topside of expectations, in a sign that the disinflationary trend seen at the back end of 2023 has hit a speed bump. Expectations of Federal Reserve (Fed) rate cuts have been dramatically scaled back as a result, supporting the US dollar’s reign as the best-performing major currency year-to-date.
The fall of underlying inflation continues to lose momentum as shelter inflation remains stubbornly high at 5.7%. The 1- and 3-month annualised core inflation rates are twice the central bank’s target at 4.4% and 4.2%. Thus, multiple policymakers, including Fed Chair Jerome Powell, have recently indicated they are in no rush to ease policy, though the latest dot plot still showed three cuts the most likely scenario this year. Market participants have listened, with pricing currently signalling just less than three 25-basis point cuts before year-end, down from around seven at the start of the year. With markets more in line with Fed projections, the degree of uncertainty has diminished leading to the correlation between the USD and the US 10-year Treasury yield falling over recent months. Hence, the dollar’s lack of strength despite the 10-year hitting November highs on Monday.
Headline CPI is forecast at 3.4% versus February’s 3.2% release and core CPI is forecast at 3.7%, down a touch from February’s 3.8% release, which should not move the dial on current Fed expectations. Overnight implied volatility gauges aren’t signalling huge swings in FX markets today, but there is still a risk that a sizeable miss or beat of the forecast could rock the boat.
Slight spring in sterling’s step
George Vessey – Lead FX Strategist
The British pound extended higher against the US and Canadian dollars yesterday ahead of today’s US inflation report and the Bank of Canada’s meeting. GBP/CAD is less than 1% away from 2-year highs, whilst GBP/USD breached $1.27 to hit its highest level since the Bank of England’s (BoE) dovish hold on March 21. Positive UK retail sales news and cautiously upbeat investor sentiment helped support sterling demand in a month where the pound usually appreciates against its North American counterparts.
Volatility in FX markets remains extremely compressed though. A measure of GBP/USD daily price changes over a rolling 3-month basis shows realised volatility at its lowest level since the 1990s. The currency pair has oscillated in a mere 3% range year-to-date, its smallest quarterly trading range since 2007. On a weekly basis, GBP/USD has swung, on average, 2% since 2007, but has failed to swing over 2% for the last 16 weeks, its longest such stretch since 2014. The current dovish policy regime, with rate cuts expected from advanced economies, is creating this low volatility environment and unless we see renewed spike in inflation or an external shock, volatility is likely to remain subdued.
Rangebound trading persists, and momentum indicators are neutral, but we do note yesterday’s bullish break above the 50- and 100-day moving averages for GBP/USD. This also saw a break north of the short-term descending trendline that’s been in place since early March. Absent an upside US inflation surprise today, we could see the pound scale back towards the top of its 2024 range nearer $1.29 over the next few weeks, but if seasonality trends persist, May could be a down month for cable.
Euro retreats ahead of US data
Ruta Prieskienyte – FX Strategist
The euro pulled back marginally across all G10 currencies, apart from CAD and SEK, as investors grew cautious ahead of this week’s key data events. European stocks traded in the red, with both the STOXX 50 and STOXX 600 falling about 0.5%, while the yield on the 10-year German government Bund also retreated to the 2.4% mark after reaching a three-week high of 2.457% on Monday.
The ECB’s quarterly Bank Lending Survey, published yesterday, showed that bank lending across the bloc continues to flatline. Expectations of loan demand recovery expressed in last quarter’s survey failed to materialise as demand for corporate loans in the Eurozone saw a substantial 28% q/q decline in Q1 2024. Meanwhile loan demand for consumer credit turned positive for the first time since Q3 2022. The survey also showed that credit standards were a little tighter for firms across the bloc. The ECB policy makers will be parsing such data to determine the timing and the magnitude of the upcoming policy rate easing. With inflation in retreat, cuts are expected to begin in June, with swap implied probability hovering around 90%. While the central bank is widely expected to maintain its key policy rates at record highs during tomorrow’s rate decision, the focus will be on the communication as the bank is expected to prepare the markets for the looming rate cuts.
For now, EUR/USD appears to be rangebound and is unlikely to exhibit much volatility ahead of the US CPI release later today. In the immediate term, the pair is trapped between three key moving averages. The 50-day and 200-day SMA around $1.0830-$1.0840 level provide support while the 100-day SMA at $1.0870 caps further EUR/USD gains. A decisive break above the 100-day SMA would support the bullish case, and we could see a rally towards $1.0940 level, while a breach below $1.0830 could see further euro weakness and could see the pair test April lows at $1.0720. Today’s US CPI could be just the catalyst for that.
Dollar struggles despite rise in US yields
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: April 8-12
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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.
