US consumer prices surprised to the downside, overshadowing the increase in producer prices. However, the price of goods imported from the rest of the world jumped by 0.9% in April, adding fuel to the thesis of a reflating supply chain.
Both retail sales and industrial production stagnated in April, ending a two-month streak of growth. The US economy came into the second quarter with less momentum than initially expected.
The Chinese economic recovery continues to be one sided and largely driven by the manufacturing sector as a weak consumer has limited the liftoff. This has prompted policy makers to announce the emission of long-term bonds.
German ZEW investor sentiment 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.
The US dollar is trading in negative territory versus most of its peers after the weaker CPI print. However, hawkish Fed speak and the strong rise in import prices came to the rescue of the Greenback and erased some of the losses.
Equity markets on both sides of the Atlantic climbed to record highs this week on the back of weaker US inflation and bond yields falling across the board.
Next week will be dominated by Fed speak, global PMIs and inflation for the UK, Canada and Japan. British inflation is expected to fall to close to 2%.
Regional outlook: United States
US disinflation picture complicates
CPI trumps PPI. The market’s suspicious take on the stronger than expected US PPI print on Tuesday has been proven right in the short term. The US consumer price index surprised the consensus (0.4%) to the downside by 10 basis points in April with the annual headline and core inflation rates falling to 3.4% and 3.6% respectively. The downside surprise reinforced the already underway capital allocation into risk sensitive assets like equities and the euro and pound.
Picture more complicated. However, we see this victory lap as investors taking comfort from the fact that US inflation is finally coming down again, after a long string of upside surprises rattled markets in Q1. The CPI report itself can hardly be interpreted as soft though as services inflation including and excluding the lagging shelter component remained elevated at 5.2% and 4.9%. Both the annualized and annual growth rates are far away from signaling rate cuts from the Federal Reserve (Fed). A separate report on Thursday also showed import prices (IPI) rise at their fastest pace in two years.
Hawkish Fed speak. Fed speak this week has displayed a hawkish undertone derived from a reflationary Q1. While rate hikes have been taken off the table by Fed Chair Jerome Powell, the central bank is not expected to ease policy in the first half of the year. Still, traders did firm up bets on Fed rate cuts in both September and December, with pricing pointing to a year-end policy rate of 4.75%-5%, down from the current range of 5.25%-5.5%. To further lift these expectations will be the job of the macro data over the coming months, which is expected to weaken further.
Weaker growth. Both retail sales and industrial production stagnated in April, ending a two-month streak of growth. The US economy came into the second quarter with less momentum than initially expected with leading indicators like the purchasing manager index for the manufacturing sector entering negative territory once again.
Regional outlook: China
Downward pressure on the yuan mounts
The two-way recovery. The Chinese economic recovery continues to be one sided and largely driven by the manufacturing sector as weak consumer confidence and spending have limited the liftoff. Retail sales surprised the consensus to the downside, rising by an annual 2.3% in April. While it constituted the 15th y/y increase in a row, it was still the slowest pace since December 2022. The property sector remains the weakest link in the Chinese economy. New and existing home prices fell by 0.58% and 0.94% in April, extending their yearly losses to 3.5% and 6.8%, the steepest declines in a decade. This has prompted policy makers to lift buying restrictions and announce the emission of long-term bonds, which have made Chinese equities the best in the world in May so far.
PBoC keeping the yuan afloat. The Chinese yuan would be trading much lower versus the G10 currencies would it not be for the central bank’s tight capital controls. The world underwent one of the most synchronized tightening cycles of the last four decades since 2022. So, what happened to financial conditions, money growth and longer-dated government bond yields in China in the meantime? They all fell to their lowest level in more than 20 years. Such a monetary decoupling from the second largest economy in the world has put pressure on the yuan since 2022. However, the incredible range-bound movement so far this year can be attributed to the PBoC holding the yuan afloat.
The trade war from 2018 never ended. The United States will increase tariffs on a variety of Chinese imports, including critical materials for both AI developments and the green revolution – two sectors China has recently made strides in strengthening its position as one of the worlds leading exporters. While the changes will affect only around $18 billion of goods, the tariff on semiconductors and electric vehicles will rise from 25% to 50% and 100%. Markets brushed off the new tariffs as the retaliatory action from Beijing is expected to be measured and targeted. While geopolitics has failed to move global markets, it will remain in investors minds as the world gears up for the US presidential election in November.
Regional outlook: Eurozone
On track for a soft landing
Worst is 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.
EC sees improving Eurozone growth and inflation outlook. As expected, the Eurozone economy expanded 0.3% in Q1 2024, recovering from a technical recession recorded at the end of 2023. The report marks the strongest GDP growth since Q3 2022, after suffering a year of stagflation throughout 2023 and even Germany, the continent’s main growth hinderance, managed to expand by more than expected. According to the European Commission’s (EC) latest projections, GDP is forecasted to increase by 0.8% this year and 1.4% in 2025 — almost unchanged compared with the winter report, but inflation is now seen as slowing to 2.5% and 2.1% this year and next — down from 2.7% and 2.2% previously.
Markets price in more aggressive rate cuts. German bond yields plunged lower across the curve, with back-end yields on 10-year benchmark Bunds sliding as much as 11.6bps – the largest daily drop since end of August 2023. The European Stoxx 50 also hit a fresh record level, as markets piled into equities on a confirmation that the common bloc emerged from a recession and a promise of imminent rate cuts. Swaps are currently pricing 24bps of easing next month and 73bps this year.
Week ahead
Fed minutes, UK inflation and European PMIs
Markets have chosen to look the other way when it comes to inflation data surprising to the upside (PPI, IPI) and have focused on CPI coming down again after a string of upside surprises in Q1. The upcoming week will be about the Fed’s meeting minutes shedding light on policy makers’ recent thinking, inflation in the UK, Canada and Japan continuing to make its way to the 2% target and PMIs in Europe confirming the acceleration of the economy. We have counted more than a dozen Fed speeches coming up next week as well, which will likely emphasize the central bank’s cautious approach.
Fed minutes. Fed officials have continued reiterating the higher-for-longer mantra against the backdrop of inflation surprising to the upside. However, the overall expectation of inflation eventually coming down to the 2% target remains persistent. Two things will be watched closely when it comes to upcoming Fed speak and the meeting minutes. 1. How is the Fed thinking about immigration and labor productivity as it relates to the labor market and inflation. 2. How is the assumption of goods disinflation continuing to put pressure on headline inflation at risk from a reflating supply chain.
UK inflation trending lower. British inflation is expected to have come down from 3.2% in March to around 2.1% in April. This would be in line with the Bank of England’s own projection and should bring the central bank even closer to considering June as the start of the cutting cycle.
Watching the European recovery. The purchasing manager index for both the services and manufacturing sector will be releases for most European countries on Thursday. Leading indicators have been trending higher as of late. It will be important to confirm the thesis that the rebound continued through May.
FX Views
Pro-cyclical currencies pounce
USD Stabilization from here? The US dollar fell against its G10 peers this week, with standout losses against pro-cyclicals like NZD (-1.7%) AUD (-1.1%) GBP (-1.1%) and EUR (-0.9). Signs of cooling US inflation and a softening US economy have raised the prospect of Fed rate cuts, hence the fall in US yields across the curve to over 1-month lows. The extent of USD weakness is a bit surprising given US inflation is still anything but soft. However, we note three key explanations for the market’s reaction. First, global risk sentiment continues to be positive as central banks are expected to ease policy this year, supporting high beta FX. Second, the dollar’s ongoing asymmetric reaction function, with the Greenback reacting more on negative than on positive data surprises – note the US Economic Surprise Index has fallen to the lowest since January 2023. Third, investors still price in inflation coming down eventually, clearly displaying the markets bias towards disinflation and the Fed cutting. In the short-term, there lacks enough US data to justify a significantly weaker dollar, thus we could see a further stabilisation in USD crosses. Plus. if cross-asset volatility remains suppressed – encouraging carry trades – this will support the high-yielding buck.
EUR Rally may be short lived. The euro advanced to a 6-week high, negating its YTD bearish trend channel. The common currency is on course for a fifth consecutive weekly advance – its best performance in 13 months, supported by a narrowing in DE-US 2-year yield spreads to the tightest level in almost 6 weeks. Short-term market sentiment, as measured by the 1-week risk reversal in the options market, is the most euro bullish so far in 2024. But as longer-term measures continue to favour the US dollar, position rebalancing is likely the main driver of recent sharp euro appreciation. As EUR/USD trades above its key short- and long-term moving averages, the pair should pull back from the current stretched levels as momentum meets fading interest. Looking ahead, as mentioned over the past few weeks, a marginal divergence in the timing and magnitude of interest rate expectations between the Fed and the ECB remains an overarching euro negative factor. The ECB is expected to cut in under 3 weeks’ time and by 73bps by year-end versus the Fed’s 60bps. As realised volatility wanes, so should the short-term euro rally.
GBP Gains fizzle, inflation crucial. Sterling surged to a 5-week high of $1.27 against the US dollar, breaking out of a 3-month descending trend channel and scoring its second largest weekly rise of 2024. Despite bets of a BoE rate cut in June rising above 50%, aided by recent signs of a cooling UK labor market, the overall rise in global rate cutting bets has bolstered demand for pro-cyclical currencies, like sterling. Although not so strong year-to-date, the pound retains a positive correlation with improving global risk sentiment, hence the recent risk rally has helped GBP/USD to punch through several key resistance barriers, including its 50- 100- and 200-day moving averages, the pair lost energy as expected given short-term momentum indicators were peeking into overbought territory. Going forward, whilst the UK economic outlook is improving and risk sentiment remains upbeat (GBP positive factors), we could witness some modest pound weakness if the upcoming UK inflation report prompts further BoE easing bets and drives UK yields lower. If the BoE doesn’t cut next month though, and absent any major external shocks, we think the pound will resume its uptrend with eyes on the 200-week moving average ($1.2860) as an upside target by the summer.
CHF Losing out to riskier peers. The recent dovish repricing of global rate expectations has boosted global risk appetite, hurting demand for less risky currencies like the Swiss franc whilst riskier counterparts thrive. EUR/CHF has thus rallied back above the 0.98 handle, just a whisker away from 1-year highs. However, the franc has benefited from the broad USD sell-off, with USD/CHF sliding almost 2% in three weeks to test March lows around 0.90. On the domestic front, Switzerland’s producer and import prices fell 1.8% y/y in April. It was the twelfth consecutive period of decline, albeit the softest since December 2023. With inflation pressures seemingly under control in Switzerland, the Swiss National Bank is no longer selling FX reserves to strengthen the franc. Plus, markets are pricing an almost 80% chance of another SNB rate cut next month. Absent an external shock triggering safe haven CHF demand, these factors should continue weighing on the low-yielding franc throughout the year.
CNY Chinese Yuan slides on housing policy speculation. The offshore Chinese yuan (CNY) is experiencing downward pressure following reports that Beijing is considering purchasing unsold homes. This development is in line with the April Politburo meeting, which called for policy measures to reduce housing inventory and optimize incremental housing supply. This subtle shift in policy stance suggests that the government may expand existing pilot programs and allow more local governments to purchase inventory directly from the market for social housing or public rental purposes, potentially helping to stabilize the housing market. Nevertheless, chart shows 3-month interbank spread which tends to lead USD/CNY by 80 days, which suggests the path of least resistance for USD/CNY is higher. Traders should monitor key domestic data releases, such as the China loan prime rates for the 5-year tenor.
JPY Japanese PPI in line, USD/JPY resistance holds. Japan’s producer price index (PPI) for April rose at a steady 0.9% y/y pace and 0.3% m/m, closely aligning with consensus expectations. Additionally, the export price index gained 1.3% y/y on a contractual currency basis and 0.4% m/m, while import prices contracted 4.3% y/y and decreased 0.1% m/m. Resistance levels from the 2022-2023 period, specifically the 151.86-152.397 range, have now become crucial support for the USD/JPY pair in 2024. A sustained break below this zone and the 150.265-150.815 range, which marks the March-April pattern lows, is required to confirm a broader shift in trend. Until then, the Japanese yen remains vulnerable to further weakness. Key domestic data to watch includes exports, trade balance, and national core CPI.
CAD Rallies to a 5-week high as risk appetite improves. The Canadian dollar registered a fresh 5-week high of $1.3591 against its US counterpart, securing its best week in three due to rising Fed rate cut expectations. The Canadian sovereign bond yield curve shifted lower, in tandem with US Treasury yields, but the relative spread tightened supporting the Loonie. This week’s broad US dollar sell-off overshadowed disappointing Canadian macro reports, which showed the economy continues to struggle to find momentum in Q2. This factor was more evident against other major currencies, with the Loonie shedding an average of 0.7% against its other G10 peers (excl. US dollar). The markets remain undecided about the BoC’s next policy move scheduled in less than three weeks. The implied probability yo-yos between a cut and a hold, but markets appear to be consolidating around the idea of a pause for the central bank to gather more evidence of easing inflationary pressures, despite most of the central bank watched inflationary measures almost within reach of the BoC’s 1-3% target. Conviction will be tested with Tuesday’s inflation print as signs of cooler price growth could prompt traders to pile in with aggressive rate cut bets and see USD/CAD recoup its recent losses.
AUD Aussie wages disappoint, putting focus on key resistance. The Australian wage price index for the first quarter rose at a slower pace than anticipated, missing expectations. The data revealed a 0.8% quarterly increase, slightly below the consensus forecast of 0.9%. Private-sector wages climbed 0.8%, while public-sector wages rose 0.5% on a seasonally adjusted basis. Despite the miss, the Australian dollar retains near-term strength, supported by the ongoing rally in industrial metals prices. Consequently, the 0.664-0.667 resistance zone, which represents the neckline of a potential bullish reversal pattern, gains heightened importance. While we remain cautious about the prospects of a robust and sustained manufacturing cycle given global policy rates, an upside break through pattern resistance cannot be ignored. Traders should keep an eye on upcoming domestic data release, such as the Westpac consumer sentiment index.
