Weaker inflation weighing on the dollar
US inflation increased by less than expected in May, rising by 4.0% during the last twelve months and by 10 basis points on a monthly basis. Economists polled by Bloomberg beforehand expected headline inflation to come in at 4.1% y/y and 0.4% m/m. The downside surprise continues the string of disinflationary data releases and constitutes the 11th fall of the headline inflation. While underlying price pressures, displayed by inflation excluding food and energy, only fell from 5.5% to 5.3%, the slump in other sticky components more than compensates for that, looking at the initial bullish repricing of stocks.
The closely watched services inflation continued its descent as well, only rising by 6.3% in May, after an 6.8% increase the month before. Excluding skewed shelter prices, services inflation rose by only 4.2%, the lowest yearly pace in more than a year, while turning negative on a 3-month annualized basis. The higher for longer narrative and the surprise rate increases in Australia and Canada, coupled with the stronger than expected British inflation and labor market reports, have spilled into Fed pricing. Markets don’t expect any rate cuts in 2023 from the US central bank. However, a look at wage growth across regions clearly dampens the speculation about any implications these data and rate surprises might have for the Fed. The US is the only country, out of the five in question, where wages & salaries have peaked and continue to come down. While individual data surprises still have the potential to shape market pricing in the short-term, the medium-term trend remains in place.
The CPI report adds to the evidence that inflation continues to weaken and has been enough to drag down market expectations of a 25 basis point hike at tomorrow’s FOMC meeting from 25% to just 5%. The US Dollar Index fell against most peers to a two-week low at around 103.20.
Hot labor market pushes pound higher
The British pound jumped against most peers in early trading today, after the latest labor market report confirmed market suspicion that more needs to be done on the monetary policy front to fight inflation. The drop in the unemployment rate to 3.8% and wage growth excluding bonuses coming in at 7.2% all but set in stone another 25 basis point hike by the Bank of England.
Demand for workers in not weakening as expected and could lead underlying inflation to remain sticky. While the 12 consecutive rate increases have impacted pro cyclical and rate sensitive parts of the economy like manufacturing and housing, post-pandemic effects are continuing to put pressure on the labor market. While the number of vacancies fell from 1.09 to 1.05 million, it is still around 25% higher than pre-pandemic levels. Markets have been bolstered in their beliefs, that the BoE will have to increase interest rates by four more times and hold the policy rate at elevated levels for longer. Rate cuts are not priced in for 2024, which stands in stark contrast to the European and US central banks.
Sterling recovered all the losses suffered during yesterday’s rout and is once again positioned around $1.26. GBP/USD is trending slightly upwards, with the levels around $1.24 and $1.2670 defining the current range. GBP/EUR has come off from its 9-month high but remains elevated at €1.1640.
PBoC coming to the Euro’s rescue
The Euro has jumped above the $1.08 mark on the back of expectations that today’s inflation disappointment would support the Federal Reserve’s plan to pause its tightening cycle on Wednesday. The uptick in global risk sentiment has been carried into the European session following the surprise rare cut announcement by the Peoples Bank of China.
China’s central bank cut its short-term policy rate, known as the seven-day reserve repurchase rate, by 10 basis points to 1.9%. Not only does the cut constitute the first easing of policy rates since August 2022. It has added fuel to the speculation that more monetary support is on the way. So far, the Chinese reopening has not held up to expectations. While the loosening up of restrictions saw metro traffic and road congestion reach post-pandemic highs, leading indicators continue pointing to a slowdown in economic activity. The latest data on the second-largest economy in the world showed worse than expected numbers for new loans, imports, retail sales and industrial production.
Fiscal and monetary support out of China might have a positive effect on the Euro. As we discussed previously, all four periods of Euro strength from 2010 to 2021 have occurred while the Chinese manufacturing sector has been expanding. This explains the positive reaction EUR/USD had after the surprise rate cut. The common currency was not affected by the continued weakness of the ZEW economic sentiment index for Germany, published earlier today, which rose from -10.7 to -8.5, remaining in negative territory.
Euro jumps above $1.08 post CPI
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 12- June 16
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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.
