Written by Convera’s Market Insights team
Markets cheer the fall of inflation
Boris Kovacevic – Global Macro Strategist
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 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%. The downside surprise reinforced the already underway capital allocation into risk sensitive assets like equities and the euro and pound. 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 this week as well, which will likely emphasise the central bank’s cautious approach.
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.
The US dollar fell against its G10 peers last 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.
Proud pound faces inflation test
George Vessey – Lead FX Strategist
The British pound remains the best performing G10 currency after the US dollar year-to-date, up over 2%, on average, versus its global peers. Against the US dollar, sterling registered its second best weekly advance of 2024 and is hovering at 6-week highs around $1.27, whilst GBP/EUR snapped a 2-week losing streak edging back above its 50- and 100-day moving averages and towards €1.17.
One supporting factor is the pound’s risk profile. Analysing the 1-year rolling average of monthly changes of G10 currencies with a global stock index shows the pound has the strongest positive relationship. Hence, the optimism about the global easing cycle and thus global growth prospects, sending equities to record highs, has also boosted pro-cyclical currencies like the pound. Looking ahead, easing UK inflationary pressures are set to open the door to Bank of England (BoE) rate cuts, potentially as soon as next month. Markets are pricing over a 50% probability of such a move. The main event influencing this market pricing and the pound’s short-term outlook is the UK inflation report published on Wednesday, in which consensus expectations point to headline CPI sliding from 3.2% to just above the BoE’s 2% target. This could cap sterling’s upside traction if traders focus on weakening rate differentials as opposed to the improving growth outlook.
In the options market, however, risk reversals have moved in the pound’s favour – i.e. demand to protect against sterling downside has lessened over the past month, with 1-week 25 delta risk reversals near March levels when cable was trading up at $1.29.
Weak data, stagnating yuan, new tariffs
Boris Kovacevic – Global Macro Strategist
The Chinese economic recovery continues to be one sided and largely driven by the manufacturing sector as data released before the weekend showed. Weak consumer confidence and spending have limited the liftoff this year. 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.
On the currency front, the Chinese yuan would be trading much lower versus the G10 currencies would it not be for the central bank’s interference. The Chinese central bank has had a tight grip on its currency this year. So much so that the short vs. medium term realized FX volatility ratio fell to its lowest in 28 years in May. The PBoC will eventually have to let go of the strong fixing if it wants to continue supporting its economy. A losoer grip could be followed by a change in strategy with policy makers going from outright liquidity measures to lowering both the reserve rate and benchmark policy rate starting next month.
The US 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 world’s 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.
The three issues (weak data, PboC policy, trade war) mentioned above continue to raise the probability of a yuan devaluation. While still far from the base case, risks have risen enough to remain cautious on the yuan in the short term.
GBP/USD up 1.2% in last seven trading days
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 20-24
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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.
