Written by Convera’s Market Insights team
Inflation just won’t bend
Boris Kovacevic – Global Macro Strategist
The latest string of hotter than expected inflation prints just got a bit longer with the consumer price index surprising once again to the upside in March, ending the first quarter with a high level of uncertainty for investors and the US central bank. Global equity markets refused to give in to the first inflation surprises that started the year off. They were discounted as distorted by seasonality effects and one-off base effects.
However, the third consecutive +0.35% monthly print on core inflation has thrown the expected beginning of the Fed’s easing cycle into question. With 3-month annualized core inflation now running at double the central banks target at the highest level in 30-years (excluding 2021-2022), markets quickly cut back the probability of a June cut from more than 50% to 4%, highlighting the drastic change in sentiment. Option markets now price in only one rate cut for 2024, down from the peak reached several months ago at seven cuts.
The shock from the inflation surprise was felt across global markets. The 10-year Treasury yield recorded its third biggest spike since 2020, jumping by almost 20 basis points to 4.55%. The 2-year break-evens (inflation expectations) hit their highest level this year at 2.9%. US and European equity markets got jolted by the capital rotation as well and the S&P500 (-0.95%) is now on track to record its first back-to-back weekly loss since the end of October. The US Dollar Index naturally benefited from markets expecting less cuts from the Fed and has broken out of its medium-term triangle formation, which lasted since the middle of 2021. April has so far been a positive month for the Greenback, which is now on track to rise for a fourth straight month.
The impact of the report will be felt for some days as investors come to terms with the possibility of the Fed not cutting interest rates in the second quarter of this year. The next important number in that regard will be producer prices published later today. Another surprise would end the week on a volatile note.
Pound drops over 1% to new 2024 low
George Vessey – Lead FX Strategist
As reported yesterday, the US inflation report was a big risk to further GBP/USD upside. Indeed, the upside surprise rattled markets with the pound falling sharply from above $1.27 to a 5-month low near $1.25 as UK-US 2-year yield spreads slipped to their lowest in a year on rising bets that the Fed will delay rate cuts and deliver less than expected this year.
Markets are currently pricing in around 40 basis points of Fed easing this year (less than two rate cuts) compared to the Bank of England’s (BoE) expected 50 basis points. The probability of the BoE cutting interest rates in May has fallen from above 20% to around 10% since the US inflation data because most major central banks are influenced by what the Fed does. However, the disinflation trend in the UK is still intact, wage growth is easing and the economic outlook pales in comparison to that of the US. As such, there are growing calls for the BoE to cut interest rates sooner, especially from the UK government ahead of the general election likely due later this year. Monetary policy divergence dictates trends in FX markets, and in the current conditions, suggesting US rates staying higher for longer than its peers, means it will be tough for the pound to reach fresh 2024 highs.
From a technical perspective, the plunge in GBP/USD has derailed the bullish story we put forward yesterday, reflecting how quickly things can change in FX. After breaking north of a descending trendline and key moving averages this week, the pair is back below its 200-day moving average and eying new 2024 lows, which brightens the spotlight on a deeper decline to the low $1.20s if the $1.25 support level is wiped out. UK GDP is due this Friday before inflation and labour market data next week.
EUR slumps on hot US CPI, ECB in focus
Ruta Prieskienyte – FX Strategist
The euro plunged to a 6-day low on Wednesday, erasing nearly all of the Q2 gains, as hotter than expected US CPI print spiked US yields, boosting US dollar demand across the board. Attention now turns to the ECB rate decision due later today, where the central bank is widely expected to hold rates unchanged at record highs but is likely to initiate preparations for a shift in monetary policy stance. Investors are now left wandering: will the ECB go at it alone with cutting rates in H1?
Across the Eurozone bloc, the preliminary March Eurozone inflation report matched November’s 28-month low at 2.4% y/y, with the core rate cooling to an over 2-year low. Meanwhile the latest Q4 2023 wages costs rose by 3.4% y/y – the slowest pace since Q3 2022. For the ECB, the progress on both fronts has been satisfactory, with both hawkish and dovish policymakers now comfortable with the first cut in June. Thus, the key question now shifts to the speed of the subsequent rate cuts. We are expecting the Fed to be the main driver to guide on ECB rate cuts. If US data continues to surprise to the upside, we think it is less likely the ECB will follow an autonomous path, and instead adopt a more cautious approach going forward. As a result, we do not expect President Lagarde to materially shift on this subject during the conference later today, reiterating that the subsequent rate cuts will remain data dependent. And going forward, US data will be a marginally more important driver for the ECB policy outlook than the domestic developments.
Having plunged over 1.0% on the day – the single largest daily drop in over a year – and towards the lower 2024 range limit, EUR/USD is in a vulnerable position ahead of today’s US PPI print and the ECB meeting. As we expect a dovish ECB tilt, the move would further weigh on the euro from an already vulnerable position and could see EUR/USD test YTD lows ($1.0692), with the next support level at $1.0650 level.
Dollar jumps to fresh 5-month highs
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.
