The latest stronger than expected US retail sales (+0,7 m/m) for March lined up with the upside surprises of both the jobs report and latest inflation print, suggesting that economic momentum remained solid all throughout the first quarter.
The rhetoric has changed within the Fed and markets are adjusting to this reality by supporting the dollar and selling government bonds. The 2-year yield is likely to rise for a fourth consecutive week, trading just shy of 5%.
Geopolitics remains front and center. Especially as Israel launched its attack on Iranian targets on Friday, leading to a brief spike in oil prices and the Swiss franc. Safe-havens could benefit from the geopolitical news flow dominating the narrative.
The recent uptick in UK unemployment and the downside surprise on retail sales add to the feeling that monetary policy is working its way through the economy. Sticky inflation has limited the pricing in of rate cuts for the BoE in 2024.
The recent macro news flow signals that the worst of economic slump in the Eurozone is now behind us, and European macro will likely not be a burden for the common currency as economic momentum starts picking up.
The US Dollar Index appreciated for a fifth consecutive day on Tuesday, but has been flat since then, leading to a marginal weekly gain as yields retraced slightly.
The upcoming week will be all about gauging how major economies started the second quarter and if the Feds preferred inflation index picked up at the end of Q1
Global Macro
US exceptionalism amid geopolitical tensions
Keeps on giving. The US economy keeps on giving and investors keep on pricing out policy easing from the Federal Reserve. That has been the story of the past few weeks, which has culminated in markets now expecting less than two rate cuts this year. This weeks stronger than expected retail sales (+0,7 m/m) for March lined up with the upside surprises of both the jobs report and latest inflation print, suggesting that economic momentum remained solid all throughout the first quarter.
Data leads to a hawkish tilt. Investors are coming to terms with this new neutral Fed. Fed officials have started embracing the string of surprisingly strong data in recent speeches by being more hawkish. Mester and Bostic said that rates can be higher for longer and that easing would be a possibility at the end of the year. Fed Governor Williams went further and suggested that a hike is not out of question if inflation continues surprising to the upside. The rhetoric has changed within the Fed and markets are adjusting to this reality by supporting the dollar and selling government bonds. This is most visible at the front end of the yield curve with the 2-year yield likely to rise for a fourth consecutive week, trading just shy of 5%.
Tensions yet to impact FX meaningfully. Geopolitical developments relating to the conflict in the Middle East add to the uncertainty surrounding the future policy path of central banks and the inflation trajectory. So far, markets seem to have taken the escalation by Iran with stride as Western forces race to avert a full-blown retaliation from Israel. Geopolitics remains front and center. Especially as Israel launched its attack on Iranian targets on Friday, leading to a brief spike in oil prices and the Swiss franc. However, the Iranian government downplayed the offensive as no major targets have been hit. In the short-term, safe-haven currencies could benefit from the geopolitical news flow dominating the global narrative.
Regional outlook: US & UK
Cracks in the British economy?
US resilience. The Philadelphia Fed Manufacturing Index was able to stay in positive territory (15.5) for a third consecutive time, rising to the highest level in two years in April. Another report showed initial jobless claims held steady at 212k, suggesting low levels of firing. While not market moving, both prints suggest that the themes of (1) the manufacturing sector bottoming and (2) labor markets remaining resilient continue to play out. They also fit nicely into the broader picture of a still robust US economy, which has caught the attention of policy makers. Fed officials have started embracing the string of surprisingly strong data in recent speeches by being more hawkish.
UK inflation still on track to hit 2%. The latest CPI print showed UK inflation falling to the lowest rate since September 2021 to 3.2% y/y in March, down from 3.4% in the previous month, but above the market consensus of 3.1%. Looking at the underlying components of the inflation basket, we do not think that the latest CPI report has changed our conviction of inflation falling below 2% in the coming months. However, the stickiness in services (6.0%), rent (7.2%) and wage (5.3%) inflation might mean that going sub 2% does not automatically guarantee we will be staying there indefinitely.
UK macro showing signs of weakness. Retail sales in the United Kingdom for the month of February missed expectations as consumers pulled back on spending. Headline retail sales stagnated on a monthly basis, while the core figure, stripping out volatile auto motor fuel sales, fell unexpectedly by 0.3%. As policy easing bets for both the Fed and Bank of England have been pared back in recent times, the pound faired better than other currencies. The recent stickiness of wage growth in the United Kingdom has given officials a reason to communicate a delay of rate cuts. Nonetheless, the jump in unemployment left a bitter aftertaste as it highlights tight monetary policy working its way through the system and the labor market.
Regional outlook: Eurozone
European macro turning neutral
Industrial production rebounds. Industrial production across the bloc rebounded by 0.8% m/m in February, marking a partial recovery from a revised 3.0% downturn in January. On a yearly basis, industrial production contracted by 6.4% in February, extending the 6.6% contraction observed in the previous month.
Investor morale improves to a 2-year high. The ZEW Indicator of Economic Sentiment improved for the 9th consecutive print, with the headline index climbing to a fresh 2-year high across both Germany and the Eurozone. German index rose to 42.9 in April, up from 31.7 in the previous month, while the equivalent measure for Euro zone rose by 10.4 points to 43.9.
ECB confirms rates are coming but remains on guard. While the sentiment across the Governing Council is growing increasingly more dovish, leaning towards impeding rate cuts, policymakers continue to warn the markets that the path to cuts is not without its risks. Collectively ECB’s Holzmann and Nagel highlighted Eurozone pay discussion, a rising geopolitical tensions and an uptick in oil prices remain as the key risks to rate cuts. Money markets assign a 90% probability that the ECB will cut the deposit rate by a quarter point in June and expect 82bps cumulative rate cuts by year-end.
The recent macro data point to signs that the worst of economic slump is now behind us, and European macro will not be a burden for the common currency as economic momentum starts picking up. While still not strong enough to be a catalyst for pushing the euro higher, markets will now focus solely on US developments to determine the path of EUR/USD.
Week ahead
Flash PMIs and PCE to shape the week
How did Q2 start? Another week has gone by with the US macro data holding up. Consumer spending remains resilient, while the outlook for the manufacturing sector continues to improve. The upcoming week will highlight on both the macro and inflation fronts. The flash PMIs for April will be closely watched as a gauge for private sector activity. The Eurozone composite PMI moved into positive territory for the first time in a year last month. However, the manufacturing sector, the German one in particular, remains weak. A continued improvement in leading economic indicators will be needed to confirm the bottoming of the European continent. Apart from the purchasing manager surveys, Eurozone consumer confidence and German consumer and business confidence indicators are up. Germany likely avoided a contraction in Q1. Now, it will be interesting to see how the second quarter started.
PCE picked up slightly in March. Inflation according to the personal consumption expenditure index – the Feds preferred gauge – has likely picked up at the end of Q1 from 2.5% to 2.6%. While only a small gain, put into the context of the recent string of upside inflation surprises, shows how inflation more broadly stagnated at levels above the Feds 2% target. Any deviation from the consensus will be market moving. Especially in the light of the recent commentary from FOMC members shifting to a more hawkish undertone. A downside surprise would be welcomed news for investors hoping for more cuts from the US central bank this year. Looking at the already published CPI and PPI reports for March, we expect the PCE print to come in benign.
The upcoming week will be all about gauging how major economies started the second quarter and if the Feds preferred inflation index picked up at the end of Q1.
FX Views
Dollar strength moderates
USD Dollar benefits from its uniqueness. Treasury yields on the long end have risen to their highest level since November, dampening risk appetite and putting the S&P 500 on track for its third consecutive weekly decline. At the same time, the global commodity index has risen by 11% so far this year. Taken together, this has created a perfect environment for the Greenback to shine, as it’s benefiting from its position as a high yielding, high growth, commodity backed safe-haven currency. As central banks outside the US continue to lay the groundwork for rate cuts, policy divergence and momentum will favor the reserve currency. The US Dollar Index appreciated for a fifth consecutive day on Tuesday, but has been flat since then, leading to a marginal weekly gain. Now, it will be interesting to see how much of this shift has already been reflected in markets and how much more rate cuts can be priced out for the Federal Reserve. This is hard to answer right now due to the current push (global inflation impulse rising) and pull (weakening leading economic indicators) effects influencing the dollar and Fed pricing.
EUR Touches $1.06 as Fed-ECB timing diverges. On the back of a sharp repricing in Fed cut expectations, 2-year swap differential plunged to the lowest level since November 2022 dragging EUR/USD to a fresh-month low of $1.0601. The Fed and ECB policy divergence raised 1-month realised volatility (close-close basis) to a 3-month high and options markets now expect volatility to pick up over the next 12-months. An improving macro backdrop will provide the euro with a cushion but is not expected to be a strong enough impetus for the currency to move higher. Dovish ECB signals will continue to suppress the euro, but in a restricted manner. With money markets pricing in close to 90% probability of a rate cut in June, the room to price in additional easing for H1 is limited. Waning dollar rally towards the end of the week saw euro recoup some of the losses, with the pair roughly half a percent away from Friday’s peak, but a key resistance at $1.0695 limits near term gains.
GBP At the lower end of its range. GBP/USD has fallen to its lowest level so far this year as the continued strength of the US dollar didn’t leave any room for other currencies to shine. However, the paring back of Bank of England cuts means that we have not seen a strong divergence between pricing for the Fed and BoE. We conclude that the recent weakness in the pound is mainly a function of risk sentiment turning sour and oil pricing rising to new yearly highs. The $1.24 -$1.28 area will now define the short-term trading range (3.2%) for the pound. The main risk for the currency pairs lies in the probability of British policy makers having to cut much earlier than November as inflation continues to fall.
CHF The hedge against geopolitics. The Swiss franc has been in the spotlight this week as investors continue to search for ways to price in rising geopolitics tensions in the Middle East. The global oil prices has been the main valve for investors to reflect their worries or the lack there of. Brent crude oil briefly jumped 4% on Friday before losing more than half of its gains as the expectations of the Federal Reserve delaying its policy easing weighted on risk assets. This is where the Swiss franc came in. USD/CHF recorded its worst weekly depreciation since early March and is currently trading around the 0.9 level. The franc was able to push meaningfully higher versus the euro and is extending its gains from last week. At the beginning of the month, the year-to-date gain of EUR/CHF has been around 6%. The gap has now closed to 4%.
CNY China’s economic recovery lags behind GDP beat. China’s first-quarter GDP growth of 5.3% year-on-year surpassed the 4.8% median consensus, but the underlying economic picture remains lackluster. The beat appears driven by investment, as fixed asset investment rose 4.5% versus the 4% expected, while consumption disappointed with retail sales up 4.7% versus 5.4% consensus. March activity data, such as weaker-than-expected retail sales and industrial output, added to concerns about the economy’s strength. The property sector has yet to show signs of a turnaround, with new home prices falling at the fastest pace since 2015. Despite the economic challenges, policymakers are likely to maintain a modest approach to stimulus. USD/CNH is nearing initial upside targets (re Weekly Jan 19th publication: targeting 7.239-7.2665 resistance) after consolidating between November-January. The focus will be on the upcoming loan prime rate decision.
JPY Japan grapples with inflation dynamics. Japan’s March inflation figures came in slightly below expectations, with headline CPI at 2.7% year-over-year and core CPI at 2.6%. While the pace of price increases has slowed, inflation remains above the Bank of Japan’s 2% target. Sustained wage growth and inflation are crucial for the central bank’s policy normalization plans, as major unions have secured substantial pay hikes this year. However, a weaker yen and higher oil prices could pose challenges for the BoJ. The central bank has signaled that further rate hikes may depend on the inflationary impact of the yen’s weakness. Chart shows the strong correlation between rate differentials and USD/JPY. USD/JPY bulls stay in control with push through 151.945 resistance. A whipsaw back through that new support and 149.795-150.292 cluster of levels is required to derail the broader trend momentum. Key economic indicators to monitor include Tokyo core CPI and BoJ rate decision this week.
CAD Strong dollar rally sees CAD weaken to 2024 lows. The Canadian dollar plunged to a 6-month low of $1.3840, as evidence of moderating domestic inflation drove markets to outline contrasting forecasts between the Fed and the BoC. For the BoC, June remains a live meeting, and markets are pricing in a 68% probability of a cut as soon as May, while Fed’s rate cut expectation were pushed back to Q3. Domestic macro continues to weigh down on the Canadian dollar, especially the slackening labour market. Loonie continues to claw back the losses, but progress remains slows as US dollar remains bid. With cooling US dollar demand, we expect USD/CAD to further retreat from the current multi-month highs towards low $1.36-$1.37, which may act as a new support level for some time. Given the new monetary divergence regime, options markets are pricing in an increase in volatility over the next 12-months, with USD/CAD 3-month ATM implied option vol surging to a fresh 3-month high.
AUD Surprise fall in Australian employment sparks concerns. The Australian economy unexpectedly shed 6.6k jobs in March, missing the consensus forecast of a 7.2k addition and reversing February’s surge of 116.5k. The unemployment rate rose to 3.8%, higher than the expected 3.9% and February’s 3.7%, as elevated interest rates weighed on demand. Official data indicated that employment flows are reverting to a more typical pattern after recent volatility. Despite the decline, the labor market remains relatively tight, with the employment-to-population ratio and participation rate still close to their record highs seen in November 2023, though they have dipped slightly. The Australian dollar remains mostly under pressure and has struggled to break out of its 2024 range, with key resistance at 0.6640-0.6708. Upcoming inflation data, due Wednesday, will be closely watched.
