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Week Ahead: Hawkish BOE, US and China CPI, but is the Fed Really Going to Cut Rates by 75-100 bp This Year?

Week Ahead:  Hawkish BOE, US and China CPI, but is the Fed Really Going to Cut Rates by 75-100 bp This Year?

The combination of the US bank stress, the approaching debt ceiling, and the Fed's opening the door to a pause in rates weighed on risk sentiment and dragged the greenback lower. KBW's indices for large and regional bank shares bled 7.4%-8.0% lower last week to cut through March's lows like a hot knife through butter. Still the price action was constructive ahead of the weekend. US Treasury Secretary Yellen warned that the X-date when the government's cash runs out and the extraordinary measures are exhausted can be as early as June 1 cast a heavy pall over the US money markets. 

The drop in US interest rates helped the yen recover impressively from the sell-off sparked by the Bank of Japan meeting at the end of April. The greenback shot up to nearly JPY137.80 from about JPY134.00 before the BOJ meeting. It gave it all back last week. Indeed, the yen's 1.1% gain was its best in seven weeks, and third best in the G10's advance after the Antipodeans. Sterling's gains more considerably more modest (~0.40%) but they were sufficient to send it to a new high since last June (~$1.2650). The Bank of England is the only major central bank to meet in the week ahead, and a quarter-point hike is understood to be as done of a deal as these things go. The euro came within a few hundredths of a cent of its highest level since April 2022 before profit-taking was seen after the ECB meeting. The greenback also fell to new six-year lows against the Mexican peso, which is up about 8.6% this year and offers a juicy yield, with policy rate set at 11.25%. 

In addition to the Bank of England meeting and a meeting on the debt ceiling at the White House, the highlight of the week ahead includes the US April CPI, where the headline is expected to be steady at 5.0% and the core rate to ease to 5.4% from 5.6%. China reports lending figures (debt-financed growth), trade (a smaller surplus is expected) and inflation gauges (CPI is seen at 0.3% from 0.7% year-over-year, while PPI sinks further into negative territory, -3.2% vs. -2.5%).

United States:  With the Fed hike and the April jobs report behind it, the market now looks toward the US inflation reports. April CPI (May 10) is expected to have risen by 0.4%, which would leave the year-over-year rate unchanged at 5.0%. It would halt the streak of improvement uninterrupted since last July. A 0.4% increase would translate into a 4.5% annualized rate of increase through the first four months of the year. Still, the base effects still auger well for lower headline CPI in May and June. Recall that in 2022, it rose by 0.9% and 1.2%, respectively. With conservative assumption of a 0.4% increase this month and next, the year-over-year rate can fall to the high-3% area by mid-year. The core rate is projected to rise by 0.3%, which matches the smallest over the past six months. At an annualized rate, through April, it would have risen a little more than 4.8%. The year-over-year is set is to slow to 5.4%, which would the slowest since November 2021. Producer prices are reported the next day (May 11) and typically do not elicit much of a market response. Headline producer prices are expected to moderate for the tenth consecutive month and are seen dipping below 2.5% for the first time since January 2021. Core producer price inflation slowed for 12 months through March (from 9.7% to 3.4%) and are expected to have ticked down to 3.3% last month. 

In addition to the macroeconomic data, there are two other issues that are also dominating discussions. First is the bank stress. When SVB and Signature issues came to light, there was a list of 6-10 banks that were seen as vulnerable for idiosyncratic reason. They each have their own comorbidities, as it were. Despite some favorable earnings and deposit flows, the market seems to be working through the list. Still, the bank stress appears to have morphed from a run on deposits to a run on shares. The quarterly results of the Fed's Senior Loan Officer Opinion Survey (SLOOS) will draw attention (May 8). It his press conference, Chair Powell suggested that the results are "broadly consistent" with the recent reports showing that while lending has continued to grow, it has been slowing since H2 22. To the extent that businesses are concerned about their exposures in excess of the FDIC insurance, there is a page from the 2008-2009 playbook that could help. It was called the Temporary Liquidity Guarantee Program (TLGP), which protected transactional accounts (mostly non-interest and NOW accounts). Resurrecting it could help take stem the pressure on banks. The Dodd-Frank reforms require Congressional approval for resurrecting the TLGP. The second issue is the debt ceiling. Treasury Secretary Yellen warned that the X-date could be less than a month away. There will an important meeting at the White House on May 9. In the US presidential system that frequently has led to a divided government, the party not in control of the executive branch often seeks to secure concessions in exchange for lifting the debt ceiling or suspending it. Besides the bellicose rhetoric, it is not clear what has changed this time, but many sense this time is different and some of bill spreads and indicative pricing in the credit-default swaps market are extreme. Still, the Biden administration seems to be soften its stance and may try to negotiate a short-term agreement.  

The Dollar Index appears to have carved a shelf in the 100.80-101.00 area. A break would target the 99.00 area, the (61.8%) retracement of the rally since the January 2021 low (~89.20). A move above the 102.00-40 area would help stabilize the technical tone. 

United Kingdom:  The UK will be on holiday on Monday to celebrate the weekend coronation of King Charles. With the calendar quirk, UK markets are closed three of the five Mondays this month (May 29 is the third one). Still, it is a big week for the UK. March monthly GDP, and details and the Q1 GDP will be reported. GDP for Q1 23 will be reported on May 11. The median forecast in Bloomberg's monthly survey sees a 0.1% contraction. The risk seems to be on for a small increase after the monthly GDP showed 0.4% growth in January and a flat February. A few hours later the Bank of England will announce its rate decision. Headline CPI has been above 10% for the seven months through March. Net-net the core rate is little changed since peaking at 6.5% last September and October. The market is confident that the BOE will deliver another quarter-point hike to lift the base rate to 4.50%. The peak is seen between 4.75% and 5.0%, with a clear leaning toward the latter.

Sterling reached its best level since last June at the end of last week near $1.2635. It has been helped by the upgraded economic outlook. The rise of the April composite PMI to 54.9, its highest since April 2022 illustrate the improved prospects. The next nearby target is $1.2660-70 area. Further afield, the $1.2760 area is the (61.8%) retracement of sterling's decline from the June 2021 high near $1.4250. The momentum indicators are not overbought. However, the upper Bollinger Band is at $1.26. Initial support may be found in the $1.2500-25 band. 

China: China's Q1 GDP was firmer than expected and this prompted some economists to revise higher this year's growth projections. The world's second-largest economy expanded by 4.5%, led by domestic consumption and a nearly 15% increase in exports. Then, the April PMI disappointed, and the "peak China growth" stories were dusted off and recycled. China reports three high-frequency data points in the days ahead, but the impact on the highly managed currency is slim to none. First, China growth has been debt-financed. Aggregate lending (banks and shadow banks) boosted lending by CNY14.5 trillion (~$2.1 trillion) in Q1 23. It is more than previous two quarters combined (CNY11 trillion). Lending often slows in April, and March was high (CNY5.38 trillion). Second, China's reports its April trade balance surplus. It averaged $68.2 bln a month in Q1, the least of any quarter last year. In Q1 22, the surplus averaged almost $51.3 bln a month. Still, the surplus is expected to have narrowed in April. In dollar terms, exports rose 14.8% year-over-year in March, and imports slipped 1.4%. However, in yuan terms, exports were rose 23.4% and imports increased by 6.1%. Third, China reports its inflation measures, CPI and PPI. Through March, CPI has risen by less than 1% (0.7%) and producer prices have fallen by 2.5%. Deflation and disinflationary forces likely strengthened Conventional wisdom seems to attribute the weak consumer price pressures to weak demand, and while this may be partly true, it also seems that excess capacity is also a key factor, and this may be the key behind falling auto prices, for example.

Due to the extended May Day holiday, the onshore yuan traded only in the last two sessions, and it was virtually unchanged. Despite the volatility seen in the other major exchange rates, the yuan was uncannily steady. Given the dollar's broader weakness, we would have expected a stronger yuan. The greenback has traced out a range of roughly CNY6.89-CNY6.9350 and we are inclined to see a downside break. 

Eurozone:  The economic calendar is light in the week ahead. There are some national reports that will draw attention. Germany's March industrial output may garner interest, after it reported horrible factory orders data (-10.7%) and French industrial output tumbled by 1.1%. The recent release of Q1 GDP (flat after a 0.5% contraction in Q4 22) renders most Q1 data moot, but the dismal March retail sales reported last week (-2.4% vs. the median forecast in Bloomberg's survey for a 0.4% increase) saw the euro slump to a seven-day low (~$1.0940). The slightly larger than expected March trade surplus, reported last week, may sap whatever market interest there was in the German current account figures that will be released on May 12. France reports its March trade and current account (deficits) on May 9. Italy reports March industrial output on May 10. Recall that in late April, Italy surprised with a 0.5% expansion in Q1.

The euro fell below its 20-day moving average for the first time since March 17 on an intraday basis three times last week and did not close below it once. This seems to reflect the "buy on dips" bullish sentiment that continues to prevail. The momentum indicators continue to trend lower with seemingly little impact on prices. The euro has been capped in front of $1.1100. A convincing break of it targets the $1.1175 area and then $1.1275, which corresponds to the (61.8%) retracement of the euros's downtrend since the January 2021 high near $1.2350. Last week's low was set slightly above $1.0940. 

Japan:  The Bank of Japan's quarterly report released last week was upbeat on the wage outlook and suggested it would support private consumption. This, coupled with rising break-evens (spread between conventional yield and the inflation-protected securities) help sustain speculation that the BOJ may adjust its monetary policy settings as early as next month. Next week's data will likely support the BOJ's assessment. March labor cash earnings likely rose by around 1% from a year ago. Investors learned recently that retail sales rose by 0.6% in March, twice the median forecast in Bloomberg's survey after the February increase was revised to 2.1% from 1.4%. The broader measure of household spending is seen increasing by 0.8% (year-over-year) in March. Japan also reports March current account surplus. Seasonally, it tends to improve over February before deteriorating in April. The March surplus is seen near JPY2.9 trillion. Note that on a balance-of-payments basis, Japan has not recorded a monthly trade surplus since October 2021. The current account surplus is driven by interest on its foreign bond holdings, profits, and licensing fees, and royalties.

The dollar initially extended the post-BOJ gains to almost JPY137.80, shy of the year's high set on March 8 (~JPY137.90) before the US banking stress emerged. However, falling US rates dragged the dollar lower and it reached JPY133.50 on May 4, the day after the Federal Reserve opened the door to a possible end to the cycle (pause). The momentum indicators are weakening but the base that extends to JPY133.00 looks formidable, and the upside may be the path of least resistance. A move through JPY135.15 targets JPY135.65 and then JPY136.00-20. The yen seems particularly vulnerable to correction from the extreme views that see nearly 100 bp of Fed funds this year. 

Australia: The Reserve Bank of Australia surprised the market by exiting its pause after one month and hiking the overnight cash target rate by 25 bp to 3.85%. The swaps market seems to be pricing in a 15 bp hike by the end of Q3. The next meeting is June 6 and expectations have yet to build. Melbourne Institute's consumer inflation expectations survey for May could be the most important of the upcoming surveys. The RBA's statement also drew attention to household consumption, which it identified as "a significant source of uncertainty."  In addition to consumption, the central bank put emphasis on "trends in household spending, and the outlook for inflation and the labor market." The RBA acknowledged that "some further tightening of monetary policy may be required" to boost the chances that inflation falls back toward its target "in a reasonable timeframe, but it lowered its inflation, growth and wages forecast. The government will deliver its budget on Tuesday. In the short run, the surge in tax revenues (from strong commodity prices and strong labor market) will give the government some room to maneuver (the deficit appears to be well below the 1.5% forecast made last October). Some economists expect Treasury Minister Chalmers could even announce the first budget surplus in 15 years for the year ending on June 30. 

The Australian dollar frayed $0.6600 support on an intraday basis in late April, but did not close below it, the lower end of where it has been for the past six months. It was already recovering before the RBA goosed it. Indeed, the the Australian dollar rose every session last week for the first time this year. The Aussie reached a two-week high slightly above $0.6755 ahead of the weekend. The $0.6800 area marks the upper end of a two-month range. The momentum indicators are constructive, and the five-day moving average is poised to cross back above the 20-day moving average. An upside break could spur a move toward $0.6860 and then $0.6900-30. 

Canada:  The April jobs report that showed loss of 6.2k full-time positions, though a 47.6 increase in full-time positions. Wages were unchanged at 5.2% year-over-year, economists had expected a moderation. Still, nothing to move the Bank of Canada off its conditional pause. The jobs report exhausted the near-term economic diary. March building permits are due on May 10 and do not spur a market reaction even in the best of times. Separately, last week, the strike of around 120k federal government workers ended a strike that began in mid-April, accepting the government's offer for wage increase of about 12% over four years. Previously, the government's offer was a 9% increase. Union members were eligible for a one-off C$2500 (~$1840) payment. An agreement about remote work was also struck. Of note, some 35k employees of the federal tax agency, seeking a larger wage increase, remain on strike. 

For two-weeks, the US dollar chopped in a roughly CAD1.3520-CAD1.3650 trading range. And despite the key downside reversal on April 28, there was no follow-through selling. The weakness in equities and oil seemed to weigh. However, as oil and the risk appetite recovered dramatically, the greenback broke down. Ahead of the weekend, it punched through the CAD1.3445 area that housed the 200-day moving average and (61.8%) retracement of the rally since the mid-April low near CAD1.3300. Th US dollar's 1.15% loss ahead of the weekend was the largest in four-month.  It seems like market positioning more than a change in interest rate expectations were the driving force. The momentum indicators have turned lower and US dollar looks poised to retest the mid-April low near CAD1.3300. 

Mexico:  International investors may not look upon AMLO's economic policies with much favor, but the near- and friend-shoring and the independence (and hawkishness) of the central bank are doing wonders. The economy grew more than expected in Q1 (1.1% quarter-over-quarter, which is what the US expanded by at an annualized pace). It reported record exports in March even as the peso was around six-year highs against the dollar. Inflation has been falling sufficiently for the governor of the central bank to indicate that a pause will be considered at the next policy meeting (May 18). The headline CPI was 6.85% higher year-over-year in March and core rate was 8.09% higher. The bi-weekly readings suggest scope for further slowing with the April report.

The peso continued to march higher and reached a new high since 2017. When the US banking stress first erupted the peso spiked lower but recovered quickly. It remained more resilient in the face of subsequent tensions. Last week's US dollar high was near MXN18.0775 and it reached a low ahead of the weekend near MXN17.7465. It is difficult to talk about meaningful support at these levels that have not been seen of almost six years. There was a congestion band in 2017 in the MXN17.45-MXN17.65 area. The 2016 low was closer to MXN17.00. The momentum indicators are not overstretched, but the greenback settled below its lower Bollinger Band (~MXN17.8340). 

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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