by Marc Chandler
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The backing up of US rates did not lift the dollar broadly as it appeared to have done previously. The dollar-bloc currencies, led by the Australian dollar, and sterling advanced last week, while the Swiss franc and Japanese yen were unable to find traction. The Bank of Japan had an opportunity to have protested the yen's weakness more adamantly but did not do so. Recognizing the role of interest rate differentials as an important driver, the Ministry of Finance threatens action but seems reluctant to intervene. Still, the market continues to probe for the official pain threshold. This year, the greenback has generally weakened in the run-up to the employment data and recovered afterward. It has trended lower over the last couple of weeks and that correction may be over.
Still, after the service PMI showed weakness in employment and Q1 GDP was not as strong as expected (dragged down by weaker net exports and slower inventory accumulation), the market may be particularly vulnerable to a disappointing US jobs report. The FOMC meeting concludes a couple of days for the data. A hawkish hold is expected, where the central bank stand pat, and Fed Chair Powell confirms that there was been a setback in officials' confidence that inflation is on a sustainable path toward its target. Meanwhile, the eurozone is expected to report that the regional economy expanded in Q1 and by more than in any quarter last year. On the other hand, improvement on headline inflation may be stalling. The UK holds local and mayoral elections and the real question seems to be how badly the Tories will perform. China reports its April PMI before starting the May Day holidays that will shut the markets from Wednesday through Friday. Many other financial centers will be closed on May 1.
United States: This could be one of the most impactful weeks of the second quarter. The Federal Reserve meets following the firmer inflation readings, and although the Summary of Economic Projections will not be updated until June, In March, it was already a fine balance, nine of 19 Fed officials thought two rate cuts of less would be appropriate this year, while 10 anticipated three cuts of more. The labor market's resilience, and especially the lack of progress on moderating price pressures in the first quarter of the year likely shifted the balance. This will be reflected in both the statement and Chair Powell's comments. At the same time, the Federal Reserve is likely to announce the winding down of its balance sheet run-off (not replacing the maturing issues in full) and a tapering to $40-$50 bln a month pace from $95 bln.
The higher than expected inflation readings in recent months will echo through the three- and six-month annualized rates cited by Fed officials. Strong jobs growth, wage increases above the rate of inflation, and solid consumer credit, have helped underpin demand. When the Fed meets, the jobs report would not have yet been sent to the Chair. However, Fed officials will be seeing that same thing that economists are and the median forecast in Bloomberg's survey is for 250k increase in nonfarm payrolls, which would match last year's average. That said, the preliminary PMI gave what could be an early hint that economic momentum is faltering after the disappointing initial estimate of Q1 GDP. The April services PMI employment index tumbled to 47.3 from 51.5 in March. The decline is notable for a narrow measure of private services that excludes, retail, wholesale, health care, utilities, and temporary help in services sectors. While recognizing that final sales to private domestic parties (excludes inventories, trade, and government spending) rose a solid 3.1% in Q1, a disappointing employment report would likely signal that the adjustment to Fed expectations is over.
The Dollar Index recorded a two-week low ahead of the weekend near 105.40. It held above the 20-day moving average (~105.35). This year, the Dollar Index has recorded highs in the run-up to the US jobs data only to retreat afterwards. The momentum indicators have turned down, suggesting that technically the pattern could repeat, but we are skeptical. The outside up day ahead of the weekend may signal that the pullback is over.
Eurozone: Only a shockingly high preliminary April CPI on April 30 will force the market to reconsider an ECB rate cut in June. Eurozone CPI peaked at 10.6% in October 2022 and was at 2.9% at the end of 2023. In March, it stood at 2.4%. This was the cyclical low set in November 2023, and it had been a little bumpy, as Powell might say. It is likely to have fallen by 2.2%-2.3% in April. At the same time, the Eurozone will publish its first estimate of Q1 24 GDP. It likely grew by about 0.2% quarter-over-quarter, which would match its best showing since Q3 22. It will be reported before the May Day holiday. More impressive, despite the past tightening of monetary policy and poor economic performance, the eurozone's unemployment has not risen. It has remained in a 6.5%-6.6% range, a record low under EMU since the start of last year. The March rate will be reported on May 3.
The euro reached a two-week high slightly above $1.0750 before the weekend and the slightly firmer than expected US PCE deflator. It pushed above the 20-day moving average (~$1.0730) but has failed to close above it since April 9. The momentum indicators have turned up but the upside appears to have stalled. The low for the year was set on April 16 near $1.06. A break of the $1.0660 area warns that the upside correction is over.
China: The first quarter is behind us and China reports April PMI on April 30. Beijing reported Q1 24 GDP expanded at 4.8% after Q4 23 growth of 5.2%. Many, if not most, market participants expect new stimulative measures are needed to ensure the 5% growth target. Typically, central banks want their exchange rate to move in the same direction as monetary policy to avoid counter-acting their efforts. However, Chinese officials continue to resist the selling pressure on the yuan. Mainland markets are closed for the May Day labor holiday May 1 through May 3. There is rightfully much criticism over Beijing's mercantilist trade policies, but it is notable that it is not seeking to devalue the yuan to aid exports. Still, the dollar made a new high against the yuan since last November near CNY7.2475. The continued yen weakness suggests that our idea the dollar will move back into the previous range (~CNY7.25-CNY7.30) still seems reasonable. There is some speculation that with falling bond yields and deflationary forces that Beijing is preparing for a one-off devaluation. We suspect this speaks more to the lack of transparency and uncertainty of Beijing's intentions than the merits sharp currency drop, when officials have been promising broad exchange rate stability.
Japan: The 7.6-magnitude earthquake that hit the western coastline of Japan on New Year's Day killed more than 200 people and disrupted economic activity. As the first quarter progressed, the economy gradually recovered. In the upcoming data, which includes unemployment and retail sales, the recovery is most likely evident in industrial output. Recall that industrial production tumbled a heady 6.7% in January and fall another 0.6% in February. It is expected to have risen in March, though, we note that the March manufacturing PMI rose to 48.2 from 47.2 in February, but is still in contracting territory. At the same time, consumption has been a drag on Japanese growth for the last three quarters of 2023, albeit at a diminishing pace (-2.7% Q2, -1.4% Q3, -1,0% Q4 23, annualized). Retail sales account for around 10% of Japan's consumption, which is slightly less than 55% of GDP. Retail sales rose 4.7% year-over-year in February, while the broader measure, household spending was off 0.5%. Japanese markets are closed Monday and Friday in the week ahead, and the following Monday, May 6.
The Bank of Japan's seemingly dovish hold sent the Japanese yen lower. The dollar rose to nearly JPY158.45. BOJ Governor Ueda did not seem exceptionally concerned about the yen's weakness and indicated that easy monetary policy would continue. This puts the onus on the Ministry of Finance, which makes intervention decisions. Officials say that they will take appropriate action if necessary. Since no action has been taken, it remains unnecessary. On April 30 the BOJ's report will likely confirm the lack of intervention (including unannounced operations) as of April 25. What made the intervention in September-October 2022 effective was not so much the size (~$60 bln) but that it corresponded to a peak in US yields. Japanese officials cannot be as confident now that a peak in US rates is at hand. There seems to be little on the charts in the way of a test on the JPY160.00-JPY160.50 area.
United Kingdom: With a light economic calendar, featuring primarily consumer credit and mortgage lending figures, local elections on May 2 loom large. It is not quite the beginning of the end of the Tory party rule, that looks to have been some time ago. The Tories have led the UK since 2010 with five prime ministers. The last and current prime minister Sunak could have called a national election to coincide with the local elections but decided against. The Tories continues to trail well behind the Labour, which, by most accounts, have tacked to the right after being locked out of government for more than a decade. The Tories are also being squeezed by the Reform Party, which has succeeded the Brexit Party. Polls suggest it may be attracting more male voters than the Tories. Some polls warn of steep losses for the Tories in the local elections and this could spur to a leadership challenge. However, there may be no one willing to take the poisoned chalice from Prime Minister Sunak.
Sterling recorded the low for the year (so far) on April 22, near $1.23. It recovered to test the $1.2540 area ahead of the weekend. It stalled in front of the (61.8%) retracement of the losses since the high for the month on April 9 (~$1.2710) and the 200-day moving average; both of which are found in the $1.2555-60 area. The momentum indicators have turned higher, but a push below the $1.2420-50 area would warn that the upside correction is over.
Canada: A recovery in government spending and business investment may have fueled Canada's economic expansion in Q1 24 as the consumer may have slowed. The February monthly GDP, due April 30, is unlikely to match January's 0.6% growth spurt, the best since January 2023. Earlier this month, the Bank of Canada revised up its GDP forecasts for this year. Canada will also report March merchandise trade balance. Canada reported monthly surpluses in January and February, but what is most notable is that more than half of February's 5.8% jump in merchandise exports was accounted for by unwrought gold shipments to Switzerland and the UK. There was also an increase in high-value shipments of refined gold and transfer of gold assets in the banking sector. Excluding the unwrought gold, Canada's exports rose 2.8%. Meanwhile, the 3.3% rise in consumer good imports would be consistent with a constructive February GDP.
The US dollar fell against the Canadian dollar for the first time in back-to-back weeks this year. However, the greenback held above the CAD1.3620 area, which is the (61.8%) retracement objective of the rally from the April 4 low (~CAD1.3480). The momentum indicators have turned down and the five-day moving average looks set to fall below the 20-day moving average in the coming days for the first time since mid-March. Still, a move back above the CAD1.3730 area would likely signal the end the US dollar's downside correction.
Australia: Australia reports March retail sales and goods trade balance. Retail sales fell in Q4 23 and have rebounded in Q1 24. Good exports have fallen for two of the three months through February. The trade surplus has narrowed for three months through February. The March surplus is expected to have grown, but is likely around half of the surplus recorded in March 2023. Meanwhile, the futures market has pushed the first rate cut out of this year. The market now has about 10 bp of cuts discounted for this year, down from 25 bp a week ago and around 45 bp at the end of March. The Australian dollar was the strongest of the G10 currencies last week, rising nearly 2% against the US dollar. It met the (61.8%) retracement of the decline since April 9 high (~0.6645) found slightly below $0.6540 and settled above the 200-day moving average (~$0.6525). The next area of resistance is seen in the $0.6600-$0.6650 area.
Mexico: It is a busy week for macroeconomic data in the lead-up to the central bank meeting on May 9. The decision to cut rates last month was based on a 4-1 vote, but officials clearly signaled a very cautious approached that did not necessarily entail back-to-back rate cuts, as several other countries in the region have done. The preliminary estimate of Q1 GDP is due Tuesday, and, mostly likely, will be better than 0.1% growth in Q4 23. That coupled with last week's news that headline inflation is getting sticky, while the core rate eased slightly, likely keeps the central bank on the sidelines. The peso suffered a flash crash on April 19, selling off by a gobsmacked-6.75% in a hour. Market conditions were thin when news broke of Israel's retaliatory strike in Iran. The trading and investment community were long. Still, before the drama, the dollar had already recovered more than 4% from the multi-year low set on April 9 (~MXN16.26). The speed of the move cleared out many positions and forced a reset. Although the peso recovered from the flash crash, sentiment has been shaken and implied volatility remains elevated (one-month implied is around 12.5%, compared with below 9% from mid-February through early April). Since the flash crash, the dollar has held above MXN16.90. A break of it could boost confidence of the peso bulls to re-establish positions that may have been shaken out.
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