by Marc Chandler
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The monthly cycle of central bank meetings and high-frequency data slow in the week ahead, though the UK and Canada report on prices and demand (retail sales). The highlight of the week may be the preliminary May PMI estimates. We play down its significance in the US because its strength seems to be an outlier and it is in expansion territory while the ISM not. The dollar has generally been trending lower, with the yen being the only exception among the G10 currencies since mid-April. The bottoming of the two-year yield near the recent 4.70% low may reflect the end of the interest rate adjustment following the recent string of mostly weaker than expected high-frequency data and the softer CPI reading. The momentum indicators are getting stretched but have yet to confirm a dollar low is in place. Still, our message is one of caution and that the risk-reward may favor a dollar bounce.
The US announced a new tariff regime on Chinese goods. The tariffs cover a small part (~$18 bln) of US imports from China (~$450 bln in 2023). In part, they were designed to be preventative--avoid China flooding the US with unfairly subsidized electric vehicles, batteries, solar panels, and a range of other products, including so-called legacy semiconductor chips (no longer cutting-edge technology. Former President Trump has threatened higher tariffs on all Chinese goods if he is elected. The direct impact on US inflation will likely be negligible. However, the domestic and international signal is clear. Two responses are awaited. The first, of course, is retaliatory measures by Beijing. Chinese officials will know US vulnerabilities by the area that they did not target or create space for exceptions. The second set of responses is from Europe. It seems more willing to allow Chinese companies, as it did Japanese companies since the 1980s, to build production locally. Before the US announced 100% tariffs, some estimated 40%-50% levies in Europe would suffice.
United States: Barring a significant shock, the upcoming string of US economic data is unlikely to move the needle for policy makers or investors. Bloomberg's economic data surprise trackers is near its lowest level in a year. Ideas that the economy is re-accelerating are being questioned. Market participants appear to put more weight on the ISM than the PMI. The March manufacturing and service PMI readings were below the 50 boom/bust. The ISM manufacturing and services were in contraction territory. Hence, an asymmetry: above 50 adds little and a sub-50 reading lends credence to the slowdown narrative. Durable goods orders are often volatile, and the 2.6% gain in March overstates the case. Still, Boeing orders rose to about 125 from 113, while deliveries jumped to 83 from 29 in March. Existing home sales likely rose after falling 4.3% in March, while new home sales probably slowed after jumping 8.8% previously. The minutes from the FOMC meeting may pose headline risk but there is still another employment and CPI report before the Fed's June meeting. Besides, for all practical purposes the market has given up on the idea that the Fed can move in June. The futures market has discounted an almost 85% chance of a cut in September. Some argue that it is too close to the November election to cut rates, but there is precedent for it.
The Dollar Index may have to retest last week's low near 104.00 after the pre-weekend reversal from 104.80. Support near 104.35, which also houses the 200-day moving average, held before the weekend, The potential shooting star candlestick pattern warns of the downside risk, maybe the 1.0350-80 area may be a reasonable target. On the topside, a move above the 105.00-35 area lifts the tone. The momentum indicators have been trending lower since mid-April and may turn higher.
China: Without the PBOC cutting the one-year Medium-Term Lending Facility rate last week, banks have little incentive to reduce their loan prime rates this week. Beijing seems to prefer fiscal measures now, and the delayed-Third Plenary Session (now in July) is the forum to expect new economic initiatives. Ahead of the weekend, Beijing announced its latest bevy of measures to stabilize the property market. The new initiative was CNY300 bln (~$42 bln) for local governments to purchase unsold homes from developers, which still seem too small to turn the tide. Although the equity market liked it, the currency market was less impressed. While de-risking, encouraged by export-controls, tariffs, trade investigations, and not to forget, a sharp price in Chinese wages compared with many in the region, it widely recognized, China is engaged in its own de-risking, and this includes the shift of its trade activity to the global south from the high-income countries. Yet, ironically, the kind of large devaluation some think Beijing is preparing for, would undermine the strategic opportunity, not only in terms of goodwill, but the focus now may be direct investment rather than exports. For that, the relative strength of the yuan may be desired. The dollar looks comfortable in a CNY7.20-CNY7.25 range. Against the offshore yuan, the dollar looks poised to test last week's high near CNH7.25.
Japan: It was confirmed last week that Japan's GDP contracted in the first quarter (0.4% quarter-over-quarter), but the economy appears to be recovering. This is likely to be reflected in the preliminary April PMI estimates. Growth is expected to surpass 1% annualized rate over the next several quarters. Despite the weakness of the yen, Japan's trade balance deteriorated in Q1, partly because of the earthquake on January 1. Still, compared with Q1 23, the trade deficit was about a third of the size and last year's deficit was about half of the 2022 shortfall. However, seasonal factors warn against improvement in April. A few weeks ago (April 26), Tokyo reported a sharp drop in April CPI, driven by the waiving of high school tuition. Even if this does not fully feed into the national figures (due May 24), it will still be softer. The headline rate, core rate, and the measure that excludes fresh good and energy can ease toward 2%. Meanwhile, market sentiment seems to be in a bit of a flux. Previously, the debate seemed to be over a hike in September or October. Now, there is more talk about a small hike in July (10 bp) and another one in October. However, the yen does not seem particularly sensitive to this development. Intervention injected new dynamics will seemingly weakening short-term correlations between the exchange rate and 10-year yields (US Treasuries and the premium over JGBs).
The dollar recorded the week's low near JPY153.60 in follow-through selling after the US CPI and retail sales but recovered as US rates firmed and the BOJ did not continue to slow JGB purchases at the end of the week after doing so at the start of the week. The greenback reached nearly JPY156 ahead of the weekend before reversing lower to record new session lows near JPY155.25. It settled firm near JPY155.70. With the late losses, the dollar settled fractionally lower on the week (<0.10%). It was only the second weekly loss this quarter and the fifth for the year. A downtrend line connecting the late April and mid-May highs is near JPY155.80 at the start of the new week. An uptrend line of this month's lows begins next week around JPY154.00.
Eurozone: The PMI signaled the economic recovery seeming to take hold in the eurozone. The preliminary May reading is the economic highlight in the coming days. The composite PMI has not fallen for five months, and it is back above the 50 boom/bust level for the first time since last May. The eurozone economy grew by 0.3% in Q1 after it contracted by 0.1% in each of the last two quarters of 2023. Bloomberg's latest monthly survey (reported last week) showed steady expectations for 0.2% growth this quarter and 0.3% next. The market remains confident that the ECB will cut rates at its meeting on June 6. The swaps market strongly favors a cut in Q3 and another before year-end.
The euro rose for the fifth consecutive week and reached almost $1.09, its best level in nearly two months. We thought it was looking tired, but it came back strongly before the weekend and settled firmly near session highs, slightly below $1.0880. It has rallied from the year's low near $1.06 in mid-April. The US two-year premium over Germany fell to almost 180 bp at the end of last week, the smallest since early April but the downside may be limited. On balance, we are more inclined to sell into euro upticks than buy the dip. Support is seen in the $1.0810-30 area.
United Kingdom: Alongside the stronger UK growth has been a dramatic moderation in CPI. Growth in Q1 24 of 0.6% offset the contraction seen in Q3 23 (-0.1%) and Q4 23 (-0.3%). Headline CPI fell from 4.0% at the end of 2023 to 3.2% in March and it is likely to fall further. The April pace may have slowed to around 2.4% and closer to 2% in May. This is partly a function of energy, but the core rate (excludes food, energy, alcohol, and tobacco) is also declining. It has not risen since last May. It stood and 5.1% at the end of 2023 and was at 4.2% in March. It likely fell below 4% for the first time since October 2021. Separately, the UK will report retail sales. Unlike most G10 countries, UK retail sales are reported on a volume basis (rather than price). Retail sales were flat in March and rose by 0.1% in February. Even excluding gasoline, retail sales have been flat in February-March. Consumption appeared to have been drag on UK growth in Q1 and may not have improved at the start of Q2. The flash PMI is expected to be consistent with modest growth this quarter. The composite has been above 50 since last November. The swaps market is pricing in about a 58% chance of a June rate cut. It was near 30% at the end of April. The market has two cuts this year fully discounted, and almost a 25% chance of a third.
Sterling has appreciated by about four cents over the past four weeks. It recovered smartly from a pullback slightly below $1.2650 to launch another assault on $1.27, which is settled above for the first time in two months. The momentum indicators allow for additional near-term gains, perhaps toward $1.2755. The first sign that a correction is at hand may be a move below the $1.2630 area. Last week's gain of about 1.4%, left sterling down by about 0.2% against the dollar this year, solidifying its lead over the euro (~-1.5%) at the top of the G10 performers.
Canada: Like the UK, Canada also reports April CPI, but it lags a month behind, and its retail sales report will cover March. Canada's inflation experience is similar to the US in that the progress seen late last year stalled this year. Consider that Canada's CPI fell in the last four months of 2023. In Q1 24, Canada's CPI rose at an annualized rate of 3.6%. The median forecast in Bloomberg's survey is for a 0.5% rise in April's CPI, which, given the base effect, will allow the headline rate to ease from 2.9% to 2.7%. The Bank of Canada puts more weight in the underlying core measures. The are expected to slow as well. The median core is seen ticking down to 2.7% from 2.8% and trimmed mean is projected to have fallen below 3% for the first time since mid-2021. Meanwhile, Canada's consumption has fared better than the January-February decline in retail sales would suggest. StatsCan does not report its first estimate of Q1 GDP until the end of the month, but the economy may have accelerated from the 1% annualized pace in Q4 23. A recovery in government spending and business investment is expected to have played a role, but consumption may have also increased.
Last week, the US dollar traded below CAD1.3600 for the first time since the last US CPI report (April 9). It was unable to close below it, but the greenback finished last week on a soft note. The CAD1.3600 area is important technically, and a break of it returns the US dollar into the February-March range. The (38.2%) retracement of this year's rally is slightly below CAD1.3600, and the next retracement (50%) target is a little above CAD1.3500. The momentum indicators are trending lower, and while they are getting extended, they do not seem poised to turn higher.
Australia: The Reserve Bank of Australia is in no hurry to cut rates and the market realizes it. The futures market as about a 20% chance of a single cut discounted by the end of this year. The minutes from the central bank meeting earlier this month will be released on May 21. The risk of a surprise seems minimal. The following day, Australia will see the May's flash PMI. The composite PMI finished last year at 46.9, net-net little change on the year (47.5 in December 2022). However, it rose to 53.3 by the end of Q1 and was at 53.0 in April. Australia is one of the G10 countries to report Q1 GDP. It is scheduled for release on June 5. Growth slow in H2 23 to about 0.25% a quarter from around 0.55% in H1 23. Growth in Q1 looks to be on par with H2 23. Then RBA sees growth slowing to 1.3% this year from 2.1% last year. The IMF is a little optimistic at 1.5%.
The Australian dollar traded above $0.6700 last week for the first time since mid-January. The high was recorded after the disappointing local employment data. The Aussie did not settle above $0.6700, but the subsequent pullback was limited to about half-of-a-cent. The rally from the year's low set last month (~$0.6365) met the (61.8%) retracement objective of this year's slide. The issue is whether, the rally has been simply a correction or is there something larger unfolding. We suspect a little of both. The momentum indicators are getting stretched and the high might not been in place, though we think it was approached ($0.6630-50). Still, we expect a reasonable pullback will be bought. The downside risk may extend toward $0.6580-$0.6600 initially.
Mexico: The national election on June 2 is approaching but it does not appear to be much of a market factor. So far in May, the peso is the second-best performing currency in the region, rising by about 3.0% against the dollar, bested only by the soaring Chilean peso (~6.5%), ostensibly driven by the surge in copper prices (~10% month-to-date, follows a nearly 14% rally in April). Sheinbaum, AMLO's handpicked successor, is easily the odds-on favorite. If this is a given, the congressional election is not. The Morena Party needs to secure a strong majority in the legislative elections. In the week ahead, Mexico reports H1 May CPI. The pace of moderation has slowed has deterred the central bank from following up the March rate cut. Mexico will also report April's trade balance. In Q1 24, Mexico reported an average deficit of slightly less than $950 mln a month. In Q1 23, the average month's shortfall was $1.6 bln. Exports were about 1.6% higher than in Q1 23, while imports increased by almost 0.25%. That said, recall that the March surplus was around four-times larger than the median forecast in Bloomberg's survey ($2.1 bln vs $450 mln). Minutes from the recent central bank meeting will be published on May 23. At the meeting on May 9, the central bank left the overnight rate at 11% and revised higher its inflation forecasts for this year, a hawkish hold. The headline is now seen at 4% at the end of this year, up from 3.6%, while the core is projected to be at 3.8% rather than 3.5%. In April, headline inflation was 4.65% and the core was at 4.37%.
The peso's recovery from last month's sell-off has extended for three weeks. The carry (rate differentials) and easing of volatility underscore the peso's attractiveness. Three-month implied volatility peaked in last month's flash crash near 12.9% and was slipping through 9.7% ahead of the weekend. In March, it traded below 9%. The dollar fell to about MXN16.60 at the end of last week, its lowest level since mid-April. Modest chart and psychological support may be near MXN16.50 but a re-test on the multi-year low set on April 9 near MXN16.26 should not be ruled out. The cautionary note comes from some momentum indicators warning that it may be stretched. Initial resistance may be encountered in the MXN16.75-80 area.
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