Dollar Firm Ahead of CPI Data

May 10, 2023

Win Thin

The budget ceiling standoff continues; April CPI will be the highlight; Fed easing expectations are starting to get pared back; Fed officials remain focused on credit conditions
Italy reported weak March IP; ECB officials appear to be tilting less hawkish; Norway April CPI ran hot; Poland is expected to keep rates steady at 6.75%
HKD is trading at the strongest level since late February

The dollar remains firm ahead of the CPI data. DXY is slowly clawing back some of its losses and is trading higher for the third straight day near 101.686. A break above 101.878 is needed to set up a test of the May 2 high near 102.404. The euro is trading lower near $1.0955 and is on track to retest the May 2 low near $1.0940 after failing to break below it yesterday. Sterling is holding up relatively better and so the EUR/GBP cross continues to make new lows for this move near .86726. Cable is trading flat near $1.2620 and a break below $1.2525 is needed to set up a test of the May 2 low near $1.2435. USD/JPY continues to inch higher above 135 and traded as high as 135.50 before stalling out. We look for continued gains and a break above 136.15 is needed to set up a test of the May 2 high near 137.75. Banking sector concerns and dovish market pricing for Fed policy have been the two major negative headwinds on the dollar and both are fading. As such, we believe the dollar has put in a near-term bottom. CPI and PPI data this week will be key to a sustained dollar bounce.

AMERICAS

The budget ceiling standoff continues. After meeting with President Biden yesterday, House Speaker McCarthy said there was no progress made by noting “I didn’t see any new movement.” He said they would meet again this Friday and reports suggests aides have already resumed talks ahead of that meeting. Biden warned that “Over these last few days and weeks, there’s going to be a lot of posturing, politics and gamesmanship and it’s going to continue for a while,” but added that the meeting was “productive.” Both sides have made it clear they aren’t interested in a short-term extension and so the task at hand will be very difficult. However, Senate minority leader McConnell stressed that “The United States is not going to default. It never has and it never will.” Distortions in the T-bill market continue as a result of the uncertainty, with the 1-month yield spiking above 2- and 3-month yields.

April CPI will be the highlight. Headline is expected to rise 0.4% m/m vs. 0.1% in March, while the y/y rate is expected to remain steady at 5.0%. Core is expected to rise 0.3% m/m vs. 0.4% in March, while the y/y rate is expected to fall a tick to 5.5%. Of note, the Cleveland Fed’s Nowcast model estimates headline at 0.61% m/m and 5.19% y/y and core at 0.46% m/m and 5.56% y/y. Both estimates are higher than consensus. After that, PPI will be reported tomorrow. Headline is expected to rise 0.3% m/m vs.- 0.5% in March, while the y/y rate is expected to fall two ticks to 2.5%. Core is expected to rise 0.2% m/m vs. -0.1% in March, while the y/y rate is expected to fall a tick to 3.3%. April budget statement will be reported today.

Fed easing expectations are starting to get pared back. At the start of last week, swaps market was pricing in a Fed Funds range between 4.0-4.25% in 12 months. Earlier, it was as low as 3.5-3.75% but now it's back in the 3.75-4.0% range in 12 months. Three cuts by year-end were fully priced in at the start of this week but the odds of a third hike have fallen to around 60% currently. That said, market expectation of a Fed pivot are misguided and must be repriced. Fed officials are likely to continue pushing back against this dovish take but it will really be up to the data. There are no Fed speakers today.

Fed officials remain focused on credit conditions. Yesterday, Williams said “I will be particularly focused on assessing the evolution of credit conditions and their effects on the outlook for growth, employment, and inflation. We’re going to get a lot of data between now and our June meeting.” In continuing to stress data dependency, he said “What we’re signaling is we’re going to make sure that we achieve our goals and going to assess what’s happening in the economy and make the decision based on that data. And if additional policy firming is appropriate, then we’ll do that.” Lastly, Williams said “I do not see in my baseline forecast any reason to cut interest rates this year. In my forecast we need to keep restrictive stance of policy in place for quite some time.” Elsewhere, Jefferson said “We have the data showing that banks have started to raise lending standards and that has contracted the availability of credit. That is typical for where we are in the economic cycle.” He added that “The credit constraints that you may be now sensing is a natural part of the transmission mechanism of monetary policy.” In other words, Jefferson sees no financial stability concerns from the Fed tightening cycle.

EUROPE/MIDDLE EAST/AFRICA

Italy reported weak March IP. It came in at -0.6% m/m vs. 0.3% expected and -0.2% in February. As a result, the y/y WDA rate came in at -3.2% vs. -2.3% in February. Eurozone IP will be reported next Monday. Recent weakness in the German data has led us to downgrade our expectations for eurozone growth this year, as China reopening has had little impact on the European exporters so far. Bloomberg consensus sees Q2 growth remaining steady at 0.1% q/q but we see growing risks of a downside surprise.

ECB officials appear to be tilting less hawkish. Nagel said “We’re coming to the home stretch in the sense that we are reaching the area in monetary policy that’s considered restrictive.” Stournaras said “We’re close to the end. We’re not there yet, so I agree with Madame Lagarde that we still have some distance to go.” He was referring to earlier comments from Lagarde that “We have moved in a very deliberate and decisive way in order to fight inflation,” adding “we still have more ground to cover.” Muller and Centeno also speak today. The split between the hawk and the doves remains in place but with even noted hawk Nagel shifting his stance, it feels like the doves have taken control of the narrative for now. WIRP suggests another 25 bp hike is 90% priced in for June 15. However, the odds of one last 25 bp hike September 14 have fallen to around 80% vs. fully priced in before last week’s ECB meeting.

Norway April CPI ran hot. Headline came in at 6.4% y/y vs. 6.1% expected and 6.5% in March, while underlying came in at 6.3% y/y vs. 6.1% expected and 6.2% in March. Last Thursday, Norges Bank hiked rates 25 bp to 3.25% and said that “Based on the Committee's current assessment of the outlook and balance of risks, the policy rate will most likely be raised further in June.” It noted that “Inflation is high and markedly above the target of 2%” and added that “Higher wage growth and the krone depreciation will contribute to keeping inflation elevated ahead.” With regards to the exchange rate, Governor Bache noted that “The krone has been weaker than forecast, and krone weakness means prices of imports rise which in isolation can mean that a higher rate than presumed earlier may be needed.” Since the hike, EUR/NOK has fallen near -3.5% but is running into support just above the 11.50 area. With price pressures still high and the krone still quite vulnerable, we look for a 25 bp hike to 3.5% at the June 22 meeting.

National Bank of Poland is expected to keep rates steady at 6.75%. The bank has been on hold since its last 25 bp hike back in September. Minutes for the April 5 meeting will be released Friday. At that meeting, the bank said inflation has started its steep decline. Of note, inflation came in at 14.7% y/y in April, the lowest since May 2022 but still well above the 1.5-3.5% target range. The market is pricing in the start of an easing cycle over the next 3-6 months, which seems too soon to us.

ASIA

HKD is trading at the strongest level since late February. The continued liquidity drain from HKMA FX intervention has finally led to higher local rates, which in turn has supported HKD. The so-called Aggregate Balance that is a measure of local liquidity is the lowest since late 2008, while local interbank rates have spiked above levels seen during the financial crisis. While higher borrowing rates will be a drag on the economy, this is exactly how the peg is supposed to work. The biggest changes for Hong Kong since 2008 are increased influence from Beijing as well as China’s more inward-looking focus. Both have put a bit of a chill on the foreign investment outlook for both Hong Kong and mainland China and this bears watching. That said, the peg will hold for the foreseeable future.

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