Dollar Soft as Europe Returns from Holiday

April 11, 2023
  • Fed officials continue to view banking system strains as separate from monetary policy; Fed tightening expectations remain depressed; Brazil reports March IPCA inflation
  • Eurozone reported weak February retail sales; reports suggest U.K. Prime Minister Sunak is planning to announce tax cuts and wage hikes ahead of the elections; Norway reported March CPI data
  • New BOJ Governor Ueda signaled continuity in policy; Japan reported weak March machine tool orders; China reported March CPI, PPI, and new loan data; Taiwan reported March CPI and trade data; Korea kept rates steady at 3.5%, as expected

The dollar is under pressure again as Europe returns from the Easter holiday. DXY is trading lower near 102.122 and have given back yesterday’s gains. Clean break below 102 last week sets up a test of the February low near 100.82. The euro is trading higher near $1.0910 and remains on track to test the February high near $1.1035. Sterling is trading higher near $1.2435 and is on track to test last week’s cycle high near $1.2525. USD/JPY is trading lower near 133.15 but has hung on to most of its gains after Governor Ueda reiterated steady policy (see below). Bottom line: the dollar may see some safe haven bid from time to time but until U.S. yields recover, the dollar is likely to remain under pressure near-term. While last week’s jobs data was dollar-supportive, this week’s inflation and retail sale data will also be key in setting the dollar’s near-term direction.

AMERICAS

Fed officials continue to view banking system strains as separate from monetary policy. Regarding the banking sector stresses this year, New York Fed President Williams said yesterday that “I personally don’t think it was the case that the pace of rate increases” were the cause. The corollary of this argument is that there is no trade-off between price and financial stability. That is, monetary policy will remain focused on inflation while regulatory policy will remain focused on stabilizing the banking sector. Most central banks have put this into practice and have hiked rates since the banking crisis began. Goolsbee, Harker, and Kashkari speak today.

Fed tightening expectations remain depressed. WIRP suggests around 70% odds of 25 bp hike at the May 2-3 meeting, up from 50% at the start of last week. After that, it’s all about the cuts. Two cuts by year-end are still priced in. In that regard, Powell has said that Fed officials “just don’t see” any rate cuts this year. This week’s CPI and PPI data are likely to underscore the fact that inflation remains stubbornly high and so we look for the hawkish tilt in Fed comments to continue this week. Retail sales Friday are expected to come in weak but we see risks of an upside surprise in light of the strong jobs report. Of note, the Atlanta Fed’s GDPNow model is currently tracking Q1 GDP growth at 2.2% SAAR, up from 1.5% previously. Next model update comes Friday.

Brazil reports March IPCA inflation. Headline is expected at 4.71% y/y vs. 5.60% in February. If so, it would be the lowest since January 2021 and back within this year’s 1.75-4.75% target range. At the last COPOM meeting March 22, the central bank left rates steady at 13.75% but raised its inflation forecasts for this year and next and warned of a deteriorating inflation outlook. Central bank officials should feel a little better about the fiscal outlook after the government announced its fiscal framework. If so, it could start the easing cycle in H2, perhaps as early as the August 2 meeting but more likely at the September 20 one.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported weak February retail sales. Sales came in as expected at -0.8% m/m vs. a revised 0.8% (was 0.3%) in January. However, the y/y rate worsened to -3.0% vs. a revised -1.8% (was -2.3%) in January. IP will be reported Thursday and is expected at 1.0% m/m vs. 0.7% in January. While there has been some improvement in the real sector data, we note that the bulk of the ECB tightening so far has yet to be fully felt. Furthermore, at least another 50 bp of tightening remains in the pipeline.

ECB tightening expectations have edged higher. The next policy meeting is May 4 and WIRP suggests nearly 95% odds of a 25 bp hike then. After that, another 25 bp hike is fully priced in for July 27. Odds of one last 25 bp hike in Q3 top out around 40% and so the peak policy rate is now seen between 3.50-3.75%, up from 3.25% during the height of the banking panic. Villeroy speaks later today.

Reports suggest U.K. Prime Minister Sunak is planning to announce tax cuts and wage hikes ahead of the elections. Local press is reporting that Chancellor Hunt is considering a cut in the headline income tax rate to be implemented next April in this year’s autumn statement. Furthermore, plans are afoot for a hike in the so-called national living wage to GBP11.16 per hour effective next April vs. GBP10.42 currently. These measures would be implemented with an eye towards calling elections next autumn. Meanwhile, BOE tightening expectations have edged higher. The next policy meeting is May 11 and WIRP suggests around 80% odds of a 25 bp hike, with odds of another 25 bp hike topping out near 90% in Q3. As a result, the peak policy rate is seen near 4.75% vs. 4.25% during the height of the banking panic.

Norway reported March CPI data. Headline came in at 6.5% y/y vs. 6.1% expected and 6.3% in February, while underlying came in as expected at 6.2% y/y vs. 5.9% in February. Headline is still down from the 7.5% peak in October but remains well above the 2% target. At the last policy meeting March 23, Norges Bank hiked rates 25 bp to 3.0% and Governor Bache said “The policy rate will be raised further in May.” Similar to other central banks that are also tightening, Norges Bank is looking through the banking stresses as Bache noted “We see no sign now that Norwegian banks have liquidity problems or of larger contagion effects in other parts of the financial system in Norway.” Next policy meeting is May 4 and another 25 bp hike to 3.25% seems likely.

ASIA

New Bank of Japan Governor Ueda signaled continuity in policy. In his first press conference as Governor, he said that current Yield Curve Control and interest rate settings are appropriate for the current economic situation. Ueda added that he’s open to the idea of a policy review but would like to discuss it with other board members before any decisions. He inherits a mixed economic picture that will make any decision to remove accommodation very difficult. Inflation has been easing but due in large part to government energy subsidies, while the economy is showing signs of slowing. Given this backdrop, we do not believe Ueda will be in any hurry to tighten. WIRP suggests no odds of liftoff April 28 or June 16 but then rising to over 25% July 28 and 50% September 22. A hike isn’t fully priced in this year. In addition, the subsequent tightening path is seen as very mild as the market is pricing in only 10 bp of tightening over the next 12 months followed by only 20 bp more over the subsequent 24 months. That is why we expect any knee-jerk drop in USD/JPY after liftoff to be fairly limited.

Japan reported weak March machine tool orders. Orders came in at -15.2% y/y vs. -10.7% in February and was the weakest reading since August 2020. Orders have contracted three straight months and five of the past six, supporting our view that China reopening has had little impact on regional trade and activity. February core machine orders will be reported tomorrow and are expected at -6.3% m/m vs. 9.5% in January. The y/y rate is expected to pick up a tick to 4.6%.

China reported March CPI and PPI data. CPI came in at 0.7% y/y vs. 1.0% expected and actual in February, while PPI came in as expected at -2.5% y/y vs. -1.4% in February. With price pressures so low, the PBOC can focus on injecting more stimulus to boost growth without having to worry about fanning inflation.

China also reported March new loan data. New loans came in at CNY3.9 trln vs. CNY3.3 trln expected and CNY1.8 trln in February, while aggregate financing came in at CNY5.4 trln vs. CNY4.5 trln expected and CNY3.2 trln in February. The pickup shouldn’t be too surprising after the PBOC cut reserve requirements and we expect further easing measures ahead.

Taiwan reported March CPI and trade data. Headline inflation came in at 2.35% y/y vs. 2.20% expected and 2.43% in February, while core came in at 2.55% y/y vs. 2.54% in February. While the central bank does not have an explicit inflation target, it delivered a hawkish surprise at its last meeting March 23 and hiked rates 12.5 bp to 1.875% vs. no change expected. However, Governor Wang said not to interpret the move as hawkish and instead portrayed it as part of the modest and gradual tightening cycle. Next policy meeting is June 15 and rates are likely to be kept steady if inflation continues to ease. Elsewhere, exports came in at at -19.1% y/y vs. -15.4% expected and -17.1% in February and imports came in at -20.1% y/y vs. -11.4% expected and -9.4% in February. The data here still suggest very little regional impact from China reopening.

Bank of Korea kept rates steady at 3.5%, as expected. It was the second straight hold and the decision was unanimous, which is in contrast to one dissent in favor of a 25 bp hike at the last policy meeting in February. The bank said it will judge whether a further hike is needed but added that a restrictive stance is warranted for a considerable time. It noted that the SVB collapse has increased risks to growth. Governor Rhee stressed that rate cut talk is unlikely until CPI is to hit its 2% target and that most BOK policymakers see market easing expectations as “excessive.” He added that five members want to keep the door open to a higher rate while one sees the terminal rate at 3.5%. Inflation eased to 4.2% y/y in March, the lowest since March 2022 but still well above the 2% target. The market is pricing in a peak policy rate near 3.5% but it really will depend on the data going forward.

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