Dollar and Yields Drift Lower

US

USD and Treasury yields are edging lower as yesterday’s soft US economic data strengthened Fed easing expectations. The retail sales control group used for GDP calculations unexpectedly fell -0.2% m/m (consensus: 0.3%) vs. 0.5% in March. Meanwhile, PPI services less trade, transportation, and warehousing which feeds into the PCE, declined -0.3% m/m vs. 0.3% in March.

Fed Governor Michael Barr warned the US economy could be headed toward a stagflation scenario. According to Barr “The outlook has been clouded by trade policies that have led to an increase in uncertainty…Potential disruptions to supply chains and distribution networks are particularly acute for small businesses…If these disruptions were to occur, we'd likely see lower growth and higher inflation ahead.”

In our view, USD has entered a short-term period of consolidation as the Fed remains in no hurry to resume easing. Nonetheless, the fundamental backdrop remains difficult for USD for three reasons: (i) the Trump administration implicitly supports a weaker dollar, (ii) the US economy faces stagflation risk, and (iii) US policy credibility has been undermined by the trade war.

US April housing starts and building permits are unlikely to generate material financial market volatility (1:30pm London). The data is expected to remain consistent with a subdued contribution from residential investment to economic activity. Residential investment added just 0.05pts to real GDP growth in Q1.

Instead, the focus today is the University of Michigan preliminary May consumer sentiment report (3:00pm London). Headline is expected at 53.3 vs. 52.2 in April. The sentiment data no longer appears to be a reliable indicator of future spending behavior. But attention will be on inflation expectations as last month’s data indicated they’re becoming unanchored. In April, consumers' one-year inflation expectations soared to 6.5%, the highest since November 1981, while inflation expectations 5 to 10 years out surged to 4.4%, the highest since June 1991.

The March US Treasury International Capital (TIC) data is also due later today (9:00pm London). The latest TIC data show foreigner investors continue to pile-into US securities. Net foreign purchases of long-term US securities increased by $142bn in February to total $1238bn over the year, the most since September 2023. Private foreign investors have led the charge with a net increase of $125.8bn in US Treasury bonds and notes in February. Private foreign investors have more than offset foreign central banks’ net selling of longer-term US Treasury bonds and notes.

However, policy uncertainty, doubts about the rule of law, and escalating fiscal burden threaten to make the US a less attractive place to invest. As Walter Bigelow Wriston (former CEO of Citicorp) said “Capital goes where it’s welcome and stays where it’s well treated.”

JAPAN

USD/JPY is back down to 145.00 after testing a multi-week high near 148.65 on Monday. Broad USD weakness offset the drag to JPY from poor Japan economic activity. Japan’s economy contracted more than expected in Q1. Real GDP fell -0.2% q/q (consensus: -0.1%) vs. 0.6% in Q4, dragged down by net exports (-0.8pts contribution to GDP growth). Private and public consumption were flat, while business investment and inventory added 0.2pts and 0.3pts to GDP growth, respectively. The swaps market implies just one 25bps hike to 0.75% over the next 12 months.

Bank of Japan (BOJ) policy board member Toyoaki Nakamura argued the bank should pause monetary tightening due to tariff concerns. His comments are not surprising as he’s the most dovish BOJ member. Nakamura voted against the bank's decisions to raise rates in July 2024 and January 2025. His five-year term as a BOJ board member end in June.

NEW ZEALAND

NZD is outperforming most major currencies. The swaps market trimmed odds of RBNZ rate cuts after the 2-year inflation expectation survey rose to a one year high at 2.29% in Q2 from 2.06% in Q1. At its April 8 meeting, the RBNZ cut the Official Cash Rate (OCR) by 25bps to 3.50% and noted it “has scope to lower the OCR further as appropriate.” The swaps market price-in the OCR to bottom around 2.75%. The risk is the RBNZ slashes the OCR towards the lower end of its 2% to 4% neutral range estimate.

ROMANIA

Romania central bank is expected to keep rates steady at 6.50% today. At the last meeting April 7, the bank kept rates steady “in light of the particularly elevated uncertainty.” Moreover, inflation remains well above the 1.5-3.5% target range.

Political turbulence suggests the risk of a policy rate hike cannot be ruled out. Romania’s currency and bonds plunged after the government collapsed last week. Far-right party leader George Simion will now face-off against Nicuşor Dan, the pro-EU centrist mayor of Bucharest in a presidential runoff scheduled for Sunday. Simion is the favorite to win. Romania cannot afford to scare-off foreign investors with political instability as the country has a huge current account deficit in excess of -8% of GDP.