FX Focus: The trick for Fed and dollar bulls

In the past week, the US inflation numbers have been levelling off a little, but as is – or should be – the case, the Fed will need to see a few months data before they can start to make assumptions on how CPI levels are going to play out.

Based on recent US dollar (USD) strength, import prices should naturally start to ease off, and in Friday’s release, April recorded a 0.3% rise vs 0.6% (rise) in export prices, so this may take time to filter through into the data.

From a rates perspective, there is the temptation to suggest the Fed may need to hike four times this year based on the surge in activity, which could also be put down to a prolonged period of weakness, and again, the latest recovery could counter-balance this dynamic in a climate of (shall we way) limited global demand.

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The clear example here was the UK, when the pound collapsed in the aftermath of the referendum vote, with manufacturing orders clearly benefiting, and the same should ‘technically’ have been true for US products over the past year or so.

Either way, this tricky balancing act for the Fed is likely to be navigated, with some tolerance of an inflation overshoot, and Fed speakers including chair Powell alluding to this in recent rhetoric.

There is a wealth of Fed speakers on the schedule in the week coming up, and this is likely to feature in some of the deliberations among Fed members, who on the whole, remain comfortable with sticking with the three-hike dot plot for this year and next.

Yield curve flattening has highlighted what the rates market believes excessive tightening in the short term will lead to, and, aside from this, it is also now widely acknowledged that should the benchmark 10-year push through the 3.00-3.05% mark, attractive fixed income yields will surely unsettle the stockmarkets.

That said, the Fed has made it known that this is not their ‘responsibility’ as such, and will maintain their normalisation path accordingly. At just 42bps, the 2-10yr spread is now at levels last seen in 2007, which was the precursor to the 2008 Great Financial Crisis leading to the economic downturn.

The US data schedule starts on Tuesday, with the US consumer in the spotlight. Consensus is looking for a 0.4% rise in sales over April, which should be enough to satisfy USD bulls – among them of which are leveraged funds across the board.

On Wednesday, we also get the April industrial production figures, which garners greater attention these days, along with capacity utilisation rates as president Trump’s policy is aimed at getting jobs and industry back into the US.

At some point this fresh confidence in the USD could push the Japanese yen (JPY) rate above 110.00. After a couple of attempts already the resistance has been clear to see, but as the rates market leads FX at the present time, the US 10 year Note is still pressing for levels noted above.

As we have already alluded to, however, the correlation with stocks will present some headwinds for the JPY carry trade in general, and this may perhaps be the reason for hesitancy in USD/JPY (see chart below) at the very least.

Source: TradingView                    Past performance is not a guide to future performance

This certainly has not done any harm to USD/CHF, but the Swiss National Bank (SNB) is taking every perceivable step to soften the CHF (Swiss franc) tone, which has managed to keep the EUR rate close to 1.2000 despite dampened sentiment on the single currency elsewhere.

Little of note out of Switzerland, though data here is deemed insignificant based on the SNB’s steadfast intentions, but central bank governor Jordan speaking this week when he will no doubt reiterate CHF value levels which we assume will not be amenable until we return through 1.2000 vs the EUR.

In Japan, however, there is plenty to chew on as it were, not least of all the inflation data on Friday. Leading up to this we get the Q1 GDP numbers which are expected to show a flat quarter vs the 0.4% rise in growth in Q4 last year, but we are also watching capital expenditure levels which are expected to rise.

All in, it is largely down to Friday’s data, and, unless inflation returns through 1.0%, the Bank of Japan (BoJ) will continue with its powerful easing measures which have sent government debt to GDP to over 250%!

No wonder that periodically, the market will stampede back into the JPY in anticipation of what many perceive to be a much needed unwind – to some degree at least.

For the EUR, the week has started off well, and some have attributed this to comments from ECB member and Bank of France governor Villeroy’s comments on the inevitability of asset buying cessation. He also defined that time of the next rate hike ‘well past’ the end of QE as a matter of quarters rather than years, seemingly underlining 2019 when rates start to normalise also.

That is some time away, and plenty of time for inflation to pick up and return closer to target. We do, however, need to see a pick-up in global demand and/or a restrained EUR rate, given the region’s heavy dependence on exports, and the recent German business surveys have not been shy in attributing recent weakness to high exchange rate levels.

Sub 1.2000 vs the USD (see chart below) should help for now, but we note both Q1 GDP and April CPI due out this week, and there is a propensity for traders to jump back into what has been one of the most overcrowded trades in recent times, based in economic pick in the eurozone despite recent ‘levelling off’.

Source: TradingView              Past performance is not a guide to future performance

Commodity prices taking a fall, as they have, does not help the arbitrary pick-up in inflation, though this is clearly differentiated in the ECB press conferences, but courtesy of the latest developments over the Iran nuclear deal, oil prices have risen considerably which should provide some positive input in Euro PPI.

It has however, dampened sentiment in the Aussie dollar (AUD), which weakened to close to 0.7400 last week, and this has been compounded by the rate differential moving favour of USD/Treasuries. 

The Reserve Bank of Australia (RBA) rate path also looks to have priced out a move this year despite some modest expectations at the start of the year, but, with trade tensions also hanging in the air, it is not hard to see why investors have been shying away from the AUD in recent weeks and months, having weakened ahead of the USD recovery which started in earnest a month or so ago.

For the RBA, wage growth and inflation are reason enough to sit on their hands for the time being, yet still maintaining that they see the next rate move as up. While the RBA meeting minutes are unlikely to reveal any fresh considerations, which spell a period of neutrality at the central bank, the April jobs report offers some prospects on whether wages can pick up on tightening slack in the labour market.

Source: TradingView                   Past performance is not a guide to future performance

More budget data out of New Zealand, which continues to produce higher than expected surpluses, which highlight the healthy public finances here.

Despite this, the Reserve Bank of Australia (RBNZ) are ever cautious on the domestic outlook, and in their meeting last week were a little more explicit in keeping the direction of the next rate move in the balance.

This naturally saw NZD hit with the spot rate hit down to 0.6900. Given this was a key target from sellers in the 0.7300-0.7400 region, it was not surprising to see a lack of follow through once the figure was temporarily breached.

Global Dairy Auctions on Tuesday this week, but this carries little weight in the market these days, with modest price deviations recorded in the past year or so.

Source: TradingView               Past performance is not a guide to future performance

Finally, in Canada, some are expecting fresh news on the NAFTA trade talks. Over the weekend, Canadian PM Trudeau weighed in with his optimistic take on negotiations where he saw a possible agreement being reached soon.

Mexico has been a little more anxious over the talks and have argued for a deadline for a text to be drafted by the end of this week.

Talk as they say is cheap, but a positive mood makes for a smoother path for a resolution to the tri-party accord and that is as much as can be expected in the meantime.

The Canadian dollar, however, remains well contained for now, and, while see the outer limits of 1.2500 and 1.3100 containing the spot rate, a potential move to the lower end of the range was scuppered last week when employment in April contracted by 1.1k. But this was all down to a loss of part time jobs (a little over 30k), while full time jobs grew by 29k or so.

Canadian inflation is due at the end of the week, but above 2.0%, this is less of a concern for policymakers as the Bank of Canada (BoC) maintain their focus on how the economy fares with the thee rate hikes already put into effect as well as the steady rise in capacity utilisation.

Household debt should steady the BoC hand for now, but stability here – and also in the data as whole – should encourage the market on the economic outlook given base rates are now up to 1.25%.

Source: TradingView                  Past performance is not a guide to future performance

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