News & Analysis


Price action in sterling remained fairly muted this morning, with the pound falling marginally in early trading against the dollar and the euro as moves continue to be dictated by developments elsewhere. In terms of data, markets have already seen the days one and only release of note, with the Lloyds business barometer ticking up slightly to print at 33 this month, up from the 32 seen in March. Perhaps more importantly, Brits also awoke this morning to news that the UK government is set to U-turn on a plan that would scrap or revise all EU law currently in force. The proposed strategy had been widely panned in recent months as unworkable given that the government and civil service had struggled to identify the sum total of laws that would even be affected, let alone spell out alternative solutions. The decision is therefore a welcome one, and continues the general trend towards more stable governance following uncertainty that came in the aftermath of the Brexit vote. As we have noted previously, whilst not immediately market moving, an increasing sense of stability in the UK is a dynamic that we see as providing upside support for the pound over the medium term, and this morning’s news builds on that trend once again.


With the Bank of Japan’s latest policy decision out of the way, all of the attention moved to the eurozone as inflation data from France, Spain and Germany is set to be released alongside advance Q1 GDP readings for the eurozone as a whole. While growth data will prove influential in soothing any lingering growth concerns on the continent, it will be the inflation data that really moves markets. CPI releases from the three largest eurozone nations account for 59% of the eurozone composite number that is released next week, meaning today’s data will give traders a good steer on what the ECB’s next policy decision will look like. However, there is one caveat to that in the form of core inflation, which is the focal point for markets as headline inflation now begins to reap the benefit of base effects. Only Spain publishes an official core reading, meaning markets will have to back out estimations of core inflation from the overall basket, which leaves margin for error. Nonetheless, we think similar to March’s data, the signs within today’s regional releases will prove enough of a signal for markets to confidently price expectations of the ECB’s next steps next week.

Ahead of German GDP data at 09:00 BST, the eurozone measure at 10:00 BST, and German CPI at 13:00 BST, the regional data released so far has shown consistent signs of economic strength, as France grew 0.2% QoQ despite the uptick in industrial action in Q1, while Spain’s economy beat expectations as it grew 0.5% in the first quarter. However, the readthrough in the regional inflation prints wasn’t as clear. Headline inflation in France exceeded expectations as it ticked up 0.2pp to 5.9% YoY, with strength shown specifically within services inflation which grew 3.2% YoY in April, while Spain’s inflation data showed core inflation pressures fell considerably with an official reading of 6.6% YoY, down from 7.5% last month. Given the mixed inflation data, markets are yet to change their stance on the 25-50 basis point debate, instead awaiting the German figures this afternoon. However, it is worth noting that Spanish inflation has led eurozone inflation for much of this economic cycle, and with core inflation pressures coming off the boil even as the economy grows at a robust pace, this may prove enough for the doves to force a more gradual path for rates moving forward. For now, however, eurozone markets are likely to trade sideways as they await the final piece of the puzzle from Germany this afternoon.


Of course the big US news today is from the NFL draft, where last night saw the Carolina Panthers take Bryce Young with the number one pick, having traded up to land their next franchise QB. An interest in trading was not just limited to sports fans however. In FX markets, the dollar’s performance over the course of yesterday was mixed in contrast, reflecting considerable ambiguity in the latest economic data. The advance GDP reading for the first quarter badly missed expectations, coming in at 1.1%. This contrasts with forecasts for 1.9% and the previous quarter’s reading of 2.6% growth. While the headline figure suggests a considerably weaker economy, the details were much stronger. The weaker GDP figure stemmed from a fall in inventories, which is a highly volatile series. If you strip out inventories and net trade from GDP, you get a cleaner read on the domestic US economy. That measure, which sums consumption, fixed investment, and government spending, was the strongest in a year and a half, which tells a rather different story from the headline number. This latest report truly embodies the broader macroeconomic backdrop: conflicting data signals have led to highly divergent economic forecasts, creating confusion in markets. On the one hand, you have contractionary monetary policy, rapidly deteriorating survey data, and market-based indicators suggesting that a recession is imminent. On the other hand, the labour market and growth numbers continue to remain strong, and three years later, massive cash transfers to households that followed the Covid recession have only partially been spent. The other data releases from yesterday were similarly muddled. Fewer applications for unemployment benefits were filed last week, missing expectations, but the broader trend has been headed upward for months. Meanwhile, the Kansas City Fed’s manufacturing activity index contracted far more sharply than expected, but we have found that the disparity across the regional Fed surveys is extremely high. Today, the flagship employment cost index is set to be released for Q1 at 13:30 BST. However, with the indicator extremely lagged and the Fed currently focused on the upstream effects of policy tightening and the fallout from SVB, the data may have a more muted impact than it did earlier in the year.


The Canadian dollar gained a bit of ground against the US dollar on Thursday, rising by 0.3%. The meagre gains are puzzling considering the massive equity rally that took place. The S&P 500, which tracks US blue chip stocks and is the most closely correlated equity index to USDCAD, rose by a whopping 2%. The Nasdaq, a more tech-focused index, posted an even stronger daily rally of 2.4%. Other cross-asset drivers don’t explain why the loonie lagged behind the stock market: Canadian bond yields largely kept pace with the 7-12bp rise in US yields, while crude oil prices rose by 0.7%. Today, the main Canadian data release will be GDP for the month of February. Economists expect that monthly growth will be subdued at 0.2% and that annual growth will fall to 2.6%.


While expectations of a policy move by the Bank of Japan had been tapered over the past fortnight following multiple public communications from senior policymakers suggesting caution in the normalisation process, markets were still slightly wrongfooted by the Bank’s latest policy decision to keep the policy framework untouched. The main surprise came in the announcement of a policy review, which is expected to be completed in around one to one and a half years’ time. Although this is not a sign that the BoJ would delay any normalisation until this review had concluded, it did add to the dovish outcome of today’s meeting. On top of the policy review, the BoJ’s latest inflation forecasts suggest that the threshold for normalisation, a stable 2% inflation forecast over the next 6-18 months, still hasn’t been met. The Bank currently forecasts headline CPI at 2% for FY24 but below 2% for FY25 (1.6%) and core inflation below 2% for both FY24 (1.7%) and FY25 (1.8%), all the while stressing that the risks to its longer-term inflation forecasts are tilted to the downside. Compounding the dovish twist, the BoJ retained language that it “will not hesitate to take additional easing measures if necessary” while it repeatedly stressed patience in the normalisation process. Nonetheless, it did tweak its forward guidance, removing reference to Covid-19 and factored in the higher outcome of the Shunto wage negotiations.

Following the BoJ’s policy announcement, the yen sold-off over a percent on the day as speculative positioning was flushed out of spot, options and JGB markets. Nonetheless, despite today’s dovish developments, we still think the Bank of Japan is likely to begin tweaking its yield curve control framework at their June meeting. Firstly, we don’t think the completion of the monetary review is necessary for any tweak in the Bank’s yield curve control. Secondly, inflation is still exceeding the BoJ’s forecasts and those provided by economists, highlighted by April’s Tokyo core inflation print today coming in 0.3pp above expectations at 3.8% YoY. This gives the BoJ a normalisation window, which will start to be dramatically closed should the global economy nosedive or financial stability concerns reappear in the second half of the year. Finally, any inaction today while inflation conditions are fructuous may lead to a cliff edge decision later down the line. For JPY bulls, today’s decision may just be a blip in what is likely to be a long road ahead.


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