In the UK, the pound gained a modest boost this morning as retail sales data came in marginally above expectations, increasing 0.5% MoM following on from a -1.2% slump seen in March. Signs of better-than-expected consumer demand are not all good news, however, especially coming on the back of the surprise upside beat to CPI seen earlier this week. The hot inflation reading, which saw headline CPI print at 8.7% YoY, sparked a slump in Gilts which continued yesterday, as traders rushed to increase bets on the prospect of future Bank of England rate hikes. Current swap implied expectations suggest that markets are now anticipating at least four additional hikes in Bank Rate, compared to less than two this time last week. This shift is now beginning to be felt in the real economy as well, with news this morning that mortgage rates have jumped once again, reaching levels not seen since the disastrous Truss/Kwarteng mini budget of last year. Consequently, the spike in mortgage rates is likely to pull down economic growth and kill off what had looked like a tentative revival in the housing market, but also weigh on inflation in the process. The likelihood of higher rates puts UK growth back in the driving seat for the pound, with speculation around the possibility of a UK recession beginning to re-emerge once again. In our view, Bank Rate hitting 5.5% is probably still unlikely, but tightening financial conditions are doing the BoE a big favour. Whilst recent developments more or less guarantee a hike at the June meeting, softer data over coming months should lead the BoE to undershoot current market expectations, with a reversal of recent price action the likely dynamic over coming weeks and months.
Despite falling 0.4% against the dollar, the euro proved to be one of the more resilient G10 currencies against the broad dollar rally yesterday. Downside momentum seems to be fading, especially as the narrative that the Fed needs to hike further and won’t be seen cutting this year is temporarily losing steam at a time when the data is only confirming a more resilient ECB hiking cycle. Meanwhile, with the PBoC injecting more liquidity into the Chinese economy and signs that state banks are selling dollars in onshore Chinese markets to prop up CNY at the same time, the decline in the euro on the back of a cooling Chinese economy may have also run its race for the time being. Throughout all of this, the dominant discussion in DM FX markets yesterday was whether there is renewed interest by the real money community to pick up euro longs at these levels, with some signs in the options market suggesting there was increased activity. While this isn’t yet evident in spot FX, it is definitely something that will remain top-of-mind. Ahead of next week’s crucial flash CPI report for May, the focus today will be on how ECB policymakers view current conditions and expectations in markets. Notably, Chief Economist Philip Lane is scheduled to speak today at 08:40 BST, with his last comments focusing the attention of markets on core services CPI specifically, which can be viewed in a hawkish manner.
The bond market has been in the driving seat this week, and yesterday was no exception. Even before Q1’s advance GDP was upwardly revised in the second reading, momentum higher in yields was firm. However, data showing that the US economy actually grew 1.3%, up 0.2pp from the flash reading, boosted expectations that the Fed would need to resume its hiking cycle to quell core inflation pressures. It wasn’t just the headline level of growth that struck a nerve for bond traders who were already fretting over persistent core services inflation following Tuesday’s global PMIs and Wednesday’s hot UK inflation report, but the fact that the level of personal consumption was revised up to 3.8% QoQ at a time when the GDP price index was also increased. Pricing of the Fed’s June meeting is now a coin flip between a hold and another 25bp increase, a far stretch from where we were just weeks ago when markets viewed the balance of risks towards easing at this meeting. Additionally, markets are now pricing less rate cuts from the Fed in the second half of the year, with the spread between the December and June OIS contracts trading at -0.26bps, up 18bps on the week.
The tumultuous session in the bond market almost took place without investors getting battered by another round of debt ceiling headlines. But with the Treasury’s cash balance falling below $50bn for the first time since December 2021, when Biden last raised the debt ceiling, it seems as if Congressional leaders finally felt the pressure. This morning, European traders awoke to news that the GOP and the White House negotiators are moving closer to a deal that would raise the debt limit and cap federal spending for two years, with Goldman analysts saying a deal is most likely late tonight or tomorrow given the June 1st deadline draws closer. However, despite the first puffs of white smoke from Washington, markets and lawmakers are yet to see the details of any deal. Most notably, the amount of any spending cap is unknown. Nonetheless, the market has taken the signs in a positive vein, with APAC equities rising overnight and European and American equity futures trading in the green. Meanwhile, in FX markets, the dollar has finally broken its strong rally, edging down 0.16% overnight as front-end Treasury yields finally take a breather. However, the break in this week’s dominant fixed-income/currency trend may only be temporary as this afternoon’s release of April’s PCE inflation data has the potential to reignite the rally in front-end yields. Outside of the inflation release, positioning ahead of what is set to be a pivotal weekend for bipartisan talks will be a dominant factor for markets.
The Canadian dollar continued to weaken on Thursday, slipping by a third of a percent against the dollar, and bringing it to its weakest level in a month. It was a day of broad dollar strength, with no market-moving headlines nor data points for Canada coming through. Volatility in the loonie has been suppressed compared to other cyclical currencies, partially due to large options expiries with strikes near current spot levels. With no major expiries today, it is possible that greater volatility in CAD could resume. Cross-asset drivers were mixed, with a solid 0.9% gain on the S&P 500 being offset by a $2.50 decrease in the price of crude and a 3-9bp widening between US and Canadian yield curves. Today’s single data point for Canada was the payrolls employment survey, which suggested that employment fell by -9.9k in March, counter to the 34.7k gain suggested by the labour force survey. The payrolls survey, however, historically tends to underestimate job growth, especially since it does not measure the agricultural sector.