News & Analysis

USD

The dollar opens mildly weaker this morning as the Fed reaffirmed its confidence to cut rates this year, signalled through both the updated economic projections and Powell’s unchanged tone in the press conference. That said, we don’t think the dollar has much room to weaken from here. While the median dot for 2024 continued to project 3 rate cuts this year despite expectations of higher core inflation, growth, and lower unemployment, the shift in the distribution of the Fed’s projections suggested there is a credible risk that rates in the US will remain structurally high. This contrasts heavily with the continued dovish messaging from the Bank of Japan, the more neutral guidance from the RBA earlier in the week, and less inflationary data in the eurozone and Canada. As such, we view the dollar’s sell-off post Fed as a shakeout of long dollar positioning on the risk of a more hawkish pivot, not the start of another sustained risk rally on the probability of a more aggressive Fed easing cycle and soft landing outcome.

As one would expect, APAC currencies like AUD, JPY and KRW have outperformed on this Fed outcome given their weak performance year-to-date under this higher US yield environment. In terms of the Aussie dollar, data this morning showing a much larger increase in employment in February and a significant undershoot in the unemployment rate is also lending a hand, helping to unwind some of the currency’s losses from earlier in the week on the more dovish RBA. Meanwhile, USDJPY has fallen back from levels just shy of its multi-decade high on lower 10-year Treasury yields and a report overnight from Nikkei that the BoJ could hike again in October or even July, the former being our base case after this week’s meeting. However, the large moves overnight have occurred in USDKRW, which traded down 1.29% as trade balance data showed considerable improvement and lower Treasury yields relieved some pressure on the currency’s capital account – outflows of which have stymied the won’s ability to rally alongside AI stocks in Q1.

With the Fed meeting in the rearview mirror and markets focused solely on its implications for near-term US rates as opposed to the implications for the belly/ back-end of the curve, the dollar is likely to remain offered into the weekend, bar any significant dovish surprises today. On this, we bookmarked the SNB as the most likely to lean in a dovish direction, but recently changed our call from a 25bp cut to a hold given the improvement in domestic growth data and the weakening of the franc. While markets will also receive updates from the BoE, Norges Bank, CBRT, and Banxico today, we think the other major development will instead be March’s flash PMIs. Here, signs of continued weakness in eurozone economic activity should weigh against the euro, potentially reversing some pressure on the broad dollar as a result.

EUR

A consistently hawkish tone from the ECB at its watchers conference and an unchanged view on rate cuts this year from the Fed has allowed EURUSD to rally back above the 1.09 handle overnight. However, as we note in our Fed response and above in the USD section, we think this later wave of dollar depreciation is temporary and reflects traders exiting speculative long dollar positions that were placed on the risk of a hawkish Fed. In our view, for the euro to sustainably rally and break back above the 1.10 handle, we would need signs that the Fed is going to ease more aggressively than they currently project or data supporting the ECB’s hawkish messaging. While the former was absent last night, especially as the Fed guided markets towards a higher rate regime through its medium longer-term dots, emphasis today is on the latter with the release of eurozone flash PMIs for March. Here, markets have been focusing on the marginal improvement in current activity measures in February and the continued improvement of forward looking indicators to suggest that eurozone recession odds have fallen, an outcome that should support the ECB’s more hawkish guidance. However, we note that the improvement comes from a significantly low base and despite ticking higher, current activity measures still signal the eurozone economy is in stagnation at best. If that is once again reflected in the data this morning, we suspect EURUSD could find itself fragile to a downside correction.

GBP

With yesterday’s CPI release landing close to expectations, we continue to expect no change in tone from the Bank of England later today. Admittedly, there was minimal risk of a change to Bank Rate in any case. But a dovish pivot in the policy statement could have been delivered, if the MPC had reason to think inflation would fall faster than expected. This, however, is not the case, with CPI having evolved almost exactly in line with Bank staff projections from February. Nor do we think the MPC has yet gained further clarity on the impact of April’s National Living wage rise, something we only expect to happen later in the year, once the second round effects become visible in the data. All told, with the outlook little changed since February, we expect policymakers to deliver a run back of their previous messaging. For markets, no change in rhetoric should be seen as hawkish at the margin, especially when placed against continued disinflation progress, an outcome that should push back easing expectations that have accelerated in recent days. If we are right, this should see sterling outperform today, especially if married to a set of PMI releases this morning that show the UK economy continues to deliver stronger growth than that found elsewhere in Europe, in keeping with recent trends.

CAD

Wednesday saw two major risk events for USDCAD play out, with markets ultimately seeing enough to take the pair half a percent lower on the day. Whilst most of this can be chalked up to relief that the Fed’s 2024 median dot failed to move last night, in our view markets have not yet seen the bigger picture when it comes to what yesterday’s events mean for both the BoC and the Fed. In the former’s case, March meeting minutes confirmed our prior that the BoC now intends to hold rates until June, irrespective of the data. Indeed, it appears that some policymakers have made the point internally that they should ignore CPI components that are a direct consequence of monetary policy, specifically those within shelter costs, an observation that we have also made repeatedly. If this were true however, the BoC should already be cutting rates given that CPI once excluding mortgage and rents is tracking below target at only 1.4% YoY. Moreover, whilst the minutes did highlight signs of economic weakness in the Canadian economy, they continue to focus on measures that have been offering a false sense of security of late, despite these only being propped up by high rates of immigration. Consequently, policy in Canada is now overly tight, meaning that faster rate cuts will be necessary further down the line. This now comes against the backdrop of last night’s SEP’s. While the FOMC failed to move the median 2024 dot higher, every other dot did rise. Furthermore, Fed voters have converged on the idea of cutting at a pace of once per quarter this year, far slower than the BoC is likely to need to ease policy in our view. If we are right, then prospects of growing policy divergence between the two central banks later this year should weigh heavily on CAD, just as soon as markets come to the same conclusion. For now though, we think  yesterday’s slide in the pair offers an attractive entry point for USDCAD longs, with expectations that the pair should move higher through Q2.

 

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