News & Analysis


Having gone back and forth at the start of the week, the dollar rallied significantly yesterday alongside front-end Treasury yields as the first quarter employment cost index, a wage measure the Fed closely follows, confirmed fears that inflation may get stuck above the 2% target. Not only did the headline measure tick up sequentially, beating expectations by 0.2pp to land at 1.2% QoQ, but the details of the report were also firm. Growth in wages and salaries increased by 0.05pp to 1.11%, as did wage growth for private sector employees to 1.09% QoQ. This leaves most measures of wage growth now tracking above 4% on an annualised basis, sustaining significant real wage growth and strong levels of consumption, both of which were evident in last week’s flash Q1 GDP report.

The reacceleration in wage growth provides policymakers with yet another reason to strike a hawkish tone at this evening’s meeting. We expect this to be primarily delivered by Chair Powell in his press conference, with his opening remarks likely to echo the ones given two weeks ago that first quarter data haven’t increased the Fed’s confidence of inflation returning to target and thus to cut rates. While we expect Powell to stick to this non-committal stance and to continue stressing the Fed’s reaction function is to hold rates at current levels for longer, we doubt he will be given an easy time by journalists who are looking to ascertain the Fed’s views on its ability to cut rates at all this year and the likelihood of further hikes. While not our base case, any indication from Chair Powell that the Fed may need to keep rates on hold until 2025 or even tighten monetary conditions further should inflation remain stuck above target for a sustained period of time will likely lead Treasury yields to break above current ranges and consolidate the move higher. Yields on the 2-year north of 5% and the 10-year converging on 4.8% would likely cause ruptures in financial markets, with stocks plummeting and the dollar taking another leg higher, potentially sparking another round of FX intervention in Japan. For this reason, we suspect Powell will try to avoid hitting the emergency button just yet. Instead we suspect he will aim to relay a hawkish message to try and tighten financial conditions further without sparking outright panic. This should continue to support the dollar’s rally north of 106.50. That said, with just one full rate hike now priced for this year, the margins for error are thin.


First quarter GDP data provided a welcome boost for the eurozone economy yesterday, printing above the ECB’s forecast of 0.1% with a reading of 0.3% QoQ. With core inflation pressures also continuing to cool, one could be forgiven for thinking that the eurozone is edging towards a soft landing outcome, a scenario that looked like a distant possibility at points last year. However, as we warned yesterday, the data out of the eurozone weren’t wholly positive. First quarter growth was boosted by downgrades to Q4 figures, the outcome of which meant the eurozone recorded a technical recession in 2H23, while disinflation progress wasn’t as substantial as economists expected. With the data pulling both ways, it wasn’t surprising to see EURUSD struggle for direction yesterday morning. Nevertheless, traders were given an easy out by the strong US Q1 employment cost index which sparked a broad wave of USD appreciation. This saw EURUSD shed half a percent to trade in the midpoint of its post-CPI range. Downwards momentum persists this morning with the euro a tenth of a percent lower, however, trading has been limited by much of continental Europe away for Labour Day. Whether or not the euro makes a break for the 1.06 handle or retraces back above 1.07 will therefore be left in the hands of Chair Powell tonight. A more hawkish tone that sparks a decline in equities should see FX markets make light work of 1.06, leaving EURUSD to plumb lows not seen since November 2023.


With yesterday’s US data proving dollar positive, sterling was left to fall more than half a percent against the greenback. The pound’s move lower belied domestic developments, however, which offered a neutral readthrough on the state of the UK economy. While Lloyds price expectations data signalled some stickiness, the BRC shop price index by contrast showed prices had fallen faster than expected. All told, this was sufficient to see GBP finish only marginally down against the euro, a performance more reflective of UK fundamentals. That said, if yesterday’s data was net-neutral for sterling, this morning’s house price release is unambiguously negative. Nationwide house price data showed an unexpected -0.4% fall in April. Coming on the back of a -0.2% MoM decline in March, it is starting to look like a nascent recovery in the UK housing market is petering out. While not quite sufficient to set alarm bells ringing just yet as house prices still rose by 0.6% year-on-year in April, this has nevertheless seen the pound kick off Wednesday with a modest softening bias. Even so, the focus for the remainder of the day is likely to be yet more events in the US, with an ISM release and a Fed meeting set to be front of mind for GBPUSD traders.


While yesterday’s US data stole the headlines, a Canadian GDP reading for February delivered a notable undershoot. Not only did the 0.8% YoY growth reading disappoint relative to expectations, which looked for a 1.1% print, but in absolute terms the February print should also be cause for concern. As we noted in advance of the release, the Canadian population has expanded by more than 3% in the past year. Against this, the rates of growth being recorded in Canada suggest growing economic slack, even while headline numbers continue to print in positive territory. All told this disappointing outturn was reflected in the loonie’s performance yesterday too. USDCAD rose more than 0.8pp to finish the day trading just 0.5% off year to day highs. We think there are risks that the pair could retest those levels today as well. While a Fed meeting this evening should see Powell reiterate that the FOMC lacks “sufficient confidence” to cut rates, which should be seen as hawkish by markets, we doubt BoC Governor Macklem will be able to echo such a sentiment in his appearance in Parliament. Canadian data has now disappointed expectations across all key economic releases in the past month. Against the backdrop, continued hawkishness from Macklem would only serve to undermine the credibility of the BoC. As such, we suspect a more dovish tone from Macklem should be forthcoming later today. Set against a hawkish Powell, this contrast should hammer home the message for traders that the BoC will need to ease somewhat faster than the Fed, a dynamic that we expect to lead USDCAD to retest year-to-date highs.



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