News & Analysis

USD

The main event for markets yesterday was the release of April’s producer price index data from the US. While not necessarily a market-moving data set, the fact that it precluded today’s CPI report for a change and markets remain in flux over the timing of the Fed’s first cut meant that it drew an unusually large following. Printing at 0.5% MoM on both headline and core measures, the data considerably overshot expectations and prompted a knee-jerk rally in Treasury yields and the dollar, while it also confirmed our view that inflation conditions in the US haven’t necessarily subsided after a strong first quarter. That said, the initial reaction in markets failed to bind as traders turned their attention to the downward revisions to March’s data and the softer readthrough of the report to the Fed’s preferred inflation measure, the personal consumption expenditure index, as components such as hospital outpatient care and airfares outrightly contracted on the month. At the end of the day, Treasury yields closed moderately lower with the 2-year hovering just above 4.8% – the lower end of its post-payrolls range – and equities finishing in the green.

Whether or not yields break lower, equities extend gains, and the slump in the broad dollar index extends below the 105 level depends on how core CPI prints today. As we highlighted yesterday, however, we think the bar remains high for Fed easing bets to significantly reflate and the dollar to trend lower as a consensus print on the core measure still keeps inflation tracking at an annualised rate above 3.4%. This isn’t necessarily the outturn that will inspire confidence in Washington. Moreover, we continue to think that risks to the consensus of 0.28-0.3% are tilted to the upside, even as yesterday’s airfares data suggests core services inflation should cool more than we expect. If our expectations are met and core inflation prints at 0.4% on a rounded basis, odds of a September Fed cut are likely to be slashed from 80% currently to around 50% priced prior to the early May Fed meeting. By our estimates, this should be enough to add around three-quarters of a percent to the broad dollar index. In the scenario that core inflation prints at 0.2% or below, the market response will be contingent on April’s retail sales data, released at the same time. The consumption data will determine whether the sudden cooling of core inflation pressures maintains the soft landing outlook in the US, which would provide the most bearish impulse for the greenback, or if something more sinister is afoot, sparking a traditional risk-off session in markets.

EUR

Contrary to our expectations, softer details of yesterday’s US PPI report, an uptick in the German ZEW expectations index, and relatively hawkish commentary from ECB members yesterday were enough to send EURUSD through 1.08, with the rally extending this morning ahead of the crucial US CPI report. As was the case yesterday, developments in the US remain the primary focus with respect to EURUSD, but that shouldn’t detract from improving sentiment around the eurozone economic outlook, which should be confirmed with the preliminary reading of Q1 eurozone GDP at 10:00 BST. Should the eurozone data meet or exceed expectations and markets interpret the US CPI report in a dovish manner, we expect EURUSD could find another 0.5% from current levels, taking it to heights not seen since March’s hot US CPI report released in mid-April.

GBP

Yesterday’s wage growth figures offered a mixed bag for the pound. While headline measures beat market expectations, crucially, the private sector regular pay readings closely watched by the MPC undershot the Q1 forecast from the May MPR by 0.1pp. More importantly in our view, the figures failed to give a clear indication on the impact of April’s national living wage rise. While this now places significant emphasis on next week’s CPI readings, alongside April’s wage data due to be published next month, yesterday it left sterling with little direction post-announcement. The same cannot be said, however, for Bank of England Chief Economist Huw Pill, who spoke at 08:30 BST, triggering a notable sterling selloff. This came after headlines appeared suggesting that he favoured a Summer rate cut. Although initially interpreted as dovish by markets, this remains consistent with his recent commentary and does little to determine whether a cut would occur in June or August, with both captured by the summer period. As such, a reversal of the initial move lower for sterling was unsurprising – and in our view better reflected the message that the Chief Economist was trying to convey which remained consistent with the rhetoric from last week’s policy meeting. All told this was sufficient to see the pound ultimately finish the day flat against the euro, while gaining a quarter of a percent versus the dollar on Tuesday in advance of today’s pivotal CPI release. Indeed, with little market-moving data expected on the domestic front it is likely to be data from outside the UK that is likely to drive the pound for the remainder of the week, along with BoE speakers, starting today with Ben Bernanke who is due to testify on his report into the BoE.

CAD

With little news flow out of North America, USDCAD found itself trading in tight ranges once again on Tuesday, a dynamic that left the pair to drift a tenth lower as the loonie found itself buffeted once again by cross currents in the absence of any notable driver for the pair. On this point, even the cross-asset indicators for USDCAD were mixed – rate differentials marginally narrowed on the back-end in favour of CAD, equities moderately gained, while oil fell over 1%. Even so, there is reason to think the pair should gain a new sense of direction today. While it is set to be a similarly quiet session of Canadian news flow, US CPI should offer some impetus. If, as we expect, today’s data offers a modestly hotter reading than markets expect, then further divergence in rate expectations between the US and Canada could well see USDCAD trading back above 1.37 by the end of the day.

 

 

Disclaimer
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