The pound remained relatively unmoved this morning, following a 0.5% rally in cable yesterday in response to new US inflation figures, with the release of both monthly GDP estimates and the latest edition of the RICS UK Residential Market Survey being digested by markets in early trading. Coming on the heels of the IMF’s latest set of economic projections, where it was suggested that the UK economy would shrink by 0.3% in 2023, traders may well have had GDP front of mind this morning. If so, then this morning’s estimates for UK growth had little to upset expectations, with a marginal upgrade to the January figures offsetting a slightly weaker than expected February number. Given the propensity for GDP numbers to be revised it is not surprising that markets discounted today’s release, but analysts and homeowners may find the housing market data, released just after midnight, harder to ignore. Whilst it is true that the RICS House Price Balance indicated an increase from -48% in February to -43% for March, against an expectation of -48%, this still suggests a slowdown in the housing market and an indication that house prices will likely fall over the course of this year. In our view, the effects of modest fall in house prices is unlikely to spillover into FX markets, explaining why sterling barely moved on the back of this morning’s release. However there remains a risk for a more sustained fall that could have a negative impact on the pound, particularly if it constrains the Bank of England’s ability to maintain a tight monetary policy stance. For this reason, we will be watching how the data evolves, and how the Bank chooses to view it, closely over coming months. In the short term however, it seems likely that technical factors will be in the driving seat, with the 1.25 level very much in range for cable.
The decline in US Treasury yields following yesterday’s US CPI report saw the spread between the US 2-year and the German 2-year yield fall to its narrowest since November 2021 at 117bps. While the dollar was under broad pressure due to the supportive backdrop for risk assets, the narrowing rate differential helped push the single currency above comparable counterparts in the G10 as it notched gains of 0.74% against the dollar and 0.23% against the pound. As we have argued previously, this dynamic should provide bullish support for EURUSD over the medium-term as the sustainability of the ECB’s hiking cycle is far greater than the US. This wasn’t just highlighted in the IMF’s financial stability report earlier this week, but again in last night’s Fed meeting minutes, which suggested policymakers now expect a US recession in Q4 2023. However, while the narrowing yield differential should provide a tailwind for the single currency’s rally, it won’t necessarily hold the spark to push EURUSD into the 1.10 region in the short-term. As a matter of fact, there is little in the way of market moving events for the remainder of this week to do just that as well. For that reason, markets may be seeing out the week in something of a holding pattern.
Just like Friday’s payrolls data, March’s inflation figures out of the US yesterday helped to dispel concerns that the US economy was nosediving into a recession before the regional banking collapse had an impact on overall credit conditions. Not only that, but with progress being made in the core measures, it also removed some right hand tail risk for US rates. This outcome was the perfect mix for risk assets and will likely result in just one further rate hike from the Fed in May, barring any surprise revelations within credit markets. Following the release, the dollar DXY index fell 0.6%, with losses largest against popular carry currencies within Latin America and the CE-3 region, alongside the beleaguered Nordic currencies.
Printing down from 0.4% at 0.1% MoM, the headline measure fell due to flat food prices and deflation in energy commodities. Alongside favourable base effects, this brought the year-on-year figure down a full percentage point to 5%. However, it was the core figure and variations of that everyone in markets was keenly observing, and this was where both recession fears were dispelled and upside risks to rates trimmed. At 0.4% MoM, core inflation in the US started to decelerate only marginally, largely due to softer shelter inflation. Unlike the headline figure, base effects were a positive contributor to the year-on-year number, which rose 0.1 pp to 5.6%, in line with expectations. With core services inflation printing at 0.4% MoM and core goods inflation ticking back up to 0.2%, the data didn’t scream that aggregate demand had capitulated in the US and a fire sale in discretionary products ensued to keep sales volumes elevated. This was also true within the micro data as price pressures in some discretionary services such as restaurants (+0.6%) and flights (+4.0%) were still showing strength. Correspondingly, the Fed’s favoured supercore measure of inflation, core services excluding select measures of shelter inflation, fell from 6.1% YoY to 5.8%, with the annualised three-month moving average printing at its lowest level since late ‘21 at 4.8%. While still uncomfortably high for US monetary policymakers, the continued disinflation trend in the data is a welcome sign. Taken together, the data not only suggested that the US economy remained in good shape heading into the period of banking stress in mid-March, but also that monetary policy measures were starting to take their toll on US inflation. It now looks likely that the Fed will conduct a final rate hike at their next meeting to cover off any further inflation doubts, and will be on recession watch thereafter.
On the topic of a recession, the release of March’s Fed meeting minutes last night showed that for the first time since officials began raising rates a year ago, the Fed staff forecast presented at the meeting anticipated a recession would start later this year due to banking-sector turmoil. Previously, staff had judged a recession was as likely to occur as not this year. While this came as little surprise, it does help confirm the market bias that a near-term top in US Treasury yields is likely in. This should, all things considered, provide a ceiling to any subsequent bouts of dollar strength over a tactical horizon.
The Bank of Canada held rates at 4.5% yesterday, meeting our expectations as well as the consensus shared across analysts and markets. While we were not surprised by the decision, we were a bit taken aback at the lack of concern expressed around the banking troubles that began last month, and the degree to which the Bank maintained its hawkish bias. The rate statement suggested that hiking could resume this cycle, while Macklem used the phrase “higher for longer” several times during the press conference when pushing back on market pricing of cuts this year. Despite the hawkish tone of the policy decision, a tightened spread between US and Canadian yields, a broad rally in high-beta currencies, and the price of crude breaking above a key resistance level to reach $83.34 per barrel on WTI, CAD was the clear laggard on the G10 currency board, ending the trading session merely 0.2% stronger against the US dollar. The loonie is still at a strong level compared to recent weeks, and is close to the local high reached on April 4th, but is likely going to continue underperforming against the rest of the G10 currency board as recession fears still linger in the US. Today, US data will likely be the main driver of volatility in the USDCAD currency pair. Nothing is scheduled on the Canadian calendar.