Weekly Overview: Can March CPI Turn the Tide After Strong US Jobs Data Didn’t Boost the Dollar?

The recent United States job data for March came in stronger than anticipated, signalling a possible acceleration in the economy and reinforcing the idea of U.S. economic superiority. In the Q1 of 2024, the U.S. saw an average increase of 276,000 non-farm payroll jobs per month, marking the most robust quarterly performance in a year. This figure is significant jump from the 2023 monthly average of approximately 251,000 jobs. Additionally, the unemployment rate dipped slightly, buoyed by a considerable increase in the household survey, reversing declines from the previous two months. Notably, both the workweek length and the labor force participation rate saw increases.

This performance challenges skeptics, suggesting that the U.S. economy is growing at a pace beyond what the FED considers sustainable without stoking inflation, which is pegged at 1.8%. Reflecting this economic enthusiasm, U.S. short-term and long-term interest rates edged higher, with the two-year yield nearing its annual high and the 10-year yield reaching a new peak.

Despite these signs of a strong economy and rising interest rates, the U.S. dollar ended the week weaker against most major currencies, except Swiss franc, Japanese yen, Canadian dollar. Interestingly, this happened as several commodities, including gold, oil, and copper, experienced sharp price increases- a scenario typically at odds with a stronger dollar and higher interest rates.

Looking ahead, attention shifts to upcoming inflation reports in the U.S., alongside key meetings of the ECB and the Bank of Canada. The U.S. inflation rate is expected to remain firm, while ECB and Bank of Canada might hold interest rates steady, possibly setting the stage for future rate cuts. Meanwhile, China’s markets are set to reopen, with the focus on the official currency policy, especially as inflation and deflation concerns loom.

On the geopolitical front, meetings between the leaders of Japan, the Philippines, and the U.S. will likely focus on security issues. Such a context makes any potential Japanese intervention in the currency market during this period seem unlikely.

United States

Federal Reserve officials are closely monitoring inflation trends, aiming to ensure it aligns with their 2% target over time. However, the upcoming March Consumer Price Index (CPI) report, following unexpectedly strong job data, might not provide the reassurance needed. In March, the economy added 303,000 jobs, the highest in 10 months, with the participation rate reaching a 4-month peak at 62.7%, and average weekly hours also increasing. Predictions suggest both the headline and core CPI rates to rise by 0.3% for March, following a 0.4% increase in February. This would mean an annual inflation rate of approximately 3.4%, mirroring the rate at the end of the previous year. Interestingly, the annualized inflation rate for the Q1 of 2024 could match 4% seen in the same period in 2023, indicating a persistent inflation challenge.

Economists use the CPI, alongside Producer Price Index (PPI) components, to predict the Personal Consumption Expenditures (PCE) deflator, the FED’s preferred inflation measure. The minutes from the FED’s march meeting, due shortly after the CPI report, are highly anticipated for the insights they may provide, particularly regarding the FOMC’s internal views on inflation and monetary policy.

Amid these developments, the US Dollar Index (DXY) experienced some profit-taking after reaching a new yearly high, indicating investor adjustments. The index saw a dip towards its moving averages before rebounding slightly on the positive job report, suggesting mixed sentiment among traders about the dollar’s direction. Analysts predict potential upside risks for the dollar, especially with upcoming inflation data, although the recent inability to maintain momentum after the job report has tempered expectations somewhat. Yet, the broader narrative of “U.S. expectionalism” could continue to support the dollar, with potential targets set higher than the current levels, especially if economic data consistently outperforms that of other major economies.

Eurozone

As the ECP gears up for its meeting on April 11, market participants are recalibrating their expectations. It’s intriguing to note that back in January, there was a full interest rate cut anticipated for this upcoming meeting -a stark contrast to the end of last year when the swaps market was not only expecting a rate cut but also saw a 70% likelihood of a second. Although ECB President Lagarde is known for not locking in future actions (pre-committing), it’s widely anticipated that she won’t reveal much could alter the current expectations for a rate cut in June. Presently, the market is pricing about 90 bps of cuts for this year, which translates to three definite cuts and a 60% probability of a fourth. This outlook adjusted slightly after the ECB’s March meeting, where four cuts were fully expected according to the swaps curve.

Last week, the euro experienced a notable fluctuation, initially surging from $1.0725 to approximately $1.0875, attributed to a short squeeze. However, following the release of the robust US jobs report, the euro depreciated to around $1.0790. The euro’s recovery attempt was short-lived; it nearly reached session highs at about $1.0845 before receding as the week closed. This currency movement underscores the ongoing divergence between the economic outlooks in the US and the eurozone—a theme expected to become even more pronounced. With the US set to report persistent inflation pressures in the March CPI, and the ECB likely maintaining a dovish stance shortly after, the euro’s strength might be tested. Particularly, the euro’s performance in the first quarter, which hit a low near $1.07 following the US January CPI report, suggests that a retest of this level could be on the horizon.

United Kingdom

The UK’s economic performance has been under close watch, especially following a shallow recession in the second half of 2023, defined by two consecutive quarters ıf GDP contraction. However, the situation appeared to slightly improve with a 0.2% growth in January 2024. Despite this, February’s data might indicate a pause in this recovery, suggesting the economy could have stagnated. Indicators like the PMI highlight ongoing challenges in manufacturing, although the service sector could provide some support. Additionally, the significant boost from the construction in January, which saw 1.1% increase, is unlikely to recur. The UK’s trade balance, which often improves in February, may offer some relief, potentially reducing its drag on growth. Last year’s export and import data showed declines, but the pace of contraction for exports may be easing at the start of this year.

In currency markets, the British pound (sterling) demonstrated resilience last week, finding support around $1.2540 and reaching highs near $1.2685 before facing resistance at the 20-day moving average and retreating after the US employment report. Yet, sterling nearly recovered to about $1.2635 as the week ended, suggesting the formation of a new trading band between approximately $1.2520 and $1.2720. The euro, on the other hand, has been gradually strengthening against sterling, hinting at potential shifts in currency dynamics. A break above GBP0.8600 could signify a positive change for the euro against sterling, though it might present challenges for sterling’s performance against the dollar.

China

China has been navigating through a period of deflation, with its Consumer Price Index (CPI) showing negative year-over-year growth since mid-last year, reflecting a broader economic slowdown. The trend hit a low with a -0.8% reading in January before a surprising rebound to +0.7% in February, partly attributed to seasonal effects like the Lunar New Year, which traditionally boosts food and travel prices. Despite this uptick, the overall inflationary pressure remains subdued, with projections suggesting a slowdown to around 0.3% in the CPI. The core CPI, which excludes volatile food and energy prices, showed a year-over-year increase of 1.2% in February, indicating modest underlying inflationary pressures.

On the producer side, prices have been consistently decreasing, marking a period of industrial deflation that’s lasted for several months. This scenario points to broader economic challenges, including reduced industrial demand and competitive pressures. The linkage between Chinese producer prices and U.S. consumer prices is often discussed, but direct effects are moderated by additional costs incurred through the supply chain, from shipping to retail.

China’s trade dynamics have also shifted, with the trade surplus adjusting in response to global economic conditions. Notably, Chinese exports to traditional markets like the US, Europe, and Japan have declined, while trade with emerging economies and the global south, including significant markets like India, Brazil, and Vietnam, has expanded. This shift underscores a diversification strategy and the changing contours of global trade.

In the context of currency markets, the People’s Bank of China (PBOC) is closely watched for its stance on the yuan, especially in relation to the strong US dollar. Recent trends suggest a gradual acceptance of a stronger dollar, with the yuan expected to stabilize within a certain trading range against the dollar. This approach indicates a nuanced strategy by Chinese authorities to manage currency fluctuations without aggressively counteracting market forces.

Japan

As the week begins, attention turns toward Japan with two key reports on the horizon. February’s labor cash earnings report is likely overshadowed by recent wage negotiations, while the predictable improvement in Japan’s February current account balance, a trend consistent over the past two decades, doesn’t stir much surprise. Last year, Japan faced a significant trade deficit, albeit smaller than the previous year, highlighting shifts in its trade dynamics. Additionally, Japanese investors have shown continued interest in foreign bonds, though at a reduced pace compared to the same period last year.

The upcoming meeting between Prime Minister Kishida and President Biden on April 10 is anticipated to focus primarily on security rather than economic issues. The discussions could lead to Japan’s involvement in the AUKUS security pact or a new defense agreement, potentially involving the Philippines, to strengthen security ties and alliances in the Asia-Pacific region.

The yen’s recent performance, reaching an 11-day high against the dollar, reflects domestic economic factors like household spending. However, the currency’s gains were temporary, with the yen retreating following the release of strong US job data. The dollar-yen exchange rate has exhibited a back-and-forth pattern without significant movement, indicating market uncertainty and closely watched by investors for signs of intervention by Japanese officials. Past interventions or signals have set precedents, and any perceived inconsistency could affect market expectations.

The fundamental backdrop includes the US 10-year Treasury yield reaching a new high, underscoring the broader economic and interest rate differences between the US and Japan. These differences are key factors for currency movements and are closely monitored by Japanese officials concerned about excessive yen weakness. Speculation about future currency levels, particularly if the yen weakens beyond JPY152 to the dollar, suggests potential volatility, with some market participants eyeing levels as high as JPY155.

Canada

As the Bank of Canada (BoC) approaches its meeting on April 10, it’s widely anticipated that they will maintain the overnight lending rate at 5.0%, a stance held since July of the previous year. This decision comes amid a somewhat improved business outlook, with a decrease in the number of firms expecting a recession. Despite these positive signs, the central bank appears cautious, not rushing towards rate cuts. This is reflected in the swaps market, where there’s a roughly 20% chance of a rate cut post the unimpressive March jobs report, but expectations for a cut in June have risen to about 75% from 66%.

Looking ahead, the focus will shift to the March Consumer Price Index (CPI) report, due on April 16. This report is crucial as headline inflation is expected to decelerate from the 2.8% year-over-year rate observed in February. Importantly, core inflation measures—which offer a clearer view of the trend by excluding volatile items—have also shown signs of easing, suggesting a gradual relaxation of inflationary pressures.

Amid these economic considerations, the Canadian dollar faced challenges, dropping to a new yearly low. This movement reflects broader market dynamics, with the Canadian dollar struggling against the greenback, which reached its highest level against the CAD since last November. Factors such as the widening interest rate differential between the US and Canada, as highlighted by the increasing US two-year premium over Canada, further exert pressure on the CAD. This context sets the stage for potential further weakening of the Canadian dollar, with market participants eyeing possible levels like CAD1.3700 or even CAD1.3750.

Australia

The conclusion of China’s boycott against Australian wines marks a positive step towards mending trade relations between the two countries, yet it doesn’t significantly shift the broader economic dynamics or the complex trade ties. China remains Australia’s most crucial trading partner, with the bilateral trade relationship encompassing a substantial portion of Australia’s global commerce. Last year’s trade figures underline this importance, with Australia exporting almost A$180 billion worth of goods and services to China and importing about A$104 billion from it.

In the financial markets, the Reserve Bank of Australia (RBA) is perceived to be trailing its G10 counterparts in the race to cut interest rates. Current market sentiments suggest a 55% likelihood of a rate cut by August, with expectations for a cut in September nearing 80%. The market consensus leans towards one definite rate cut within the year, with a 50% probability of a second, a more cautious stance compared to the more aggressive rate cut expectations set at the end of 2023.

The Australian dollar’s recent performance in currency markets provides an interesting case study of these economic and financial dynamics. Following the release of the US employment report, the Aussie dollar dipped from its high of nearly $0.6620 to around $0.6550 but managed a swift recovery back to the $0.6590 level. This resilience, alongside positive momentum indicators, suggests a constructive outlook for the currency. A break above the $0.6600 threshold, a level not surpassed since March 13, could signal further strength and potentially propel the Aussie into the $0.6660 range. Conversely, a drop below $0.6545 could dampen market sentiment.

Mexico

As we approach the release of Mexico’s March Consumer Price Index (CPI) on April 9, indications are that the moderation in inflation is decelerating. This development could heighten market speculation regarding the central bank’s upcoming decision in May, with the swaps market leaning towards a potential rate cut in the second quarter, albeit not with full conviction.

Following closely, Mexico’s industrial production data for February will shed more light on the economy’s current state. Notably, the automotive sector showed signs of strength, and the manufacturing Purchasing Managers’ Index (PMI) improved for the first time in three months. However, contrasting signals like the decline in the IMEF manufacturing index and a significant drop in new export orders as per the March manufacturing PMI—particularly highlighting reduced demand from the US—paint a mixed picture of Mexico’s manufacturing sector.

Amid these economic signals, the Mexican peso has emerged as a standout performer on the global stage, securing its position as the world’s strongest currency this year. The peso reached new nine-year highs against the dollar, showcasing remarkable resilience. Interestingly, it has gained over 3% against the dollar this year, a feat unmatched by the G10 currencies, with only the Colombian peso and Peruvian sol similarly advancing against the greenback.

The market’s earlier apprehensions about potential unwinding of peso positions ahead of Mexico’s upcoming election have not materialized. The prevailing sentiment suggests that if the peso has thrived under President Andrés Manuel López Obrador (AMLO), known for his less investor-friendly stance, the election of his likely successor, Mexico City Mayor Claudia Sheinbaum, might continue this trend. Sheinbaum is perceived as a somewhat moderate figure compared to AMLO, which could be reassuring for investors.

The currency’s performance indicates a strong trend-following momentum, with the dollar experiencing gains in only two weeks since the end of January. Looking ahead, the MXN16.50-60 range may present resistance, while further strength in the peso, potentially towards MXN16.0, does not appear far-fetched.

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