Weekly Overview: FOMC, BOJ Meetings, and US and China Inflation Data

The market’s reaction to the recent data releases was quite telling. April’s weaker-than-expected high-frequency US data pushed the two-year Treasury yield down to around 4.70%, while the ten-year yield hit a two-month low of just above 4.25%. This move also impacted the Dollar Index (DXY), driving it below the uptrend line established from the lows in December 2023, March 2024, and May 2024. Despite the apparent economic slowdown, we believe April’s data may have exaggerated the extent of the downturn. The upcoming May jobs report will likely provide a more accurate picture of the broader economic conditions.

The Atlanta Fed’s GDPNow tracker had dropped to 1.8% as of June 3. However, subsequent data released last Thursday and Friday boosted the tracker for Q2 GDP to 3.1%. This positive shift led to a jump in US rates, with the two-year yield settling near 4.88% and the ten-year yield around 4.43%. Consequently, the dollar rebounded, and the DXY moved back above the trendline.

Emerging markets experienced volatility due to election results in South Africa, India, and Mexico. By the end of the week, the South African rand and Indian rupee remained relatively stable, but the Mexican peso saw significant losses, dropping around 7.3% for the week to reach seven-month lows.

Looking ahead, the Federal Reserve (FOMC) and Bank of Japan (BOJ) meetings are in focus. The Fed is expected to maintain its current policy but may adjust its economic forecasts. We anticipate the median projection for rate cuts will decrease from three to less than two, indicating a potentially hawkish pause.

For the BOJ, market participants are speculating on a possible rate hike in July, which might be signaled in the upcoming meeting. At most, the BOJ could announce plans to reduce its monthly bond purchases from the current JPY6 trillion (approximately $38.5 billion). Despite the recent 10 basis point drop in the 10-year Japanese Government Bond (JGB) yield, the largest weekly decline this year, the surge in US rates before the weekend suggests JGB yields might rise at the start of the new week.

Additionally, May’s US CPI report, due just hours before the FOMC meeting concludes, is expected to show a modest month-over-month increase of about 0.1%, with the year-over-year rate remaining largely unchanged. In China, CPI and PPI data will be released, with indications that disinflationary pressures are easing. Meanwhile, the results of the European Parliament elections will be scrutinized for their implications on national politics and the composition of the new European Commission, though final decisions are not expected until the end of the month.

United States

Two highly market-sensitive events are set to unfold within hours of each other on June 12: the Consumer Price Index (CPI) report and the Federal Open Market Committee (FOMC) meeting. Bloomberg’s survey forecasts a modest 0.1% increase in May’s CPI, the smallest monthly rise since last October. Should this prediction hold, the three-month annualized inflation rate would drop to 3.2% from 4.4%, and the six-month rate to 3.4%. With a 0.1% increase in May 2023 as well, the year-over-year inflation rate is likely to remain steady at 3.4%.

For core CPI, a 0.3% increase is expected, matching April’s rise. Due to base effects, the year-over-year core inflation rate might dip slightly to 3.5% from 3.6%. This would bring the three-month annualized rate down to 4% from 4.4% and the six-month rate to 4.2%. The base effects will make comparisons easier in Q3 but tougher in Q4, which is where expectations for rate cuts persist. Unless there’s a major surprise, these figures are unlikely to significantly alter investor or policymaker perspectives.

The FOMC meeting concludes a few hours later. Fed funds futures haven’t fully priced in a rate cut for this meeting since late February and haven’t even priced in a 50% chance of a cut since before the March CPI release on April 10. The first fully discounted rate cut is anticipated for the December meeting, with an 80% chance of a cut in November and nearly a 55% chance in September.

May’s nonfarm payrolls increased by 272,000, surpassing expectations and the January-April average of about 242,000. Despite a slight uptick in the unemployment rate to 4.0% from 3.9%, the strong job growth allows the Fed to maintain its focus on price stability. While no rate changes are expected, the Fed will update its Summary of Economic Projections. In March, the Fed projected 2.1% growth for this year, on the low end compared to the IMF’s 2.7%, the OECD’s 2.6%, and Bloomberg’s survey median of 2.4%. For the PCE deflator, the Fed forecasted 2.6% overall and 2.8% for the core rate, both of which now seem high given April’s readings of 2.7% and 2.8%.

In March, the Fed was nearly evenly split between three or more cuts and two or fewer, with Chair Powell likely breaking the tie. Subsequent data and comments suggest a shift, with dovish members conceding and hawkish members gaining confidence. We anticipate the new median projection will lean closer to one cut this year rather than two.

The Dollar Index, which had broken below its uptrend line from the end of last year at the start of the last week, rebounded following stronger-than-expected US job growth. It settled back above the trendline, which was around 104.60, with initial resistance expected in the 105.00-105.25 range.

Eurozone

After contracting in the second half of 2023, the eurozone economy is showing signs of recovery. It grew by 0.3% in the first quarter and is projected to expand by around 0.2% in the current quarter. Industrial output is anticipated to have increased for the third straight month in April, marking the longest stretch of growth since late 2021. The eurozone has largely bounced back from the terms of trade shock and disruptions caused by Russia’s invasion of Ukraine.

The current account, as a percentage of GDP, peaked at just over 3% in 2017 and was about 2.4% just before the pandemic. It recovered to 2.8% in 2021 before plummeting to -0.6% in 2022. Last year, it returned to a surplus of approximately 1.7% and is expected to be around 2% this year. As market participants keep an eye on incoming data, there will also be close attention paid to the maneuvering and negotiations following the European Parliament elections, which will result in a new European Commission.

The euro declined from the upper end of its recent range, slightly above $1.09, to below $1.0820, driven by stronger-than-expected US job growth and rising US rates. We anticipated a downturn in the euro after its rally from $1.06 in mid-April, but it showed resilience as US rates fell faster than the European Central Bank’s cuts. The US two-year yield premium over Germany fell from slightly above 190 basis points in late May to below 170 basis points before the US employment report, marking the lowest level in about two months. Ahead of the weekend, the US premium rose by nearly nine basis points, the largest increase since the March US CPI was reported on April 10. This recovery in the premium coincided with a stronger dollar. However, from a technical perspective, the euro needs to break below the $1.0785 area to signal a more significant pullback, potentially dropping another cent.

United Kingdom

The UK economy has shown a notable recovery from its contraction in the second half of 2023. The cumulative monthly GDP prints for Q1 2024 amounted to 0.9%, following a -0.8% decline in H2 2023. On a quarterly basis, GDP grew by 0.6% in Q1 2024 after being flat in Q2 2023 and contracting by -0.1% and -0.3% in Q3 and Q4 2023, respectively.

The UK will release April GDP figures and detailed reports in the middle of the week. Survey data suggests continued recovery, albeit at a slower pace than in the first quarter. The day before the GDP release, the UK will report April/May employment figures and wage data, which are crucial for Bank of England (BoE) policy expectations. Average weekly earnings (three-month average year-over-year) have remained steady at around 5.7% over the four months through March, after peaking at 8.5% last July. Despite the stronger-than-expected CPI in late May, the market now anticipates the first BoE rate cut in November, with nearly a 66% chance of a cut priced in for September.

Sterling has been showing signs of a near-term top after rallying five cents from the April lows. Like the euro, sterling approached the US jobs report near the upper end of its range, above $1.2800. Despite multiple attempts, sterling struggled to sustain levels above $1.28 and was pulled back by nearly a cent following the US employment data, briefly dipping through its 20-day moving average for the first time in almost a month (around $1.2720). However, it remained above the week’s low set last Monday, just below $1.2700. A decisive break below $1.2675 would likely confirm a downside move, with the next support levels around $1.2620-30 and potentially closer to $1.2550.

China

China is set to release its May CPI and PPI data on June 12, with signs indicating that deflationary pressures may be easing. Producer prices have been on a year-over-year decline since the end of Q3 2022, peaking at a 5.4% drop last June. As of April, producer prices were down 2.5% year-over-year, an improvement from the 3.6% decline in April 2023.

Consumer prices experienced year-over-year declines during the last three months of 2023 and in January 2024 but have since seen slight and irregular increases. In April, all major components of the CPI rose, except for food (including alcohol and tobacco). Excluding food, China’s CPI increased by 0.9% in April. Consumer goods prices remained flat year-over-year, indicating weak demand, as evidenced by sluggish retail sales growth. This lack of price pressure also reflects China’s industrial structure, characterized by fierce competition and local government support for producers, leading to excess capacity. The US faced similar issues, which eventually led to industry rationalization and the formation of oligopolies.

The recent increase in US rates and the dollar, particularly against the yen, suggests potential downside pressure on the yuan as the new week begins. The greenback has stayed below CNY7.25, but this level may break, potentially moving back into the previous range of CNY7.25-CNY7.30. In the offshore market, the dollar appears poised to test CNH7.2750, with the yearly high recorded in mid-April near CNH7.2830. Last year’s high was closer to CNH7.3680.

Japan

The swaps market is currently pricing in a 70% chance of a 10 basis point hike by the Bank of Japan (BOJ) in July. However, there’s also a potential case for a hike at the conclusion of this week’s meeting on June 14. The Japanese economy is recovering from a contraction in the first quarter, with subsidies for household energy consumption ending and income tax cuts set to be implemented this month.

The Ministry of Finance’s recent decision to intervene in the foreign exchange market was unexpected, especially as it occurred a couple of hours after the last FOMC meeting. However, under Governor Ueda’s leadership, the BOJ has not been surprising the markets, likely as part of efforts to normalize monetary policy. The BOJ could potentially slow its Japanese Government Bond (JGB) purchases, as officials have suggested this might be the next step in monetary policy normalization. Despite this, JGB yields fell last week, which seems counter to the expectation of tapering quantitative easing (QE).

Other central banks sometimes seem to enjoy surprising the market, and if it were another central bank, the odds of a hike now might be higher. On a trade-weighted basis, the yen is near its lowest since the late April intervention, which was itself the lowest in over 25 years. According to the OECD’s measure of Purchasing Power Parity, the yen is 66% undervalued, more than twice the undervaluation that existed before the historic Plaza Agreement in 1985. Japan’s current account surplus was nearly 4.5% of GDP that year, and last year it reached 3.6%, similar to 2019 levels. Japan will report its April current account on June 10, which historically (19 out of the past 20 years) deteriorates from March. The March surplus of JPY3.4 trillion appears to be a record. However, net exports shaved 0.3% off Japan’s Q1 GDP.

Two factors may explain why the US and Europe have not expressed more concern about the yen’s weakness. First, Japan has moved some production offshore, so the yen’s weakness is not triggering a surge in exports. Second, China poses a more pressing challenge for these economies.

The dollar showed a bullish outside up day against the yen ahead of the weekend, trading on both sides of the previous day’s range and closing above its high. Resistance is seen in the JPY157.50-70 area, and then around JPY158. Beyond that level, the market perceives an increased risk of intervention, despite Japanese officials emphasizing volatility over the absolute level. One-month implied volatility is near 8.8%, down from about 12.4% in late April. Dollar support is in the JPY154.50-JPY155 area.

Canada

Following the recent central bank meeting and employment report, the upcoming week looks relatively quiet for Canadian economic data. Nonetheless, the Canadian dollar often reacts to external factors such as global risk appetite and the overall direction of the US dollar. The Bank of Canada was the first G7 central bank to cut rates in this cycle, with a clear focus on moderating price pressures as the trigger for any further moves. At the end of last month, the swaps market priced in slightly more than two rate cuts this year. Despite the central bank’s cut, the market continues to expect two more cuts.

The May jobs report was disappointing, showing a loss of nearly 36,000 full-time positions after a gain of 40,000 in April. The unemployment rate edged up to 6.2% from 6.1%, even though the participation rate remained steady at 65.4%. A potential concern for the Bank of Canada is the rise in hourly wages for permanent employees, which increased to 5.2% from 4.8%. However, the key determinant will be the actual inflation data, with the May CPI scheduled for release on June 25. The swaps market currently indicates almost a 60% chance of a rate cut in July, but this seems overly optimistic.

The US dollar reached its highest level against the Canadian dollar since May 8, climbing to nearly CAD1.3770 and closing above CAD1.3750 for the first time since mid-April. Chart resistance is noted in the CAD1.3785-CAD1.3800 area, and a move toward the year’s high near CAD1.3845 is possible. However, caution is warranted as the greenback settled above the upper Bollinger Band (~CAD1.3740). Initial support might be around CAD1.3720.

Overall, while the Canadian dollar’s immediate outlook hinges on external influences and upcoming inflation data, the market’s expectation of further rate cuts remains high. Traders will be watching closely for any signs that could alter these expectations, particularly as global economic conditions evolve.

Australia

The Australian employment report, due on June 13, is the final high-frequency data release ahead of the Reserve Bank of Australia (RBA) meeting on June 19. The Australian labor market has been expanding at a similar pace to early last year, with employment rising by an average of 40.6k per month through April this year, compared to nearly 35k in the first four months of 2023. Full-time positions have grown by an average of almost 30k per month this year, up from about 26.5k in the January-April 2023 period. Despite this growth, the unemployment rate has increased to 4.1% from 3.7% last April. This rise is partly due to a higher participation rate, which has climbed to 66.7% from 66.5% last year. Essentially, job creation is not keeping pace with the increasing workforce.

Expectations for an RBA rate cut are building, with the futures market now discounting about a 50% chance of a cut this year, up from less than 10% a week ago.

The US dollar’s rally following the jobs report pushed the Australian dollar to its lowest level since mid-May, near $0.6580. For nearly a month, it had been trading in a range between $0.6600 and $0.6700 on a closing basis. It settled near $0.6590 ahead of the weekend. There’s potential for a further decline toward $0.6540, and possibly $0.6500. However, some caution is warranted. At the start of last week, the Australian dollar was testing its upper Bollinger Band and ended the week testing the lower band.

Traders will be closely watching the upcoming employment report for any signs that might influence the RBA’s decision-making process. With growing expectations for a rate cut, any significant deviation from expected job growth or changes in the unemployment rate could impact market sentiment and the Australian dollar’s trajectory.

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