Weekly Overview: Short-Term Dollar Forecast More Uncertain Than Last Week

Last week, stronger-than-expected economic data and hawkish Federal Open Market Committee (FOMC) minutes boosted US interest rates and strengthened the dollar. The market’s reduced expectations for European Central Bank (ECB) easing this year were noteworthy, though they didn’t prevent the euro from ending its five-week winning streak. The 10-year Japanese government bond yield rose above 1% for the first time since 2012, yet the US dollar surged past JPY157 for the first time since the Bank of Japan (BOJ) is thought to have intervened earlier this month.

Despite a dip in May’s flash composite PMI (52.8 vs. 54.1) and a sharp decline in April retail sales (-2.3%), the British pound showed resilience. These negative reports couldn’t offset the impact of stronger-than-expected inflation on interest rate expectations. The swaps market now projects the first rate cut in November, a shift from the previous expectation of August following the CPI report. The UK’s two-year yield increased by 16 basis points, the largest rise in Europe last week, pushing sterling to its highest close in over two months before the weekend.

A draft of the G7 finance ministers’ statement is expected to adopt a tougher stance on China’s trade practices. In early June, the EU is likely to announce new tariffs on Chinese-made autos. A critical question remains whether the dollar’s decline before the weekend signals a resumption of the downward trend that began in mid-April, excluding the yen. Our analysis suggests otherwise, and we highlight key chart areas below that might indicate a shift.

Looking ahead, next week’s highlights include the preliminary May CPI data for the eurozone and Tokyo. Both are expected to show increases after a dip in April. A stronger eurozone CPI reading is unlikely to change expectations for a rate cut on June 6. Similarly, a higher Tokyo CPI won’t affect BOJ expectations. Due to different methodologies, the US PCE deflator, the Fed’s preferred inflation measure, is unlikely to mirror the mild softness seen in April’s CPI.

Furthermore, forecasts for the June 7 US May nonfarm payroll report have been revised down from around 225k to 180k (175k in April), with the private sector expected to contribute 115k, the lowest in six months. Even if accurate, these figures may not reach the threshold for Fed concerns.

United States

The term “stagflation” might be an overstatement for the current US economic situation, but upcoming data could reignite such discussions. Growth in the first quarter fell short of expectations and is likely to be revised down from 1.6% to around 1.2%. Additionally, April’s income and consumption figures are expected to show a slowdown, and the monthly PCE deflators may not exhibit the minor improvements seen in the April CPI.

Since the March CPI release on April 10, the futures market has increasingly discounted the likelihood of a Fed rate cut in June, currently pricing in no chance of such a move. Despite some economists advocating for another rate hike and some market participants hedging against this risk, Fed funds futures have consistently indicated at least one cut this year. However, confidence in a second rate cut has waned, with the market now only reflecting about a 35% chance, down from almost complete pricing out by the end of April. We anticipate that market sentiment will return to the view of no additional rate cuts this year. While the US economy appears to be slowing, the process seems gradual, and recent disappointing data might have overstated the situation. We expect better US data with the May prints, particularly from the next ISM services survey (potentially back above the 50 boom/bust level) and the June 7 jobs report (around 225k expected). Notably, the ECB is expected to cut rates a day before the US employment data release.

The Dollar Index hit its yearly high in mid-April near 106.50 but trended lower, reaching almost 104.00 on May 16. It has since recovered but stalled near the 20-day moving average, slightly above 105.00, meeting the minimum retracement objective of 38.2%. The next retracement level of 50% is around 105.30. Despite last weekend’s pullback, the technical outlook remains positive, with momentum indicators turning higher. The five-day moving average is poised to cross above the 20-day moving average in the coming days. A break below the 104.40-50 area would likely negate this constructive view.

Eurozone

The preliminary May CPI data, set to be reported on May 31, is crucial for the European Central Bank’s (ECB) upcoming decisions. Unless there’s a significant upside surprise, the ECB is expected to cut rates in early June. Several factors contribute to this expectation. The base effect highlights the risk of the year-over-year inflation rate exceeding the 2.4% recorded in March and April, given that the CPI was flat in May 2023. However, a stronger euro and softer oil prices may counterbalance this risk.

The ECB faces a high bar to avoid a rate cut next week. It might opt for a “hawkish cut,” acknowledging emerging positive economic signs and downplaying the likelihood of another cut in July. The May CPI data will also inform the ECB’s updated economic forecasts, to be released at the June 6 meeting. Recent data suggesting a recovery and official comments indicating no consensus after the June meeting have led the swaps market to reduce expectations for ECB cuts this year. Initially, the market anticipated 180 basis points (bp) of cuts by the end of last year, which halved by the end of February and dropped to less than 60 bp after the preliminary May PMI last week.

Last week, the euro ended a five-week rally, slipping by about 0.20%, marking only its second weekly loss in Q2. It reached a two-month high slightly below $1.09 on May 16, then approached $1.08 a week later. Several technical indicators converge around the $1.0785 area, and a break below this level would suggest a high is in place. Daily momentum indicators have turned lower, while a move above the $1.0860-65 area would invalidate the bearish outlook. Broadly, since the start of last year, the euro has traded in a range between $1.05 and $1.10, with an average of around $1.0815. This year’s average is marginally higher.

United Kingdom

The UK will release its mortgage lending, consumer credit figures, and money supply data this week. Typically, these reports don’t significantly impact the markets. The UK, like the US, has a bank holiday on Monday (May 27), resulting in closed markets.

The Bank of England (BoE) is set to review another employment report and the Consumer Price Index (CPI) before its June 20 meeting. Following last week’s CPI, retail sales, and preliminary May PMI reports, the swaps market has significantly reduced the chances of a rate cut next month to less than 10%, down from nearly 60% a week ago (May 17). The market’s previous expectation that the base rate would reach 4.75% by the end of August has also diminished, with the likelihood now at just 40%. The first rate cut is now fully anticipated for November, with swaps pricing indicating around 31 basis points (bp) of cuts this year, down from over 60 bp on May 15.

Sterling hit a low last week near $1.2675 following the disappointing retail sales report but rebounded, reaching new session highs after stronger-than-expected US durable goods orders. It peaked at $1.2750, just shy of the week’s high at $1.2760, which was also a two-month high. Sterling has risen in four of the past five weeks. As long as support at $1.2650 holds, there is potential for a new high, though momentum indicators suggest not to expect a substantial move. Initial resistance is around $1.2800.

China

China’s continued deflation in producer prices and low capacity utilization indicate that industrial profits likely remain weak. This weakness in returns on capital underscores the problem of excess investment. In March, industrial profits were down 3.5% year-over-year, following a 19.2% drop in March 2023. China will report the April estimate on May 27, followed by the May PMI on May 30.

The manufacturing PMI has been above the critical 50 boom/bust level in March and April, the first consecutive months above 50 since the end of Q1 2023. The non-manufacturing PMI has been above 50 throughout 2023, though it slowed in Q4 and finished the year at 50.4. It reached 53.0 in March but slipped back to 51.2 in April. The composite PMI ended last year at 50.3, peaked at a 10-month high of 52.7 in March, and eased to 51.7 in April. The consensus is that more stimulative measures will be needed to achieve the 5% growth target.

The yuan has been on a seven-session losing streak. Since returning from the May Day holidays, the yuan has fallen in all but three of the last 15 sessions. Notably, the 60-day rolling correlation with the yen is at its highest for the year (~0.52), while the 30-day correlation is even higher (~0.80). This doesn’t suggest China has pegged the yuan to the yen, but rather that both currencies share characteristics that make them attractive for funding. The dollar is approaching last month’s high against the yuan (~CNY7.2475) and briefly traded above CNH7.26 against the offshore yuan, with last month’s high at around CNH7.2830. Chinese officials might more forcefully resist further yuan weakness if the equity market continues to decline. The CSI 300 index’s 2.25% loss over the past two sessions brings it back to late April levels.

Japan

BOJ Governor Ueda seems to be making monetary policy effective again by easing off aggressive measures. The focus is on strategic, long-term objectives rather than short-term economic fluctuations. Recent data suggest the Q1 downturn was due to unique factors, and the economy is already recovering. April retail sales and industrial production figures, due at the end of the week, should confirm this recovery. The April jobs report will also be released, with the unemployment rate holding steady at 2.5%-2.6% for over two years, including 2.6% in March.

The market may be most sensitive to Tokyo’s May CPI, a proxy for the national figures due in a few weeks. In March, the abolishment of high school tuition caused the headline and core measures to fall below 2% (1.8% and 1.6%, respectively).

Rising US rates have lifted the dollar above JPY157 for the first time since May 1. BOJ data expected next week should confirm two bouts of intervention, totaling around JPY9 trillion ($58-$60 billion), similar to the intervention seen in 2022. Market caution is expected as JPY158 approaches, the level of the last BOJ intervention. Despite modest moves, the market has been mostly one-way, with the dollar retreating only once in each of the past three weeks. One-month implied volatility is below 8.5%, back to mid-April lows, down from near 11% before the first BOJ intervention. The dollar settled above the five-day moving average every session last week and starts the new week near JPY156.65.

Canada

Canada will report its Q1 GDP on May 31, one of the last G10 countries to do so. In Q3 2023, the economy contracted by 0.5% (annualized rate) due to weak consumption, a decline in business investment, and a drag from trade. However, the economy rebounded in Q4, growing by 1%. Q1 2024 appears to show further strengthening: consumption likely accelerated, capital expenditures rose for the first time in three quarters, and government spending increased after falling in Q4 2023. The contribution from net exports may have diminished. Monthly GDP rose by 0.5% in January and 0.2% in February. With the Bank of Canada meeting on June 5, the odds of a rate hike in the swap market hovered slightly above 60% in the latter half of last week.

The US dollar experienced buying pressure on dips below CAD1.36 at the start of last week, rising to nearly CAD1.3750 on May 23. This level corresponds to the 61.8% retracement of losses from the year’s high set on April 16 (~CAD1.3845). Retail sales disappointed before the weekend, with Canada reporting a third consecutive decline. The 0.6% drop excluding auto sales was the largest since last June. Amid these corrective forces, the greenback was sold off slightly below CAD1.3650. Initial support is likely near CAD1.3625. Momentum indicators have turned higher, and the five-day moving average crossed back above the 20-day moving average ahead of the weekend.

Australia

Australia is set to release April retail sales and CPI data in the coming days. The futures market has been volatile, with expectations fluctuating from fully discounting two rate cuts and a 2/3 chance of a third cut in early February to about a 40% chance of a hike by the end of April. Currently, there is about a 65% chance of a cut priced in. Retail sales fell by 0.4% in March, marking the first decline since 2021, although they have remained flat over the past six months, highlighting the Australian consumer’s weakness. The monthly CPI, which peaked at 8.4% at the end of 2022 and fell to 3.4% by the end of 2023, stalled in Q1 2024, standing at 3.5% in March. The Reserve Bank of Australia (RBA) places more weight on the quarterly CPI figure.

The Australian dollar fell to an eight-day low, just above $0.6590, before recovering to $0.6620 ahead of the weekend. It had reached a high of $0.6710 on Monday last week. The Aussie was the worst performer in the G10 currencies last week, declining by almost 1%. Momentum indicators have turned lower, and the five-day moving average could fall below the 20-day moving average early next week, a crossover last seen in late April. The $0.6580 area represents the 38.2% retracement of gains from the year’s low on April 19 (~$0.6365). Conversely, a move back above the $0.6650 area would signal a more constructive outlook.

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