Macro and Drivers
- • The Chinese Politburo’s statement before the weekend, which helped spur the equity market recovery in Asia and Europe, was light on details, and with Chinese markets closed until Thursday, greater clarification may be lacking. The PMI readings warn that the world’s second-largest economy is struggling mightily.
- • A record surge in US labor costs more than offset the unexpected contraction in Q1 GDP. The implied yield for the end of the year rose 16 bp to 2.86% since the day before the GDP report. A 50 bp Fed hike and a signal that the balance sheet unwind will begin shortly is well anticipated. At the end of the week, another strong employment report is expected, with around 400k jobs filled.
- • The acceleration in Q1 CPI reported last week has fanned speculation that the Reserve Bank of Australia will not wait until after the May 21 election to raise rates. A 15 bp hike this week has been discounted. The market is pricing an aggressive tightening cycle that will lift the cash rate from 0.10% currently to about 2.35% this year.
- • The Bank of England will most likely lift the base rate 25 bp. It will be the fourth move in the cycle. England and Wales also hold local elections. Northern Ireland’s Assembly will also be elected. A poor showing for the Tories will add pressure on Prime Minister Johnson.
- • Norway’s Norges Bank meets. Its tightening cycle is not over, but it will likely wait until the June meeting to hike again.
- • Tokyo’s April CPI at the end of the week will give an idea of what is in store for the national reported release a in few weeks. Last year’s cut in cell phone charges drop out of the 12-month comparison and headline inflation is likely to jump by one percentage point.
- • Four emerging market central banks meet: Brazil, Chile, Poland ,and Czech. They are all expected to lift policy rates. The former two think their cycles are nearly done, while the two from central Europe see more work to be done.
We offer our weekly macro and technical commentary below ahead of tomorrow’s publication of Bannockburn’s May monthly outlook.
The week ahead is packed with several central bank meetings and important high-frequency economic data. The week begins off with China’s April PMI over the weekend. The world’s second-largest economy is being hit by the lockdowns as part of the policy response to the outbreak of Covid. However, the economic impact seems somewhat milder than when the pandemic first arose in Q1 20, and the economy shrank by 10.3% quarter-over-quarter. Still, more stimulus measures from Beijing and the PBOC seem likely.
The Reserve Bank of Australia meets on May 3. The market’s perception of the likelihood of a hike increased markedly after last week’s stronger than expected Q1 CPI. It rose to 5.1% year-over-year from 3.5% in Q4 21 and was above the 4.6% median (Bloomberg survey) forecast. The underlying measures quickened to above 3% and more than expected. Before the inflation report, the cash rate futures implied a 1-in-4 chance of a 25 bp hike. Now there is about a 60% chance of a such a move, but a 15 bp move is fully discounted. Previously, the conventional wisdom was that the RBA would wait for June after the May 21 elections. Like other central banks, Governor Lowe emphasized developments in the labor market. Perhaps, the pullback in the Australian dollar (~4.2% in April) provides extra encouragement, but it should not be over-emphasized. The RBA’s trade-weighted index did pull back after approaching last year’s high, but it is still relatively firm and near mid-March levels, almost 6% above the late January low.
The Federal Reserve meets on May 4. A 50 bp hike is a foregone conclusion. The Fed funds futures market has priced a 50 bp hike not only at this meeting but also at the following three meetings (June, July, and September). The Federal Reserve will also announce its balance sheet roll-off strategy. The forward guidance has suggested a short ramp-up period in June and reaching a maximum of $95 bln a month. Investors (and reporters) may have some questions about the bill holdings and if the Fed would consider selling some MBS outright to achieve its goals. The market has shown a recent pattern by which it reacts one way to the Fed’s statement and reverses it during Chair Powell’s press conference. The economic highlight is the April employment report at the end of the week. The early estimate is for around a 400k gain in nonfarm payrolls. Under normal circumstances, it would be regarded as robust. However, if the forecast is accurate, it would be the smallest increase since last April. Subject to revisions, job growth averaged 562k in Q1 22. Still, and even if average earnings growth slows, Powell’s assessment that the labor market is strong (perhaps “too strong”) will not interrupt the Fed’s “expeditious” course to neutrality.
The Bank of England and Norway’s Norges Bank meet on May 5. Despite some poor economic data, including the squeeze on the cost of living that has seen retail sales, excluding gasoline, falling in nine of the past 11 months, the market is confident that the BOE will deliver its fourth hike in the cycle that began in December. That will lift the bank rate to 1.0%. The swaps market is looking at another 100-125 bp hikes this year. Also, on May 5, England and Wales hold local elections. The Tories do not appear to be doing well. Prime Minister Johnson will come under pressure, but a compelling alternative does not jump out now that Chancellor Sunak’s support has waned. Note that Sein Fein looks poised to oust the Democratic Unionist Party to lead Northern Ireland’s Assembly.
The Norges Bank has also lifted rates three times already, and the deposit rate stands at 0.75%. The underlying rate of inflation, which excludes energy and adjusts for tax changes, stood at a relatively mild 2.1% in March. The krone has been no match for the dollar, but it has appreciated against most of its major trading partners this year. The recent weakness is unlikely to be sufficient to spur the Norges Bank into faster action. After hiking last September, December, and March this year, it will likely wait for the June meeting to hike again.
Tokyo’s April CPI will be reported at the end of next week. Tokyo’s CPI is reported ahead of the national figures but provides a good economic tell. The April report is important because the cut in mobile service prices last April drop out of the 12-month comparison. This means that Tokyo, and by extension, Japan’s consumer price measure, will jump. The phone charges are thought to be worth around one percentage point, and this is what the market is anticipating. As a result, the headline pace rises to 2.3% from 1.3%, and the core rate, which excludes fresh food, may increase to 1.8% from 0.8%. It means that the measure that excludes fresh food and energy will turn positive for the first time since March 2021. However, the BOJ will see through it, and the new fiscal measures are projected to reduce consumer inflation by around half of a percentage point in the May-September period.
Four other central banks of note meet next week, two from South America and two from central Europe. With next week’s hikes, Brazil and Chile are maybe 1 or 2 hikes away from being done. A 100 bp hike in the Brazilian Selic rate brings it to 12.75%. The latest CPI reading puts inflation slightly above 12% year-over-year. The swaps market looks for rates to peak near 13.5%. Chile’s CPI is closer to 9%, and its policy rate is 7%. The last two hikes, January and March, were 150 bp each, and before that, the central bank hiked twice by 125 bp. It raised rates by a total of 100 bp in June and July last year. The swaps market envisions 155 bp tightening over the next six months for the peak.
Poland and Czech central banks have wood to chop, with March inflation around 11% and 12.7%. Poland’s central bank has hiked rates at each of the last seven meetings for a total of 440 bp. It hiked by 100 bp in April, and another hike of that magnitude appears likely. The swaps market looks for a peak near 6% next year. The Czech repo rate is at 5.0%. The central bank has also hiked rates at its last seven meetings for 475 bp in total. It dialed back its hikes after 125 bp, and 100 bp moves last November and December to 75 bp and 50 bp in February and March. A 50 bp hike is the most likely scenario. The market also looks for the Czech rate to peak near 6% next year.
Turning now to the price action in the foreign exchange market despite or because of naysayers is trading new multi-year highs against the euro and sterling. The greenback may begin consolidating the gains that took it to 20-year highs against the yen. Chinese efforts to slow the yuan’s descent appear to have done the trick and broken the strong downside momentum. The unusual Politburo statement ahead of the weekend and extended holiday is conducive of a consolidation phase. After a sharp decline, and with signals of policy support forthcoming, Chinese stocks may draw some new attention.
Dollar Index: The six-day rally ended before the weekend with the help of China’s allusion to more economic support for the world’s second-largest economy. The modest pullback was only the third decline since March 30. It barely slipped through the previous day’s low and was marginally inside the upper Bollinger Band (~103.35). The momentum indicators are stretched but do not appear to rule out a new high. It may take a break of the 101.80-102.35 band to signal a correction instead of a flattish consolidation. April’s nearly 5% net gain is the largest monthly rise since January 2015.
Euro: The euro bounced ahead of the weekend to snap a six-day fall that took it from around $1.0850 to almost $1.0470, its lowest level since early 2017. The momentum indicators are over-extended but do not appear poised to turn higher yet. The squeeze that carried the single currency to almost $1.06 before the weekend was met with new selling and it settled in the middle of the day’s range. There is more talk about a test on $1.00 (parity). Ahead of it, the 2017 low ($1.0340) may offer the next target. Given the sharpness of the euro’s decline, a move above the $1.0650-$1.0700 area is needed to cause the bears any pain.
Japanese Yen: The BOJ’s signals of its intent to defend the 0.25% cap on the 10-year cap indefinitely broke the dollar out of the pennant or flag formation and sent it to JPY131.25. The BOJ Governor recognized that rapid moves are not helpful for businesses but saw the weaker yen as a net positive force for the economy overall. The Finance Minister’s rhetoric is gradually strengthening, but intervention ahead of what is expected to be a 50 bp Fed hike is highly unlikely. Ahead of the weekend, and with Tokyo markets closed for a holiday, the dollar found support near JPY129.40. Some lighter activity during the holiday period may be conducive for consolidation. Maybe the lower end of the range may be in the JPY128.60-JPY129.00 area. On the other hand, a move toward JPY135 would likely coincide with US 10-year yields pushing above 3%.
British Pound: Sterling dropped like a rock too. Since reaching a high a little shy of $1.31 and reversing lower on April 21, sterling nearly declined seven cents to almost $1.24 on April 28. It has not been lower since July 2020. The six-day slide ended before the weekend amid the broader dollar pullback. Before the bounce, sterling had settled five consecutive sessions below the lower Bollinger Band. The MACD looks poised to turn higher and appears to be a little ahead of the Slow Stochastic. The next important chart point is around $1.2250. Meanwhile, the $1.2670 area offers the nearby cap. A bout of short-covering could lift sterling further ahead of the BOE meeting. The swaps market has a 25 bp hike fully discounted now and another at the June meeting. The market appears nearly evenly divided between a 25 bp and 50 bp move at the August meeting.
Canadian Dollar: The US dollar has extended its pullback into a third session ahead of the weekend, when the dramatic decline in US equities turned it around. The greenback’s small correction stalled near CAD1.2720, the (38.2%) retracement of the advance from the April 21 low (~CAD1.2460). The MACD and Slow Stochastic are still rising, suggesting a re-test of the CAD1.2880-CAD1.2900 ceiling. Canada has a solid macroeconomic story, but it has been overshadowed by the broad gains for the greenback, the unwinding of the commodity currency theme as questions raised over Chinese demand, and the risk-off mood. The correlation between changes in the exchange rate and the S&P 500 over the last 30 sessions is about -0.60, which is about twice the inverse correlation with oil (~-.30). A break of CAD1.27 could spur a move into the CAD1.2620-CAD1.2640 area.
Australian Dollar: The Aussie has fallen out of bed. Coming into this month, it appreciated in seven of the past eight weeks. Starting with the week ending April 1, it has fallen for five consecutive weeks. The latest leg down was brutal. After peaking near $0.7460 on April 21, the Australian dollar fell by about 5.25% to the low on April 28 `by $0.7055. That was the lowest level since early February. The pre-weekend bounce stalled around $0.7180. It must get above $0.7200 to be meaningful. It seems more likely to retest the year’s low set in late January near $0.6970. The risk of a deeper decline toward $0.6850 may be growing. The MACD looks like it can turn higher soon, but the Slow Stochastic may take longer. The RBA meets, and if it does not hike the cash target rate by at least 15 bp, the Aussie may be vulnerable to a new bout of selling. The swaps market has discounted about 245 bp of tightening this year. That seems too aggressive, and an adjustment could also leave the currency vulnerable.
Mexican Peso: When everything is said and done, the Mexican peso proved itself relatively resilient in April to the greenback’s surge. The peso fell by about 2.6% in the month, less than all the major currencies but the Canadian dollar. The dollar recouped half of what it lost from the early March high near MXN21.4675. It stalled after reaching almost MXN20.64. The initial pullback found slightly below MXN20.29. This seems like a rather shallow pullback, warning of the risk of a new attempt higher next week. That said, the momentum indicators may be poised to turn lower in the coming days. A break of MXN20.20 would undermine the dollar’s technical tone.
Chinese Yuan: The dollar gapped higher against the yuan on April 25 and has not looked back. The gap would be particularly significant in a less controlled currency because it appears on the weekly charts. The dramatic losses in the euro and yen put downward pressure on the yuan, which the PBOC says is managed against a trade-weighted basket. The PBOC’s 1% cut in required reserves for foreign currency deposits was seen as a tepid protest, more a warning. The dollar’s surge extended to CNY6.65 before the Politburo’s pledge of more economic support, which sent it to about CNY6.5850. With mainland markets closed for the first three sessions next week, CNH will be monitored more closely. As typically happens when the yuan falls, the offshore yuan falls faster. The spread between the two is the largest of the year (e.g., the dollar settled at CNY6.6080 and CNH6.6400). Consolidation over the next few days may serve nearly everyone’s interest. Arguing backward from the 20th Party Congress later this year, where China’s Xi is expected to take a third term, there must be a desire to provide a good economic backdrop. It is partly a function of the Covid response and partly a function of the economic stewardship.
Bannockburn Global Forex