US CPI, Fed, ECB, BOJ and the Week Ahead

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Marc Chandler
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Of the three G3 central banks that meet in the days ahead, the market is the most confident of a rate hike by the European Central Bank. The market sees a hawkish hold from the Federal Reserve. However, the idea of a skip, a topic which even Fed officials have broached, would seem to pre-commit to another hike, and this is not typically the central bank's modus operandi. Moreover, it may be difficult for the Fed to resume hikes in July if inflation falls as we expect toward 3.2%-3.3% in this month (due July 12) and the economic activity slows. Still, the Chair Powell may go to pains to underscore that a pause is simply the decision not to raise rates now rather than necessarily signaling an end to the cycle. In fact, a dissent in favor a of hike seems possible given some recent statement. Ideas that the extraordinary BOJ monetary policy was largely a function of former Governor Kuroda seem less convincing given his successor's endorsement of the policy setting and call for patience.

With the US debt ceiling drama behind us for this cycle, the Treasury's pent-up issuance kicks in with vengeance. Last week, it sold almost $330 bln of bills. Outside of the four-week bills there was strong demand (high bid-cover ratios and stronger indirect bids). In the week ahead, between bills and coupons, the Treasury may raise close to $400 bln. Most economists seem to expect that the lion's share will be funded out of reserves (not drawing funds from the reverse repo facility) and this is seen tightening financial conditions.

The US dollar was weaker against the G10 currencies last week but the Swedish krona. The greenback's technical weakened but outside of sterling, which approach $1.26 ahead of the weekend, no key technical levels were violated. The greenback continues to appear broadly sensitive to interest rate developments. Among emerging markets, Latam currencies accounted for five of the top seven performers last week (joined by the South African range and Polish zloty). The Mexican peso remains a market favorite and it rose to new seven-year highs. Mexico, Brazil, and Colombia reported softer inflation figures, which helped spark more talk of rate cuts in the second half. 

United States:   The week ahead is one of the busiest for the US this year. The main features are the May CPI and the FOMC meeting but also on tap are retail sales, industrial output and the NY State and Philadelphia Fed June surveys. The May CPI will be reported on June 13 as the FOMC meeting gets under way. Due to the base effect, a sharp fall in the year-over-year rate is expected. In May 2022, CPI rose by 0.9%. This will likely be replaced by 0.2%-0.3% increase. This will bring the year-over-year rate to 4.1%-4.2% from 4.9%. The 0.2%-0.3% increase in May brings the annualized rate in the first five months of 2023 to 3.8%-4.1%. Moreover, another large decline is like when this month's data is reported in July. In July 2022, the monthly headline CPI jumped by 1.2%. Assuming this is replaced with 0.3% or 0.4% increase, the year-over-year rate can fall to 3.2%-3.3%. However, in some ways, this is the low hanging fruit, and the base effect makes for more difficult comparisons in H2 23. In H2 22, US CPI rose an annualized rate of about 2.8%. That said, the lagged measure of shelter costs the BLS uses should begin reflecting the decline in prices that have already been recorded. This may help the core rate, which has been firmer than the headline rate, play a little catch-up. The core rate is expected to have risen by 0.4% last month for a 5.2% year-over-year rate. It peaked last September at 6.6%.

In late May, the market begun warming up to the idea that the Fed would hike again. The Fed funds futures market had around a 70% chance of a hike discounted. But then, the Fed's leadership (Chair Powell, NY Fed President Williams, and Governor Jefferson, nominated to be vice chair) seemed to launch a campaign for a pause. The market accepted the pushback and took the odds back to around 20%, though finished the week near 30%. The Fed will attempt to make this a hawkish pause. It will do so by indicating that a pause is not a declaration of "mission accomplished" and that it is prepared to hike again if needed. There will be updated forecasts and they are also part of the Fed's communication, even though Powell's predecessors seemed to play down the significance of the Summary of Economic Projections. The hawkish hold will be underscored by an increased in the median dot for GDP from a lowly 0.4%, which will like surpassed in the first six months of the year. The median forecast for unemployment is bound to be lower than the 4.5% year-end rate seen in March. Yet, the changed forecasts will not really convey new information as much as the Fed playing catch-up with already reported data. The other data will help fine-tune expectations for Q2 GDP, which still looks a bit stronger than Q1 even after the upward revision to 1.6% (annualized). Sequentially, retail sales and industrial output look to slow. We suspect the Q2 may turn out to be the strongest of this calendar year. 

The Dollar Index recorded a low before the weekend near 103.30, which it has not seen since May 23. It settled below the 20-day moving average (~103.65) for the second consecutive session. The five-day moving average is drifting lower and looks poised to fall below the 20-day moving average next early next week. It has crossed higher on May 12 when DXY settled slightly below 102.70. The momentum indicators are trending lower. The 103.30 area corresponds to the (38.2%) retracement objective of the rally from the May 8 low near 101.00. The halfway mark is closer to 102.85 and the (61.8%) retracement is about 102.45.

Eurozone:  The ECB meets on June 15, the day after the Federal Reserve. There is practically no doubt that it will lift key rates by a quarter of a point. This will lift the deposit rate to 3.50%. The swaps market is confident that the ECB will not be finished and anticipates at least one more quarter-point hike in late Q3. The ECB's staff will update its forecasts. In March, eurozone economy was seen growing by 1% this year. This seems optimistic and seems vulnerable to a downward revision toward 0.5%. Its CPI forecast for this year was 5.3%. This seems fair, though maybe a little on the high side. May's inflation stood at 6.1%. At an annualized pace, eurozone prices rose slightly more than 5% in the first five months of the year. Unlike the US, the base effect works in its favor in H2. In H2 22, eurozone CPI rose at an annualized rate of 5.8%. The ECB is likely to provide an update on its balance sheet strategy. Through May, the ECB's balance sheet has been reduced by about 13% from its high last June (the Fed's balance sheet has fallen around 16% since peaking in April 2022). The decline is a function of not fully reinvesting the maturing proceeds from its Asset Purchase Plan, which pre-dated Covid, and banks repaying of their loans (under the Targeted Long-Term Refinancing Operations, TLTRO). Recall that toward the end of June, around 475 bln euros of TLTRO loans come due. They account for almost half of the outstanding TLTRO loans and amount to about 6% of the ECB's balance sheet.

The euro poked slightly above $1.0785 last week, stopping shy of the (38.2%) retracement objective from the decline from almost $1.11 seen in early May. That retracement is found near $1.0810. The next retracement (50%) is about $1.0865 and the (61.8%) mark is slightly above $1.0915. The momentum indicators are constructive, and a move back below $1.0740-50 would be disappointing. Like we saw in the Dollar Index, the euro's five-day moving average looks poised to cross above the 20-day moving average in the coming days.

Japan:  The Bank of Japan meeting concludes on June 16. Since Ueda became governor, surveys have identified this meeting as the likely time frame for an adjustment to the extraordinary policy stance. However, in recent weeks, the market has pushed out expectations, encouraged, perhaps, by BOJ Governor Ueda. In mid-May Ueda still saw the risks of moving early were greater than the risks of being patient. A recent Bloomberg survey found only 6% of the economists it surveyed look for a policy adjustment, down from almost 40% in its previous poll. Now a little more than a third expect a change in July. Still, that may be earlier if the BOJ wants to wait for the spring wage round (Shunto) negotiations results in 2.3% wage increase and 3.8% overall all) to be reflected in actual wages, which may not be until August/September data. It was not apparent in the April wage data reported last week, which say labor cash earnings slow to 1.0% year-over-year from 1.3% in March. Many think the BOJ's first step will be an adjustment to the yield-curve-control policy, which caps the 10-year yield at 0.50%. The market appears split between abandoning YCC altogether, lifting the cap or the mid-point (now zero), or targeting a shorter-term rate, which the IMF previously advocated. That said, we are not convinced that YCC is the first order of business. We suggest that the BOJ may first eschew the easing bias for a neutral stance. The July meeting may offer a better opportunity to adjust its guidance under the cover of new forecasts.

The dollar spent last week inside the previous week's range against the yen (~JPY138.45-JPY140.95). The low for the week was set before the weekend near JPY138.75. It frayed the 20-day moving average (~JPY139) for the first time since mid-May. The five-day moving average (~JPY139.50) has been above the 20-day moving average for two months but could cross below next week without a new dollar advance. US rates continue to be a key driver of the exchange rate, but we note that over the past 30 sessions the correlation is stronger with the two-year US yield (~0.67) than the 10-year yield (0.53). The two-year US yield is bumping up against the 4.60% area. A push above there may be worth another 10 bp and could be enough to lift the dollar back above the JPY140 area. This month's high is near JPY140.45 and the year's high were set in late May slightly below JPY141.00. 

China: The PRC insists on reporting its data differently than convention and this make comparisons difficult. On a year-to-date year-over-year measure, retail sales and industrial production are expected to have increased sequentially last month. Fixed asset investments may have slowed and completed real estate (buildings sold) is seen extending the decline that began in April 2022. More measures to support the economy are expected to be delivered shortly. News last week that banks were asked to cut deposit rates has spurred speculation of a small cut in the benchmark rate of the one-year medium-term lending facility (on June 15). The rate has been at 2.75% since last August when it was shaved by 10 bp. A reductio in the   A cut would in turn encourage banks to cut the loan prime rate, which is set on June 20. Sentiment toward Chinese assets seems to be at a potential inflection point. On valuation grounds, some houses ae making a pitch for Chinese equities. It is one of the only major markets that are lower this year. Meanwhile, the US premium over China on 10-year yields is near 110 bp. This is the upper end of the range going back to last November.

The dollar rose for the fifth consecutive week against the Chinese yuan. It has only fallen in two weeks since the end of Q1. It has surpassed the CNY7.07-CNY7.11 area we had targeted. The next important chart area is found around CNY7.18-CNY7.20. The CNY7.10 area may offer initial support. Chinese officials do not seem too distraught over the yuan's weakness and the divergence in monetary policy provides the fundamental backdrop.

United Kingdom: The UK reports April/May employment figures and April's monthly GDP with some of the underlying details. The UK's labor market has been resilient to the rising interest rates and weak growth impulses. The Bank of England continues to see wage growth as problematic. Average weekly earnings rose by about 5.8% in Q1 year-over-year. While this is below the 2022 peak of 6.5%, it is still well ahead of the 3.4% pace seen in Q1 19. And that includes bonuses. If bonuses were excluded the three-month year-over-year rate matched last year's high set in December of 6.7%. It is wages and inflation rather than economic activity itself spurring market's confidence of additional rate hikes. The swaps market has fully discounted a quarter-point hike at the June 22 meeting and sees about a 20% chance of a 50 bp move. The year-end base rate is seen near 5.40% from 4.50% now. It was near 4.65% in early May and was already creeping higher before the firmer than expected CPI figures on May 24. The UK economy unexpectedly contracted by 0.3% in March. The median forecast in Bloomberg's survey was for a flat number. It is difficult to see the good sector accelerating in April after industrial production and manufacturing output rose by 0.7% in March. Instead, improvement is more likely to come from services, which contracted by 0.5% in April. The construction PMI ticked up to 51.1 in April from 50.7 in March, signaling possibly improvement from March's 0.2% increase. The trade deficit has fallen sharply beginning in the second half of last year. It seems to be stabilizing around GBP3 bln a month. 

Sterling recovered from the week's low set on Monday near $1.2370 to finish the week with a new high since May 11 around $1.2585. It has stalled in the middle of the week in resistance band ($1.2500-40) bought overcome it and finished higher for the second consecutive week. The momentum indicators are constructive, and the five-day moving average moved above the 20-day moving average for the first time since May 16. A move above $1.2600 signal a return to the $1.2680 area, the high for the year set on May 10. Above there, the next target is around $1.2760.

Canada:  The Bank of Canada's "conditional pause" ended last week with a 25 bp rate hike that took most participants by surprise. It cited the strong Q1 growth resilient demand, the rebound in the housing market. The "excess demand" helped lift the underlying inflation's three-month averages. Yet, the market did not see the hike as a late-cycle insurance policy but as a sign that central bank's pause was premature. The market has another hike fully discounted by the end of Q3 that would lift the target rate to 5.0%. The swaps market and has about a 25% chance of another hike in Q4, even after the softer than expected May jobs report seen ahead of the weekend. As recently as mid-May, a 4% year-end rate was discounted.

The US dollar was sold below CAD1.34 on the Bank of Canada hike and fell to almost CAD1.3315 ahead of the weekend. The disappointing employment report squeezed the greenback toward CAD1.3370 where it was greeted with fresh sales. The US dollar has not traded below CAD1.33 since mid-February. The low for the year was near CAD1.3260. The momentum indicators are falling but getting stretched. Previous support around CAD1.34 should now act as resistance.

Australia: In a rare turn of events, the Reserve Bank of Australia surprised the market for the second consecutive month by lifting its target rate by a quarter-point. Sentiment has swung hard. The futures market has nearly discounted one more hike by the end of Q3 that would bring the policy rate to 4.35%. The year-end rate is seen at almost 4.50%, which is 50 bp higher than it was at the start of the month. The RBA's statement drew attention to the mismatch between wages (3.7% year-over-year) and the poor productivity growth (not increased in three years). Australia reports May employment data on June 15. Employment has risen by about 28k a month this year, of which almost 23.5k have been full-time posts. In the Jan-Apr 2022 period, Australia grew 51k jobs a month and 64.5k full-time positions. In early March, Australia's 2-year yield was nearly 165 bp below the US yield, which appears to be the most since the mid-1980s. It has been reduced dramatically, and briefly slipped to less than a 50 bp discount, the least in nine months before recovering to almost 60 bp before the weekend. 

The Australian dollar was recovering the from the low for the year set at the end of May (~$0.6460) before the RBA's surprise hike. It had stalled near $0.6640 but extended its rally after the hike and reached $0.6740 ahead of the weekend. It closed above the 200-day moving average (~$0.6690) in the last two sessions. The five-day moving average cross above the 20-day moving average in the middle of last week for the first time since May 16. The momentum indicators are constructive and there is little on the charts to prevent a test on the $0.6800 area. It has not closed above $0.6800 since late February.

Mexico: The favorable case for the Mexican peso is well known (carry and other portfolio inflows, direct investment, favorable external account, strong and independent central bank, and Supreme Court). It has appreciated by more than 12.6% this year and goes back-and-forth with the Colombia peso (~17.1%) for the best among emerging markets. Even though the peso reached new seven-year highs last week, the price action suggests profit-taking into the new highs. That does not mean that the move is over, just that some participants are turning more cautious. The dollar slipped below MXN17.29 before the weekend. We suspect the next important target is near MXN17.00.