US CPI, New Security Initiatives with Tokyo and Manila, Bank of Canada Meeting

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Marc Chandler
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Overview: The dollar has been confined to narrow ranges ahead of the US CPI report. Given the backup of US rates and the stronger-than-expected jobs growth, the greenback's performance has been unimpressive. The Reserve Bank of New Zealand signaled that it was in no hurry to cut rates and it helped underpin the New Zealand dollar. Up about 0.2% today, it is leading the G10 currencies higher. Strong earnings from TSMC may have helped underpin the Taiwanese dollar (~0.3%), which is trailing the Mexican peso (~0.35%) to lead the emerging market currencies.

Many Southeast Asian markets are closed to the holiday today, including South Korea, where the parliament election is taking place. Exit polls suggest a strong showing by the opposition Democratic Party. The Hang Seng (1.85%) and the mainland companies that trade there (2.06%) were the led the region. Europe's Stoxx 600 is recouping yesterday's 0.6% decline, while US index futures are firm. Benchmark 10-year yields are mostly slightly softer in Europe. The 10-year US Treasury yield is hovering near 4.35%. Gold is consolidating in about $2345-$2360 range. It peaked yesterday slightly above $2365. May WTI peaked at the end of last week around $87.65 and fell to a low near $84.70 on Monday. It is consolidating in a narrow range today above $85.

Asia Pacific

As widely expected, the Reserve Bank of New Zealand stood pat, with the cash rate target at 5.5%. The economy contracted in H2 23, but officials are concerned about the sticky inflation. It will report Q1 24 CPI next week. It rose 1.2% in Q1 23. The 0.5% increase in Q4 23 matches the smallest uptick since the decline (-0.5%) in Q2 20, but the year-over-year rate was 4.7%. The New Zealand dollar is off about 4% this year against the US dollar and around 1.4% lower against the Australian dollar. The RBNZ meets next on May 22. The swaps market sees little chance of a cut, but the odds rise to about 35% in July (down from closer to 40% yesterday and ~55% at the end of last week). and almost 95% in August (unchanged). 

Fitch affirmed China's A+ rating but cut the outlook to negative from stable. The risks to public finances were cited, as the Beijing seeks a more sustainable growth model after the property-driven growth has ended. The rating agency expects the economy to slow to 4.5% from 5.2% this year due to the continued drag from the property sector and soft household demand, stemming from the fallout from property and weak income growth. The market impact seemed marginal at best. 

The pullback in US rates saw the greenback return to Monday's low, slightly below JPY151.60 yesterday. It is in a narrow range today; slightly below JPY151.70 to almost JPY151.90. The market is cautious about the JPY152 level, but the dollar is bought on "weakness."  The Australian dollar rose to almost $0.6645, its highest level since the February US jobs report on March 8. The high set on March 8 was near $0.6670. There are A$1.4 bln in options that expire at $0.6645 today. and the Aussie is trading between about $0.6615 and $0.6630 today. The New Zealand dollar is firm, trading near a three-week high around $0.6075-$0.6080. The dollar remains pinned near the upper end of the 2% band it is allowed to trade within. Today, the band is CNY7.9540-CNY7.2378 and the dollar has traded to CNY7.2333. The PBOC set the dollar's reference rate at CNY7.0959 (CNY7.0956 yesterday). The average forecast in Bloomberg's survey was CNY7.2314 (CNY7.2262 yesterday). Yesterday, and again, today, the US dollar briefly traded inside the onshore band against the offshore yuan. 

Europe

The swaps market has less than a 7% chance of a cut at tomorrow's ECB meeting discounted. The ECB has prepared the market for a June cut and the market has around a 90% of cut then priced. It has about 87 bp of cuts this year, which is three quarter-point cuts and a 50% chance of a fourth move. In contrast, the market has about 67 bp of easing by the Federal Reserve, and that is two cuts and about a 70% chance of a third cut. Currently, the US effective Fed funds rate is 5.33% and the eurozone's effective overnight rate is 3.90%. Given the expectations, the policy rate differential may widen from around 143 to 165 bp. The US offers about 185 bp more than Germany on two-year money. The US premium peaked last year around 207 bp. So far this year, the premium peaked in early January slightly above 190 bp.

The market is now pricing in a greater likelihood that the Bank of England also cuts before the Federal Reserve. The swaps market has almost an 80% chance that BOE cuts in June and about a 60% chance the Fed does. The market is discounting almost two BOE cuts and around a 90% probability of third cut. The US two-year premium over the UK is near 55 bp, the most since April 2023. The US premium peaked at almost 128 bp last year. Briefly in January and February, the US two-year yield traded at 10-12 bp discount to the UK.

At yesterday's high near $1.0885, the euro had rallied 1.6-cents off the April 2 low, and reached the best level since March 21, the day after the last FOMC meeting concluded. This met the (61.8%) retracement of the euro's decline since US February jobs data on March 8. A move above there would initially target the $1.0920-50 area. There are nearly 2.1 bln euro of options expiring at $1.09 today. The euro is trading quietly holding mostly above $1.0850. It is setting session highs in the European morning near $1.0865. Sterling traded above $1.27 for the first time since March 21. It stalled less than a tenth of a cent from the (50%) retracement of the decline since the US February employment report (~$1.2715). The next retracement (61.8%) is near $1.2760. Sterling has also rallied about 1.6-cents from the April 2 low. It is firm, mostly above $1.2670 and holding slightly below $1.27.

America

There are four highlights in the North American session today. First is the US March CPI. The median forecasts in Bloomberg's survey are for both the headline and core rate to rise by 0.3%. Given the base effect, this would mean the year-over-year headline rate will rise to 3.4% from 3.2%. The core rate by be steady at 3.8% or decline to 3.7%, likely depending on the rounding. As we have seen, the market has already adjusted its interest rate expectations. It is less confident of a June/July move and is not fully convinced any more that the Fed will deliver the three rate cuts that the median dot plot had in the March Summary of Economic Projections. The FOMC minutes will be released late in session and may shed light on the qualitative aspects about the 10-9 split between officials thinking three or more cuts would be appropriate and those that saw two or fewer cuts. 

Second, the US Treasury's quarterly refunding kicked off yesterday with the sale of $58 bln three-year notes. The auction was poorly received, generating a two-basis point tail, and soft bid-cover (2.5x). Today, $39 bln of 10-year notes will be sold. The last sale produced a high yield of almost 4.17%. The current yield is about 4.36%. Third, there is a high-profile meeting between US President Biden, Japanese Prime Minister Kishida, and Philippine's President Marcos. Biden is likely to reaffirm that the Second Thomas Shoal, around which China has been particularly aggressive lately is indeed covered by the mutual defense treaty. The US is also expected to announce closer defense collaboration with Japan, possibly in the defense supply chain (though apparently Nippon Steel's bid for US Steel continues to be questioned), possibly more formally in part of the AUKUS. There is also talk of a new US-Japan-Philippines pact. Japan and Philippines are thought to be near an agreement that would allow Japanese forces in the Philippines for joint military exercises. 

The fourth highlight is the Bank of Canada meeting. With inflation easing more than expected over the past two months, the jump in unemployment to 6.1% (from 5.0% last March), we think there is a compelling case for a rate cut. However, the Bank of Canada seems more cautious and swaps market has about a 1-in-6 chance of a cut today. The odds of a June cut are almost 77%. A surprise cut today, and the Bank of Canada is not above surprising the market, would likely weigh on the Canadian dollar.

The US dollar initially extended yesterday's losses and slipped briefly through CAD1.3550. However, amid a stock market pullback, the greenback retraced some of its earlier losses and US equities slumped, the dollar recovered to CAD1.3600. At the lows, the US dollar approached the (61.8%) retracement of the rally in the second half of last week (~CAD1.3480 to CAD1.3645). Ahead of the Bank of Canada meeting, the US dollar is in a tight range of about 10 ticks on either side of CAD1.3570. The Canadian dollar is underperforming this month. Its roughly 0.35% decline makes it the weakest in the G10 so far here in April. The other dollar-bloc currencies are up 1.15%-1.45%. Mexico's March CPI came in a little softer than expected. The headline rate ticked up to 4.42% from 4.40% and the core rate eased to 4.55% from 4.64%. The dollar put in a new multiyear low near MXN16.26 in the European session yesterday and had already begun recovering, but the greenback's leg up to above MXN16.40 appeared more related to the sell-off in US stocks than some monetary implication of Mexico's CPI. It appears the peso was again bought on a small pullback. Today, the dollar has not traded above MXN16.40 and has been pushed back to MXN16.3235.