Dollar Consolidates but Adjustment is Not Over

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Marc Chandler
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Overview:  Higher than expected US CPI for the third consecutive month drove US interest rates sharply higher and lifted the greenback broadly. The market appears to be catching its proverbial breath today, but the shallow consolidation suggests the moves are not over. The ECB meeting is likely to highlight the new divergence that has opened. The dollar has reached nearly JPY153.30, and although Japanese officials cautioned about the fx moves, intervention while Prime Minister Kishida is on his state visit to the US strikes us highly unlikely. In any event, the broad dollar gains were fundamentally driven. China's March CPI (-1.0% month-over-month and 0.1% year-over-year) underscores the scope for the easier monetary policy, but the PBOC continues to resist the downward pressure on the yuan. 

The large Asia Pacific equity markets were mixed. Of note, South Korea's Kospi eked out a small gain amid a significant political setback for the pro-business president, whose People's Power Party lost more seats in parliament, leaving Yoon Suk Yeol's agenda at risk. Europe's Stoxx 600 is off about 0.3% in late morning turnover. US index futures are slightly softer after yesterday's sharp losses. The US two-year yield surged 23 bp yesterday to approached 5.0%. It is closer to 4.95% now. The US 10-year yield jumped 18 bp yesterday to about 4.55% and is hovering near there now. European 10-year yields are 1-4 bp firmer today. The market has downgraded the chances of a June ECB cut to around 80%, the lowest since last October. Gold fell by about $18.75 an ounce yesterday, its largest loss in about a month. It is trading softer today near $2332. The yellow metal's record high was set on Tuesday a little above $2365. May WTI is little changed, consolidating above $86 a barrel.

Asia Pacific 

China's March CPI rose 0.1% year-over-year, slower than the 0.7% pace seen in February, which seemed to have been boosted by the lunar New Year holiday and lower than expected. On a month-over-month basis, CPI fell by 1% after rising by 0.3% in February. Food prices tumbled 2.7% year-over-year. Non-food prices rose by 0.7%, down from 1.1% previously. The core rate rose by 0.6%, half of February's pace. Producer prices deflation, which began in October 2022 continued, with the PPI off 2.8% over the past 12 months. China's PPI has been between -2.5% and -3.0% since last July. The subdued price pressures give the PBOC scope to cut rates or reserve requirements. But officials are believed to be concerned about the weakness of the yuan, which continues to hover near the lower end of its band against the dollar. The CSI 300 rallied a little more than 16% off its early February lows but stalled three weeks ago. The 10-year Chinese bond yield set a multiyear low near 2.75% in late March and continues to trade near the trough. Separately, note that Beijing has ordered three-star hotels and better, and major tourist attractions, to accept foreign bank credit cards.

After bumping near JPY152 for three weeks, the surge in US rates after the March CPI lifted the greenback to JPY153.25 yesterday has edged marginally higher today. The dollar has held above JPY152.75. While we thought Japanese officials missed an opportunity to intervene over the Easter holiday, we also argued that the risk of intervention this week, with Japanese Prime Minister Kishida in the US, the first state visit in nine years, was slim at best. The dollar is at its best level since 1990. It reached slightly above JPY160.20 in Q2 90. We have suggested initial potential toward JPY155. The Australian dollar slid more than 1.75% yesterday, its biggest drop since March 2023. It has steadied today and held above $0.6500. The next support may be near last week's low near $0.6485, while the Q1 low set in mid-February closer to $0.6445. It has held below $0.6530 today. The New Zealand dollar recorded a key reversal by setting new highs for the move (~$0.6085) and then selling off and settling below Tuesday's low (~$0.6030). Like the Aussie, it steadied today but has been unable to resurface above $0.6000. There is little to prevent a test on this month's low near $0.5940. The greenback's broad strength saw it rise to a six-session high against the offshore yuan (~CNH7.2640). The year's high was set on March 25 around CNH7.2820. Contrary to ideas that China wants a weak yuan to boost exports, officials continue resist the downward pressure. The PBOC set the dollar's reference rate at CNY7.0968 (CNY7.0959 yesterday). The average projection in Bloomberg's survey was CNY7.2565 (CNY7.2314 yesterday). We suspect that the dollar is headed back into the former range of CNY7.25-CNY7.30. The press reported state banks were sellers of dollars today.

Europe

Perhaps it is the sell-off in the euro, perhaps it is that Fed easing looks to start later and deliver less than had been anticipated, but the market has downgraded the chances of an ECB cut in June. To be sure it is still the odds-on most likely scenario, but around 80%, it is at the lowest since last October. The ECB does not target the exchange rate, but it does feed into central bank's economic forecasts. And the risk seems squarely on the downside. It is difficult to envision a hawkish ECB. However, ECB President Lagarde may recognize that there are some economic green shoots. The periphery appears to be doing better than the core and within the core. Retail sales remain disappointing in Germany, but expectations have improved, and industrial output is off to a strong start (rising 1.3% in January and 2.1% in February).

It took the euro six sessions to rise from around $1.0725 to $1.0885. It practically unwound it all yesterday. The 1.1% loss was the largest drop of the year. The low in Q1 was slightly below $1.07. Note that there are substantial options struck at $1.07 that expire today (2.3 bln euros) and tomorrow (2.6 bln euros). After the low was set in North America yesterday, the euro was unable to trade above $1.0755. Today's high has been $1.0750. A break of $1.07 would initially target the $1.0650 area, but we suspect the new divergence could see $1.06. Sterling was slammed yesterday and spiraled to $1.2520, taking out last week's low around $1.2540 and matching the Q1 low recorded after the January US jobs data on February 8. A fragile consolidative tone has emerged today, and sterling saw new sales near $1.2570. There are GBP560 mln options at $1.2515 that expire today. Sterling has not traded below $1.25 since last November. A break of the $1.2480 area could spur another cent drop. 

America

The third monthly US CPI reading above expectations lifted US rates sharply and lifted the greenback. The measure that Fed Chair Powell has referred to, which is core services excluding housing, rose by 0.65%. This follows a 0.47% rise in February and a 0.85% increase in January. That is about 8% annualized pace. Auto insurance and medical costs were the key drivers. The headline rare rose by 0.4%, and about half was driven by gasoline and shelter costs. The year-over-year rate of 3.5% is the highest in six months. The firm CPI comes on the heels of continued stronger than expected US job creation. The market has all but given up on a June rate cut. There is less than a 20% chance still being priced, the least since last September. After the March employment report on April 5, the futures market still had about a 55% chance of a June cut discounted, but it has not been fully priced in since February 20. The odds of a July cut were nearly halved after yesterday's CPI and is now near 45%. For the first time, the market does not have at least a quarter-point cut discounted for September. More than two rate cuts were completely discounted as recently as March 25. 

The Bank of Canada took baby step toward a rate cut. While leaving policy on hold at 5.0%, the central bank boosted its GDP forecast while shaving its CPI projections. In its statement, it dropped the reference to the "persistence of core inflation." However, is also raised the middle of its assessment of the neutral rate by 25 bp to 2.25%-3.25%. The market downgraded the chances of a June cut to about 50% now from 78% on Tuesday. The swaps market sees about 55 bp of cuts this year, which is two quarter-point moves and a little less than a 20% chance of a third cut. Recall that as recently as February 20, the market was favoring 100 bp of cuts this year. Last Thursday, the swaps market had slightly more than three cuts fully discounted.

The US CPI triggered a sharp sell-off in the Canadian dollar, and the reaction to outcome of the Bank of Canada meeting hardly is seen in the tick chart. The US dollar jumped around 0.9%, the most this year, and briefly traded above CAD1.37 for the first time since last November. It has held slightly below it today. The next chart area is around CAD1.3765-75. The Bollinger Band is set two standard-deviations around the 20-day moving average. Yesterday, the greenback traded beyond three standard deviations (~CAD1.3685) from the moving average. The three-standard deviation mark is slightly above CAD1.3705 today. The US dollar surge proved too much for the high-flying Mexican peso. The greenback had recovered a bit from Tuesday multiyear low near MXN16.16. It was trading near MXN16.30 before the US CPI and shot up to MXN16.52. This is the kind of setback for the peso that we suspect will bring in new buyers. Barring a Fed hike, the carry remains a key prop for the peso. The dollar is consolidating around MXN16.4260-MXN16.4820. The 20-day moving average is slightly below MXN16.60, and the dollar has not closed above it since late February.