The sharp move upward in the US dollar last week was somewhat counterintuitive, as inflation and wage data out of the US were both reassuring for the Federal Reserve and consistent with a slow downward trend in inflationary pressures. The main suspect is likely to be market positioning. After the relentless move from below parity to above the dollar, positioning indicators point to record long euro positions among traders, an overhang that will have to work itself out before the euro moves decisively higher from here. We note that risk aversion also prevailed in markets, as soft Chinese inflation data raised concerns on the global economic recovery. This led to a general outperformance in the safe havens, notably the US dollar. While the dollar rose against all other G10 currencies, Latin American ones continued their impressive run upwards so far this year, and the Mexican peso and Brazilian real topped the week’s performance tables.
We now go into an unusually quiet week in terms of macroeconomic data, where only the April employment report out of the UK stands out. The monetary policy calendar is more crowded, with an unusually large number of speakers from the Fed, the ECB and the Bank of England who will be expected to clarify their respective institutions’ outlook. A number of second-tier indicators worldwide should be followed closely for confirmation of the apparent slowdown we have seen in economic data over the past few weeks.
The Bank of England executed yet another communications turnabout at its meeting last week. There were no large surprises in the actual decision to hike rates by 25bps, while the forward guidance was left unchanged in an apparent sign that at least one more hike is on the way at the next MPC meeting in July. The bank did, however, issue the largest ever upgrade to its macroeconomic outlook since the GDP projections began in 1997, stressing that it now no longer expects a recession. Moreover, the BoE revised upward its projected inflation path, suggesting that the terminal UK rate may end higher in 2023 than previously anticipated. The pound should remain well supported in the coming weeks. A cheap valuation and a relatively hawkish Bank of England should remain tailwinds, and sterling does not have the same positioning issues that the euro suffers from in the short-term.
The euro is back at the middle of the trading range that has held so far in 2023, despite the significant narrowing in interest rate differentials that we have seen with the US. Some weakness in volatile economic indicators out of the Eurozone, like German industrial production and factory orders, have dented sentiment somewhat, but we think that the main driver of the dollar rebound has been short covering. This week, the main market mover for the common currency should be a barrage of speeches by ECB Council members, including President Lagarde. We expect no real change in the bank’s tone of communications, with Lagarde likely to reiterate that the bank remains in ‘data-dependent’ mode. As things stand, markets are almost fully pricing in two more 25bp rate hikes from the Governing Council in the coming months, though additional upside surprises in Euro Area inflation data could ensure that this is somewhat of a conservative estimate.
US inflation data for April was marginally weaker than expected, helping cement the view that the Federal Reserve is done hiking interest rates and will pause at its June FOMC meeting. A downtick in the best measure of US wages, the Atlanta Fed wage tracker, also points in the same direction, as does the clear uptrend in weekly jobless claims and the loosening in the labour market that can be seen in the JOLTs open positions indicators. For now, these hints of a slowdown in the world’s largest economy are driving a short-covering rally in safe-havens generally, and the US dollar in particular. We may have to wait for the May inflation data and June central bank meetings before the trend downward in the US dollar is re-established. In the meantime, industrial production and retail sales data will be released this week and could receive some attention among market participants.