Dollar remains around highs on strong US activity data

Highlights:

US dollar remains around recent highs after strong retail sales data.

UK inflation surprise buoys sterling ahead of PMI figures.

ECB chief Lagarde hints again at June interest rate cut in the Euro Area.

Swiss franc outperforms on safe-haven flows, yen remains around intervention levels.

Chinese GDP data surprises to the upside, but data points to weak momentum.

Activity in the foreign exchange market was mostly subdued last week in the absence of key macroeconomic reports or policy news.

The little data that we did receive mostly confirmed the view of a strong US economy, with bubbling demand and slowly improving growth in Europe, while UK inflation pressures remain relatively high. In the end, all G10 currencies finished the week within 1% of where they started it. Moves in emerging markets were wider, but it is hard to discern a common theme there as well, particularly as tensions in the Middle East appear to be cooling.

Focus this week will be the PMIs of business activity, the timeliest indicator of economic growth in most large economic areas. The Eurozone, UK and US numbers will all be released on Tuesday. The US PCE inflation report on Friday will also be key, as this has been traditionally the Federal Reserve’s preferred inflation measure, and it has been running a bit less hot than the CPI number. A batch of ECB speakers over the week will also be in focus.

USD

Macroeconomic data out of the US remains highly impressive, characterised by last week’s very strong retail sales report for March. Resilient consumer spending and stubborn inflationary pressures have triggered a dramatic repricing in market expectations for Federal Reserve cuts this year, and communications from Fed officials have been hawkish and largely consistent with this repricing.

Futures markets now see little chance of a June rate cut and are barely pricing in a full cut by the Fed’s November meeting. The dollar has rallied on the back of this, but current levels reflect some significant overvaluation in our view, and a further rise would necessitate significantly hotter inflation data than what we have seen so far. Friday’s PCE inflation figures will be highly important in this regard, with markets bracing for a modest uptick in the headline and a mild drop in the core number.

EUR

Communications from European Central Bank members on future policy moves have mostly settled that the first cut will be in June, with President Lagarde again strongly telegraphing lower rates ahead during her remarks last week. Additional cuts beyond the June meeting are in the air, however, and will remain entirely data dependent.

The economic improvement seen in the data, the remaining gap between core inflation and the hawkish turn in the Federal Reserve’s communications all militate against an aggressive cutting cycle. Current market expectations of three cuts before year-end are much more conservative than they were just a few weeks ago, but this remains contingent on a continuing downward trend in inflation, unlike what we are seeing in the US. There will be no inflation data out of the bloc this week, but Tuesday’s PMI numbers are seen showing a continued rebound in growth.

GBP

February wages and March inflation both surprised to the upside in the UK last week, a sign that it will be more difficult for the Bank of England to justify interest rate cuts than for the ECB. Market participants continue to see a 50/50 chance of a June cut from the BoE, although additional upside surprises in both inflation and wages in the interim will make it very difficult for the MPC to justify lower rates just yet. We think that a background of high rates, continued inflation pressures and resilient economic growth paints a constructive picture for sterling during 2024.

This week’s PMI data out of the UK should remain constructive and consistent with the healthy expansion we have seen in the last couple of monthly GDP prints. It appears increasingly clear that Britain’s economy likely emerged from technical recession at the beginning of the year, with tomorrow’s data seen showing continued expansion at the start of the second quarter.