Dollar drifts higher as traders brace for inflation report
Highlights:
Currencies mostly bounced around in narrow ranges amid the absence of major news.
BoE’s governor Bailey suggested market might be under-pricing cuts in the UK.
Eurozone macro data continues to point to economic recovery.
Riksbank cut its policy rate by 25 basis points last week to 3.75%.
Currency markets traded listlessly last week, bouncing around in narrow ranges in the absence of major inflation news, on which traders and investors have fixed obsessively lately.
The only significant moves among major currencies were moderate selloffs in the Brazilian real, weighted down by a dovish Banco de Brazil, and the Japanese yen dragged down by increasing doubts about authorities’ will to defend the currency amidst a massive interest rate gap with the rest of the world. The week’s winner was the Mexican peso, which rose 1% and is now the only major currency to have withstood the dollar´s rally so far in 2024.
The April CPI inflation report out of the US on Wednesday is perhaps the most critical macroeconomic print we will see in a while. In order to maintain the rate cut narrative, it is important to start seeing core numbers consistent with the Fed’s inflation target, that is, no more than 0.2% a month. Also important will be the UK labour report for March on Tuesday and the revision to Eurozone first quarter GDP growth numbers on Wednesday. An unusually long roster of Federal Reserve and ECB speeches will provide further background for currency trading throughout the week.
USD
The Federal Reserve’s plans to cut rates in 2024 depend crucially on inflation data resuming the interrupted disinflationary trend of 2023, and that, in turn, necessitates CPI monthly prints of no more than 0.2% increases, particularly in the core index. That hasn’t happened in about half a year, and is unlikely to happen in this week’s April CPI report, according to economists’ expectations.
Any further upward surprises would probably lead to a significant rethink to the Fed’s path of rates over the remainder of the year. Consequently, we expect to see quite a bit of volatility right after the publication of the numbers on Wednesday. It bears noting, however, that dollar positioning is stretched, and the dollar is very expensive by most metrics at current levels.
EUR
The PMI indices of economic activity, as well as the lagging hard data, notably retail sales, have been pointing to a significant recovery in economic activity led by resilient domestic demand and the services sector. The first-quarter GDP report out this week should confirm this trend, and perhaps we will see a positive surprise, just as we did last week in the UK. However, none of this is likely to derail the first cut out of ECB, which is almost certain to come in June. Beyond that, the pace of cuts remains murky as the economy recovers and the Eurozone faces that ‘last mile’ in the inflation fight, with core inflation still significantly above the ECB target.
GBP
The first-quarter GDP report out of the UK provided a pleasant surprise, suggesting demand is recovering, growth is picking up fast, and the 2023 growth hiccup is now behind us. The Bank of England, however, sounded a more sceptical note at its May meeting, and Governor Bailey went as far as suggesting markets were under-pricing the pace of easing.
With growth picking up steam and inflation still far from the Bank’s target, this may prove, in the end, just another of many Bank of England communication head fakes. This week’s labour report will be key. Markets are expecting a continuation of the slow downward trend in wage increases, and any upward surprise.