Dollar falls hard on inflation relief

Highlights:

Slightly lower-than-expected CPI reading dragged down the US dollar, allowing for improvement in market sentiment.

High beta currencies, notably NZD and NOK, performed particularly well. Safe havens underperformed.

Economic data from China was mixed but highlighted issues in the real estate market, which authorities try to address with new measures.

The US CPI inflation report for April was a touch softer than expected, and investors worldwide celebrated by sending stock markets to fresh record highs and selling safe havens like the US dollar, which fell against every G10 currency save the Swiss franc.

The relief rally lifted most risk assets and commodities, and the undisputed winner of the week was the Chilean Peso, soaring on the back of investor enthusiasm and rocketing copper prices.

The next couple of weeks will be remarkably light in terms of either macroeconomic data or major central bank meetings. This week’s focus will be on the worldwide releases of the advance PMI indices of business activity for May, out Thursday. These are particularly important in Europe, while their US version seems to have lost some of its predictive power. Markets are expecting a slight improvement. A positive surprise here would add to the sense that European economies are picking up momentum and could further fuel the dollar sell off. UK inflation out Wednesday will round up the week.

USD

The massive relief rally in financial markets caused by a very mild downward surprise in the April inflation report confirms to us that fears were running very high, and that speculators and traders remain quite long the US dollar. While the headline number was lower than expected, the more important core subindex was not, and services inflation is still running hot at above 5%.

However, there will now be a lull in data out of the US, with nothing really market moving on tap this week, so we would expect the US dollar to continue to grind lower as the overhang of long positions gets liquidated.

EUR

Communications from the ECB make it increasingly clear that while a June cut has been committed to and is inevitable, any moves beyond that remain highly uncertain and data dependent. Markets seem to expect either one or at most two additional cuts this year, which sounds quite reasonable to us, especially as the Eurozone economy picks up momentum and diminishes the urgency of monetary relief.

Over the medium term, we think that euro undervaluation, resilient domestic demand and a Chinese recovery remain tailwinds for the common currency.

GBP

The May meeting of the Monetary Policy Committee essentially left the question on whether to cut in June open. It will depend on the two months’ worth of data between now and the meeting, particularly inflation, of course. The first such data point comes out this week. The consensus is for another large, though base-effect driven, drop in the annual data both on the headline and the core indices, which would open the way for a June move. This data will be followed on the next day by the advance PMI indices of activity for May. The number is expected to be strong but should have less impact on sterling trading.