FX Weekly Update – April 15th, 2024

Posted Under: Weekly updates

Happy Patriots Day if you up here in New England.

Highlights:

  • Dollar outperforms as strong US inflation report delays expected timing of Fed cuts.
  • Middle East tensions fuel safe-haven flows as Iran launches missile attack on Israel.
  • ECB hints at June interest rate cut. UK economy grows in February, easing recession fears.
  • JPY sinks to fresh three decade lows. RBNZ and BoC keep interest rates unchanged.

The March CPI inflation report delivered yet another nasty surprise for the Federal Reserve, coming in above expectations and confirming that the disinflationary trend of 2023 has completely stalled, and perhaps even partially reversed.

Treasury yields spiked, traders pushed back expectations of cuts and the dollar soared against every major currency worldwide. On the back of this move appears to be the possibility that inflation and policy in the US will diverge from those of other major economies. Jitters about the Middle East conflict only added fuel to the fire. Particularly hard hit were European currencies, as rising commodity prices mean worsening terms of trade.

We go now into an unusually quiet week in terms of data or policy. CPI reports out of the UK (Wednesday) and Japan (Thursday) will provide the main references, as will a spate of ECB and Federal Reserve speeches throughout the week. We expect markets to mostly continue dealing with the aftermath of the CPI report and the possibility that Federal Reserve cuts will be delayed well into year end.

An economy in full employment, with rates barely above inflation, and a massive fiscal deficit, will not be particularly conducive to interest rate cuts, and markets have gone from pricing six cuts in 2024 a few weeks ago to less than two now. This has led to a repricing of rates across the curve and strengthening of the US dollar against almost every other currency. This week, Federal Reserve official speeches will be crucial to gauge the extent to which the Fed’s views justify this dramatic repricing.

EUR: As expected, the April meeting of the ECB resulted in no change in monetary policy, but the telegraphing of an interest rate cut in June. In case the message from the meeting had not been sufficiently clear, ECB ‘sources’ were confirming this was the case immediately after the meeting. Specific mention was made at the meeting by President Lagarde of the divergence in inflation pressures that would enable the ECB to cut before the Fed does.

We think that the six month lag in inflation data between the Eurozone and the US means that it may be premature for the central bank to declare victory over inflation, but nevertheless the June cut is on track. The key question is now the speed at which subsequent cuts will take place. Lagarde made no mention of this last week, although the ‘sources’ did hint at a pause in July, suggesting that cuts at every other meeting are probably a safe bet.

GBP: A positive monthly GDP report triggered optimism that the UK economy will continue to outperform gloomy expectations. The UK economy expanded by a modest 0.1% MoM in February, in line with consensus, although there was a welcome upward revision to the January data to +0.3% from the initial +0.2% estimate. This likely ensures that last year’s technical recession was both shallow and short, barring a sharp contraction in output in March.

Sterling, however, was caught in the general sell-off against the US dollar, though it managed to outperform the euro modestly. This week will be key for the timing of Bank of England rate cuts, expectations for which have so far been delayed almost as much as those for the Federal Reserve. Wage information on Tuesday, and inflation on Wednesday, will be key to see if the disinflationary process in the UK continues or whether it begins to stagnate as it has in the US.

JPY: The yen outperformed most of its major peers last week, as concerns surrounding rising tensions in the Middle East fuelled investor flows into the safe-havens. However, the USD/JPY pair still rose to fresh highs, extending those advances during Asian trading this morning, with the Japanese currency currently trading at its lowest level in more than three decades. At around the 154 level to the dollar, this puts the pair just shy of the mark at which analysts expect authorities to step in by intervening in the FX market to prop up the yen.

Both finance minister Suzuki and Bank of Japan governor Ueda are down to attend the G20 meeting this week, with investors to be watching closely for any remarks that would indicate direct FX intervention is near. While intervention could put a temporary floor under the yen, communications that would hint at further rate hikes will likely to be needed to trigger a more sustained rally.

CAD: The Bank of Canada firmly kept the door open to a June interest rate cut following its policy meeting last week. In the statement, the bank said that inflationary pressures were ‘easing’, having previously characterised them as ‘persistent’. This year’s inflation forecast was revised lower, with the BoC saying that wage pressures were ‘moderating’. Governor Macklem reinforced this narrative during his press conference, saying that the bank was ‘seeing what it needs to see’ to be more confident on progress towards price stability.

While the above shift in rhetoric means that the June meeting is a ‘live’ one, the broad repricing in rates and Middle East concerns ensures that it is now less than 50% priced in by swap markets. Tuesday’s inflation report for March will be highly important in this regard. A rebound in monthly inflation is expected that, if confirmed, may further dampen expectations for a June rate reduction.

CNY: The Chinese yuan weathered the storm of a broadly stronger US dollar, outperforming most of its peers and ending the week nearly unchanged against the greenback. This was despite domestic economic data raising concerns about the country’s economic performance. CPI inflation came in at just over 0% in March, much lower than expected. Credit and trade data were also disappointingly weak.

This week will be a test for these reignited concerns, with macro data set to remain front and centre. Tuesday will see the release of first-quarter GDP growth as well as a bundle of key March data. At this point, the picture looks blurry, with cautious optimism following earlier releases giving way to concerns after last week’s data. The calls to address those concerns with more policy easing have thus far have fallen on deaf ears, with today’s PBoC decision to drain liquidity via MLF for the second time in a row suggesting the central bank has become more cautious in the face of depreciation pressures on the yuan.