Plenty of US data, but nothing to alter the dovish Fed tone
More hawkish UK MPC stance boosts GBP, but yield spreads don’t suggest gains will extend
ECB also still seen as dovish. CAD and NZD yields continue to suggest value
JPY weakness hard to justify fundamentally, but the downtrend continues
A fairly heavy US data calendar on Friday, with the PCE price index the main focus. We expect April’s core PCE price index to surge by 0.7%, not quite as strong as the 0.9% core CPI increase, but enough to lift yr/yr growth to 3.0% from 1.8%. We expect personal income to fall by 14.0% after March data inflated by stimulus payments, but see a 0.8% increase in personal spending. At the same time we expect a sharp increase in April’s advance goods trade deficit to a fresh record of $96.6bn, from $90.6bn in March. May Chicago PMI and final Michigan CSI data follow. The fact that the PCE price index has been preceded by the CPI makes it less likely to have an impact, but the market will be sensitive to any upside surprises. Our forecast is slightly above the market expectation of 0.6%, but probably not high enough to alter market perceptions of policy. As we have seen in the last week, the FX market is much more interested in central bankers’ projections of policy than the data which will inform their decisions, and while there are some on the FOMC who are talking about talking about tapering, as long as there is no indication of an H2 2022 rate hike along the lines of the indications from Canada, New Zealand and now the UK, it is hard to see a significant USD rally.
Thursday’s indication from UK MPC member Vlieghe that he saw the likelihood of a rate hike in 2022 boosted GBP on Thursday, helped by the fact that Vlieghe has in the past tended to be on the dovish side of the argument. Still, the market has only partly reversed the decline in rate expectations seen in the last couple of weeks, with the 2 year OIS up around 4bps on the day to 0.14%, still below the peak above 0.15% seen on May 13. This reflects the fact that UK rate expectations are influenced by the movements in the US and Eurozone, and the dovish stances and declining yields seen in the USD and EUR markets have being weighing on the UK market. GBP strength on Thursday was certainly spurred by the Vlieghe comments, but the expectation of the UK enacting relatively early tightening isn’t well reflected in yield spreads. While spreads moved slightly in the UK’s favour on Thursday, they have been drifting against GBP in the previous few weeks, so that the case for an interest rate spread related GBP rise looks quite weak. The market pricing suggests that the market doesn’t really buy the differences in timing between the first UK move and moves in the US and Eurozone, and it does seem odd that the UK appears to be planning an earlier hike when the UK economy remains some way behind the US and even behind the Eurozone in its recovery. With spreads as they are, it is hard to justify GBP strength from here, as the pound had been outperforming rate spreads ahead of Vlieghe’s comments, so unless we see the market fully embrace the idea of a UK rate hike in 2022 and push UK yields significantly higher, EUR/GBP looms unlikely to push far below 0.86.
In the Eurozone, we see French preliminary May CPI released at the beginning of the day on Friday, and although everyone is declaring that they will look through short term rises in inflation, the market may be sensitive to a significantly higher French number given the focus on the chances of a reduction in the pace of PEPP purchases. The market expects a 0.4% increase. We also have the EU Commission survey, but this is near certain to be strong after a strong PMI and INSEE and IFO surveys and strong Italian confidence numbers. This is nevertheless not enough to boost the EUR at this point, with the market now expecting no change in policy from the ECB, and very much favouring the currencies of the more hawkish central banks. While GBP was the star on Thursday, spreads suggest the CAD and NZD have more potential upside.
JPY weakness remains a surprising theme. It is no longer possible to justify it on the basis of rising yields, rising risk appetite or rising equities, and there is nothing particularly notable in Japanese portfolio flow data, so we are left just noting that it remains a strong trend that is seemingly continuing regardless of fundamental news. Wait for a technical signal for a break lower, but until then the trend is your friend.