"We have passed the recent meetings of RBA, ECB, and Fed, and now we can look forward to upcoming events such as the release of US inflation data, significant loan and trade figures from China, and the Bank of England meeting."
The upcoming week will likely see deadlocked talks between Democrats and Republicans over the debt ceiling, which could have catastrophic consequences for the global economy. Traders will also be keeping an eye on key economic data, such as AUD wage and employment data, EUR quarterly employment and growth data, and JPY CPI, GDP, and trade data. In addition, there will be US retail sales, industrial production, and regional business sentiment reports to consider.
The Dollar had its best week of the year, rising against all G10 currencies and appreciating against most emerging market currencies. This seems to be a technical correction rather than a genuine belief that the US will default, though the dysfunctional appearance weighs on sentiment.
The market is pricing in aggressive rate cuts, but this requires significant development to force the Fed to reverse itself.
On technical grounds, the dollar looked oversold, but there is a fundamental narrative that may help frame the correction. The risks to growth are on the downside, with less momentum going into Q2. Despite underlying drags, corrective technical forces could lift the Dollar Index further, and overcoming initial resistance around 103.00 could signal gains towards 103.50-104.00.
The industrial production data for March in Germany and France were reported as terrible with both countries experiencing declines of -3.4% and -1.1%, respectively. Italy's figures also disappointed as it fell by 0.6% instead of the expected 0.3% rise. The only positive result came from Spain, which had a better-than-expected reading of 1.5%. However, this was not enough to offset the overall weakness in the eurozone. These reports will be used to revise Q1 GDP figures, which were initially estimated at 0.1% quarter-over-quarter. The preliminary estimate suggested that the German economy had stagnated, but weak retail sales, exports, and industrial production numbers indicate that the eurozone's largest economy may have contracted, leading to a potential downward revision of the aggregate figure.
Furthermore, the May Sentix survey showed weakness, and the poor news stream warns of further weakness in the ZEW survey. The European economy is now facing stark economic resurfacing, and it is further behind inflation than the US. In April 2022, eurozone inflation was 7.0% higher than a year ago, and in April 2023, CPI had risen 7.5% over the previous 12 months. In contrast, the US CPI stood at 8.3% in April 2022 and was at 4.9% in April 2023.
The euro had peaked just under $1.11 in late April, but the momentum indicators did not confirm the new highs. However, a "buy on dips" strategy gave the single currency resilience until last week when it closed below its 20-day moving average, and the five-day moving average fell below the 20-day moving average for the first time since mid-March. The euro was pushed through support in the $1.0880-$1.0900 area and settled at session lows, around $1.0850. The next chart support is near $1.08 and then $1.0740. A move back above the $1.0940-$1.0950 area would help stabilize the technical tone.
Japan: On May 17, Japan, the world's third-largest economy, is set to release its first estimate of Q1 GDP. According to a Bloomberg survey, the median forecast is for a 0.2% quarter-over-quarter expansion (equivalent to an annualized rate of 0.8%), following a flat Q4 22. Net exports are expected to have reduced growth by half (-0.2%), while inventory accumulation may have contributed 0.1 percentage point to growth. Consumption is anticipated to have been the main driver of growth, rising 0.4%, while business investment has been weak and is likely to have offset the consumption increase. Additionally, the GDP deflator is expected to be at 1.8%, up from 1.2% in Q4 22. On May 18, Japan's April trade balance will be published, which typically worsens from March. In March, the trade deficit was JPY755 billion (~$5.6 billion), and it averaged JPY1.73 trillion in Q1 23 and JPY1.13 trillion in Q1 22. The Tokyo CPI report, which was released at the end of April, has already overshadowed most of the thunder for the April national CPI. In March, the national headline and core CPI (excluding fresh food) were at 3.2% and 3.1%, respectively, 0.1% below the Tokyo readings. In Tokyo, the measure that excludes fresh food and energy was at 3.4%, which increased to 3.8% in April. The risk is that the national figure comes in higher still, which may bolster ideas that the BOJ will adjust policy as early as next month.
The US dollar has been trading between JPY133.75 and JPY135.75 over the last week, settling on the highs, which were the best in seven sessions. For the past three months, the dollar has traded in a roughly JPY130-JPY137.50 range, and it appears that it may persist for a bit longer. The greenback is expected to test the JPY136.00-15 area, with constructive momentum indicators, and near-term potential may extend toward JPY137.00, where the 200-day moving average is found. The five-day moving average (~JPY135) approached the 20-day moving average (~JPY134.80) but has remained above it since April 11.
GBP: Last week, the Bank of England increased the base rate to 4.50% amidst double-digit inflation, making it unlikely for them to pause anytime soon. This brings the cumulative move to 440 basis points. The swaps market predicts a terminal rate between 4.75% and 5.0%. The central bank's reaction function is dependent on important labour market data points, which will be revealed in the upcoming May 16 labour market report. Despite its 1.5% loss last week, the pound remains the strongest G10 currency this year, up approximately 3.0%. It recently reached its highest level since June 2022, nearing $1.2680, before profit-taking kicked in. It experienced its largest drop in three months, snapping a three-week advance, and finished the week below the 20-day moving average (~$1.2505) for the first time in almost a month. It may find support at the top of a band extending to $1.24. While the euro and Dollar Index's five-day moving averages have fallen below the 20-day, the pound's has not, but the technical tone is weakening. Given its significant rally since mid-March, the pound could fall towards $1.2350, even under a shallow correction.
The Bank of Canada announced a conditional pause in January, and while growth at the start of the year was stronger than expected, the bank is confident that the economy will slow down later this year. The April CPI report will be released on May 16, and Governor Macklem has stated that the Bank of Canada could raise rates if necessary to bring inflation down. However, the market views a rate hike as highly unlikely and is fully pricing in a quarter point cut from current levels later in the year. Inflation is expected to peak in June 2022 at 8.1%, but the base effect from Q2 22 suggests there is scope for a further decline. Assuming a conservative monthly increase of 0.4% in Q2, the CPI could be close to 3% by mid-year. The second half of the year could be more challenging, with Canada's CPI falling slightly in Q3 22 and rising by less than 1% at an annualized rate in Q4 22. In Q1 23, Canada's CPI rose at an annualized rate of about 5.6%. The trimmed and median core rates have been sticky, but the pace of slowing has accelerated in recent months. March retail sales are expected to be soft, but they need to be considered in the context of the 1.6% surge in January.
The US dollar hit a low for the month at the start of last week, just above CAD1.3300, but rebounded to CAD1.3565 by the end of the week. It has surpassed the (61.8%) retracement target of its losses from the April 28 high. From a technical perspective, there is little preventing a return to the CAD1.3650-70 highs seen earlier this month, and even the CAD1.3700-30 area. The momentum indicators are mixed, but sentiment toward the Canadian dollar is soft in the absence of a bullish hook. Although the Canadian dollar declined 1.30% last week, it performed better than the Australian dollar and the New Zealand dollar, suggesting that it might not be about the Canadian dollar, but the US dollar.
Australia's central bank recently raised interest rates, pushing the Australian dollar to the upper end of its trading range. The futures market predicts that the bank will maintain its current stance. Australia's strong Q1 jobs report could impact expectations. The Aussie may test the lower end of its range after being rejected at the upper end. Although momentum indicators are turning lower, the next big move is expected to be higher, but a downside break is not ruled out.
The week ahead (key events and themes):
Turkey’s election, read our forecast
US debt ceiling talks
China data dump
US retail sales
Eurozone GDP, employment, inflation and ZEW sentiment
RBA minutes, Australian wage data and employment report