FX Moves
USD
As noted yesterday, after weeks in which markets have been dictated by dollar dynamics, local factors have once again taken centre stage. This has resulted in outsized moves in CAD, NZD and GBP in the past 24 hours in what has otherwise been a relatively uneventful period for markets. In Canada, further disinflation progress boosted the odds that the BoC cuts next month as per our base case, leading the loonie to trade a third of a percent lower on the day. In contrast, rate expectations have become more hawkish overnight in New Zealand and the UK. In the former, the latest Reserve Bank of New Zealand meeting saw rates held at 5.5% as widely expected, but the accompanying guidance strike a notably hawkish tone. RBNZ staff not only revised up their projected OCR path for this year from 5.6% to 5.65% to show a building risk of a future hike, but compounded this in the formal summary of the meeting where it was noted that a rate hike was actively discussed at this week’s meeting. This was confirmed by Governor Orr in the subsequent press conference, with the Governor stating that this option was a “real consideration”. Turning to the UK, it was the penultimate inflation report before the BoE’s next meeting in June that dealt a blow to expectations of earlier easing, with all aggregate inflation measures overshooting economist and BoE expectations. As we noted in our preview, there was considerable uncertainty around today’s release, especially because of the potential effects pertaining to the National Living Wage hike. This was seemingly confirmed with most of the inflation strength occurring in wage sensitive categories. This has led both NZD and GBP to trade higher against a relatively flat broad dollar, with gains reaching 0.4% and 0.33% respectively.
With regards to the latest developments, they have largely reinforced our medium-term calls. That is, we continue to like sterling on crosses against European counterparts on the basis of later monetary sequencing, while structural supply constraints in Australia and New Zealand support our medium-term bullish view on the Antipodes, especially as the external rates environment is becoming more accommodative. Moreover, despite yesterday’s dovish reaction in Canadian rates, we still think markets are underpricing the extent to which the BoC will cut this year. If this becomes apparent at the Bank’s meeting next month and coincides with a softer but still strong US payrolls report two days after, USDCAD could break back into the 1.38 region.
That said, while this morning’s European open has provided some excitement, there is little else planned for the day to maintain current levels of volatility. This evening’s release of the Fed’s May meeting minutes are likely to be stale upon arrival given both the payrolls and CPI report have shown a subsequent cooling in the US economy, negating some of the concerns policymakers had back in early May over inflation persistence. Moreover, the message from the majority of central bank speakers set to hit the wires today are already known, meaning the rest of today should make for plain sailing.
GBP
This morning’s inflation numbers put a big dent in the odds of a June rate cut from the BoE. While headline inflation eased notably, falling from 3.2% in March to 2.3% in April, all major inflation readings overshot consensus expectations. This was most notable for services inflation which was a focus for the BoE at the May policy meeting. Bank staff had predicted that this would fall to 5.5% YoY in April, markets expected a reading of 5.4%. Instead, the reading barely budged, easing just 0.1pp to 5.9% YoY. Moreover, with much of this unexpected resilience appearing to stem from wage sensitive components, this will be particularly troubling for the MPC, especially given the uncertain impact of the April 1st rise in the National Living Wage. As an example, while price growth for recreation and culture as a whole eased by 0.9pp in April on an annual basis, recreation and cultural services inflation jumped, with prices rising from 5.1% to 7.1% YoY. As we noted in advance of the release, recent BoE communications appeared to imply that a series of on or below forecast prints between now and the June meeting would be sufficient to start cutting rates. This morning’s overshoot kills that narrative, a fact that is being reflected in market pricing. The implied odds of a June rate cut have fallen from close to a coin toss to just 14%.The widening of rate expectations in sterling’s favour has seen the pound bounce in early trading with both GBPUSD and GBPEUR up 0.3% so far this morning.
EUR
Yesterday was a notably quiet day for those tracking EURUSD, with the currency pair trading in just a 0.3% range on the day. While President Lagarde did hit the wires to reiterate her confidence that the ECB can cut rates in their June meeting, this did little to settle the debate over July, which based on market pricing is currently being won by the hawks within the Governing Council (~20% prob of a second cut). Whether or not this still stands will depend on Thursday’s flash PMI reports and the crucial Q1 negotiated wage data. Should the data show further signs of disinflation progress, we suspect the probability of a second rate cut in summer will materially increase, especially if this coincides with signs of a renewed slowdown in economic activity. With this event risk on the close horizon, we expect today to be another quiet session in markets, even with President Lagarde set to speak again at 09:05 BST.
CAD
April’s inflation data showed further signs of disinflationary progress in Canada, with all major inflation aggregates now well within the Bank of Canada’s 1-3% tolerance band. Of what inflation there was in the past month largely came from gasoline and shelter components, which most core measures strip out to varying degrees. Seeing as Governor Macklem hailed the disinflationary progress made since the turn of the year but stated that policymakers need further evidence this can be sustained back at April’s meeting, the two subsequently softer inflation reports leads us to think that the Bank’s confidence threshold has now been met. While an argument can be made that the recent strength in job growth and the partial acceleration in growth provides the BoC with scope to wait until July to cut, we think in the broader context of an economy already operating below capacity that such a stance is merely delaying the inevitable and puts the Bank at risk of undershooting its inflation target. Moreover, it poses a communications challenge for Governor Macklem and co seeing as the Bank previously conditioned easing on sustained disinflation, which has been visible since.
While markets began to converge on our forecast for the BoC’s policy rate this year, pricing in more than a 50% chance of a cut next month and just shy of three rate cuts this year, we think markets continue to underestimate the degree of policy loosening that is likely over the coming quarters. We think this is a result of traders’ reluctance to price a considerably diverging path for the BoC from the Fed. But given Governor Macklem stated earlier in the month that rate differentials aren’t at the levels that concerns them, we think there remains scope for a further dovish reassessment on Canadian rates and continue to favour bearish CAD expressions.