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30.05.24 Daily Report

Published 30/05/2024, 05:40 pm

FX Moves

The bond market remained the centre of attention in markets again yesterday as rate cut bets continued to be slashed, driven by beats in Australian and German inflation data, while yet another round of Treasury auctions received poor demand. The continued rally in yields weighed heavily on risk appetite, leading US equity benchmarks to drop in the region of 0.5-1% and the dollar to receive a traditional risk-off bid. However, we suspect this isn’t the start of a new trend similar to the duration sell-off in 3Q24 as longer-term interest rate expectations in the US are relatively well anchored this time around. Instead, technical factors are seemingly in the driving seat. This was on full display yesterday as the only economic development in the US was actually dovish at the margin. The Fed’s beige book of regional contacts reported that the US economy expanded at a “slight or modest” pace since early April, with retail spending reported as weakening due to lower discretionary spending and this limiting the extent to which firms could raise prices. This doesn’t necessarily align with higher longer-term interest rate expectations.
With the outcome of tomorrow’s PCE report broadly known in advance, especially in terms of inflation due to more timely CPI and PPI data already at hand, we suspect there will be a limit to the extent US Treasuries sell-off this week and yields consequently rise. This should put a ceiling on the broad dollar, which has been the case this morning. A solid JGB auction overnight has put a halt to the rise in Japanese yields, which earlier in the week had hit heights last seen in 2011 and contributed to the broader bond sell-off, while there are reports that some traders are trimming short JPY positions as the pair approached levels that triggered Bank of Japan intervention towards the end of April/ start of May. Despite the better session in bond markets, however, equity futures continue to trade in the red, suggesting that we haven’t fully returned to the soft landing environment markets found themselves trading in at the beginning of the week. This has seen CHF similarly catch a bid with JPY, while the dollar also gains ground against the rest of the G10 currency board as traders broadly de-risk portfolios.
Today, we will get the second reading of US Q1 GDP, which is expected to be revised down 0.3pp to 1.3% annualised on the back of personal consumption. If realised, we suspect this will contribute to the decline in Treasury yields once again, but whether this takes some of the wind out of the dollar’s sails is dependent on the equity market reaction. In terms of Fed speakers, today will see Atlanta Fed President Bostic, NY Fed President Williams, and Dallas Fed President Logan speak. Only Bostic and Williams have voting rights this year.

The one standout currency move so far this morning has been the South African rand, down almost 1.3% against the dollar so far this morning. This move lower for ZAR comes as estimated results from the elections for the national assembly, held yesterday, begin to trickle through. Perhaps most significantly, it now looks clear that the ANC is set to lose its legislative majority for the first time since multi-racial elections were first held in 1994. Preliminary model estimates suggest that the ANC is only set to secure 41.5% of the vote. If realised, not only would this take the prospect of meaningful reform and stable government off the table, an outcome that we had viewed as likely to be ZAR positive, but if the ANC does lose its majority, then a period of fractious coalition negotiations lies ahead. The next best outcome under this scenario would likely be an ANC-DA coalition, an outcome we expect would see much of the current ZAR selloff reverse. That said, the risk of a populist coalition between the ANC and either the MK or EFF parties remains a notable risk for markets, with the prospect of such a government almost certain to be deeply negative for the rand. Given this balance of risks and the associated uncertainty, the rand is naturally trading under pressure as the initial results come through, a trend that we expect will continue until any likely governing coalition emerges, if the early polling data is confirmed as accurate.

Headline inflation in Germany printed in line with expectations yesterday, although the EU harmonised index printed above expectations at 2.8%. While the reacceleration in services inflation will give ECB hawks yet another basis to argue against back-to-back cuts this summer, we think the debate hasn’t been completely settled. After all, the acceleration in services inflation was well telegraphed seeing as the €49 train ticket has now expired, fuelling an increase in transport services. Arguably more important for policymakers is the data out of Spain this morning, which showed headline inflation rising from 3.3% to 3.6% in May, but undershooting expectations of 3.7%. Notably, however, was the increase in core inflation pressures from 2.9% to 3%. While this met expectations, it adds to the risk of an overshoot in the eurozone core measure tomorrow.
The impact on the currency was negligible, however. Bond markets are seemingly dancing to their own beat at the moment, and the inflation data is having little effect on overall easing expectations for the ECB. Set against a more hawkish Fed backdrop and a weaker equity environment, this has provided little support for the euro, which has sunk back below the 1.08 handle this morning.

While yesterday’s risk off move across markets saw sterling slide half a percent against the dollar, the pound nevertheless outperformed amongst G10 FX, with only the Swiss franc, the Japanese yen and the New Zealand dollar posting better returns. This is in keeping with our current view on sterling. A light data calendar offers little impetus for the pound in either direction. Similarly, with an election campaign underway, the BoE has suspended all public events, meaning that central bank speak has also become a non-factor for GBP traders. All that remains is the election campaign itself as a sterling driver, but as we have noted previously, we think the polls are in the sweet spot for sterling. The prospect of a moderate Labour government with a large stable majority should offer upside support for the pound, and as a result see sterling outperforming heading towards July 4th, even as intraday moves for the pound remain dominated by external developments.

Like much of the G10 FX complex, the loonie suffered at the hand of a resurgent dollar on Wednesday. USDCAD eased just over half a percent as a risk off tone gripped markets, with the associated move lower for both oil and equities compounding the downside pressure. Looking forward, we doubt that this pattern is set to change either. While the focus for the week remains tomorrow's Q1 GDP reading, today brings with it SEPH payroll employment change data for March as a warm up event for loonie traders. Given our view on the Canadian economy, that growth remains weak and the labour market is soft, our bias is to expect another disappointing print, with the readings having previously delivered a -17.7k print in February. Other more timely indicators would suggest that this is likely  too. The net employment reading for March fell by -2.2k, while the unemployment reading jumped from 5.8% to 6.1% in the same month. All told, this leaves risks skewed towards another negative reading in our eyes, an eventuality that should see further acceleration of BoC easing bets and more loonie underperformance again today, if these expectations are realised.

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