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USD: Three drivers of rate expectations
FX liquidity was reduced yesterday due to a national holiday in the UK, and while major pairs did not move dramatically, we saw quite significant gains in some G10 commodity currencies: NZD, NOK and AUD. Driving the move was the rebound in oil prices from the March bottom after Canada’s wildfires generated supply disruptions. This morning, some weaker-than-expected import data (-7.9% year-on-year) out of China seem to be softening the tone for the commodity space and maintaining a not-so-constructive picture on the demand side. Still, exports (+8.5 YoY) and the trade balance (US$90.2bn) beat expectations.
This will be a rather crucial week for markets to fine-tune their Fed rate expectations after Chair Jerome Powell seemed to trade the explicit openness to a pause in tightening with some pushback against rate cut speculation last week. There are currently 68bp of easing priced into the USD curve by year-end, with three drivers set to influence further swings: US banking developments, data and Fedspeak.
While data would intuitively be the most important driver, the now well-established link between the depth/length of banking turmoil and economic downturn is keeping a forward-looking market highly sensitive to incoming news, despite the Fed’s more resolute attempts to provide an anchor to rate expectations. A report published by the Fed yesterday flagged increasing concerns about credit tightening by financial institutions, which can only worsen as the turmoil continues.
This week’s calendar includes the release of US inflation for the month of April, which is expected to have steadied at 5.0% while the core rate may have slowed from 5.6% to 5.5%. So far, data are the missing bit in the market’s dovish rhetoric, with last week’s payrolls beating estimates, both on the headline numbers and on wage growth. Today, the NFIB survey will be in focus. In terms of Fed speakers, we’ll hear Philip Jefferson and John Williams today, and many others are lined up later this week.
While the short-term outlook for the dollar remains neutral in our view, thanks to positioning skewed to the short-side (more in the euro section) and unstable risk sentiment, markets remain ready to price in more Fed rate cuts, so downside risks are non-negligible. We favour a stabilisation around 101.50, but a drop below 101.00 and a test of 100.00 in DXY are tangible possibilities in the near term.
Francesco Pesole
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