Markets were mostly closed last night for northern hemisphere holidays so not much in the way of price moves to report. Westpac has the data wrap:
Event Wrap
German CPI inflation rose 2.4% y/y in May -above the 2.3% expected and the highest level since 2018. Reopening and goods shortages were the main factors.
Event Outlook
Australia: Strength in the Corelogic home value index has carried into May, with the daily index pointing to another big 2.2% gain nationally, Sydney tracking towards a 3% rise. We expect dwelling approvals to show a 10% drop in April, as the boost from the HomeBuilder scheme unwinds.
Alongside this, we will get a raft of Q1 GDP partials. Firstly, on Q1 company profits, we’re forecasting a lift of 3.5%; this increase will come at a slower pace than sales revenue – with government support continuing to moderate. Inventories are forecast to rise by 1.0%, up by $1.6bn, to still be some $6bn below the level at the end of 2019. Such an outcome would see inventories add 0.3ppts to activity in Q1 (subject to revisions). For the 2020 year, net exports subtracted 0.8ppts, including a 2.1ppts drag over the second half of the year. The March quarter 2021 has seen a further sizeable subtraction – we estimate in the order of -1.1ppts. The current account surplus is forecast to widen from $14.5bn in Q4 to $21bn in Q1, representing around 3.6% of GDP – making history, this will be the 8th consecutive quarterly current account surplus.
Finally, The Reserve Bank Board will announce its June policy decision. The minutes of the May meeting confirmed that the Board will decide on the next stage of its Yield Curve Control and Quantitative Easing policies at its July meeting. As such, the June meeting will be one of ‘marking time’ and discussing the recent run of data.
New Zealand: We expect that monthly residential building consents will ease by 7.5% in April. That’s due to an expected pullback in the ‘lumpy’ apartment category after last month’s strong rise. But underlying this is a picture of very solid demand in the residential construction sector. We expect that annual consent issuance will breach fresh record highs in April. The GlobalDairyTrade auction should show prices treading water at elevated levels (WBC f/c: 0.0%)
China: We will be looking for signs of supply disruptions in the May Caixin manufacturing PMI, but sentiment should remain upbeat (market f/c: 52.0).
Euro Area: The unemployment rate is expected to hold at 8.1% in April; the relative health of the labour market bodes well for the H2 economic recovery. The May CPI is set to print around 1.9% per year, and while the figure is inflated by base effects, the underlying pace is still muted.
US: A 0.6% rise in April construction spending is likely to be driven almost entirely by the residential sector. The May ISM manufacturing survey is expected to recover some of the ground lost in April, when new orders and output moderated from elevated levels (market f/c: 61.0). The May Dallas Fed Index is expected to hold around 36.5; prices paid have surged ahead in recent prints. The FOMC’s Quarles and Brainard
will speak.
Inflation remains the topic de jour and on that and its impact upon forex I give you Mizuho:
With the incoming economic data so volatile, we forecast that the Fed will push back the start of formal discussions about a monetary easing taper beyond June or August. The earliest an actual taper could begin would be Apr–Jun 2022 and the first rate increase would be in 2024, as indicated by the FOMC dot chart published in March. Assuming the Fed does maintain its current accommodative settings for the time being, we would expect the 10y US Treasury yield to trade in a narrow range of 1.50–1.75%, pending developments in the autumn (particularly with regards to inflation). The USD/JPY has settled around JPY108, firmly within the recently formed range ofJPY100–110.
The risk of a weaker dollar grows as inflation picks up
Let’s do some mental gymnastics around that: what if these dovish forecasts are wide of the mark and higher inflation proves to be a sustained trend rather than a blip. In that event, central bankers would be forced into snap decisions to avert a surge in inflation expectations. We regard this as an extremely small risk but let’s consider how it would affect bond yields and the USD/JPY. We expect that the Fed would move first to get out in front of the markets by announcing that it would adapt policy to this change in circumstances. That could include a decision to go straight to a rate hike, rather than follow the usual process of starting to discuss a taper, giving fair warnings, then implementing and completing it. The most likely move, in our view, would be to raise its policy rate by 50–100bp, rather than the conventional 25bp. Would such a move prompt investors to buy dollars, given such a decisive move in the yield gap? Theory says yes, if that theory consists solely of focusing on the widening gap between American and Japanese bond yields. In practice, we think it would not.
Economies and markets are dynamic things. A sudden rise in central bank and market interest rates would probably bring the US economy to its knees. That said, consumer prices are a lagging indicator of the business cycle. The moment the Fed announces that it regards the CPI as a key policy input, it would position itself as a follower of the economy because it would have admitted that it is driving monetary policy via the back mirror rather than looking ahead. Another key consideration is that a sharp rise in interest rates would probably cause the stock market to plunge. The Fed would not be allowed to sit back and watch while this happened, given that share prices area leading indicator of the economy, have a major impact on how positive businesses and consumers are about the future, and are closely watched by the political world. The idea of successive rate hikes to keep inflation under control, while balancing the risk of stagflation, may be fine as armchair theory but has next to no chance of being developed as a matter of actual policy. If the Fed were to spring a surprise rate hike, with the almost inevitable damage that would cause to the economy, we would expect the Treasury yield curve to invert. It is hard to know which section of the curve the currency market would look at when assessing the US-Japan yield gap. It is easier to predict that the financial markets as a whole would turn heavily risk-off, on the view that the days of tepid monetary easing had been brought to a sudden end. We would expect investors to flock to safe-haven currencies: the dollar, the yen, and the Swiss franc. In this scenario, we would not expect buying to concentrate on either the dollar or the yen to the detriment of the other. However, it is entirely possible that the yen would appreciate sharply if a US stock market plunge reduced funds’ capacity for risk and forced them into a major unwinding of carry trade positions that involve yen selling. Given all this, we conclude that it would be highly risky to trade purely on the simplistic idea of the dollar being a buy if US long-term bond yields rise on inflation fears.
Perhaps. But maybe that’s just overthinking it. If there is a sustained inflation breakout in the US such that the Fed hikes early then DXY will go straight up as markets go straight down. Sometimes you only need two-dimensional chess to know what’s coming.
That said, I think this is highly unlikely. More probable is that as China slows ahead and commodity prices tumble, the entire supply-side bottleneck inflation pulse globally is going to reverse in 2022.
The more interesting question, therefore, is what will the Fed do if it’s not only proven right about temporary inflation but inflation undershoots even its dovish outlook. This:
- Fed on hold for longer.
- Long bond yields tumble.
- Stocks fall initially on profits growth fears and to remind the Fed that it needs to ease more.
- Then growth factor overtakes value in the rebound.
- DXY spikes then falls and AUD falls anyway with commodities.
