So says Goldman.
USD: Divergence ready to go if only the data would say so. In a relatively quiet week for the US, foreign central banks, especially in the G10, played their part and demonstrated a willingness to diverge from the Fed. The Riksbank cut rates and declared succinctly that “when inflation approaches the target while economic activity is weak, monetary policy can be eased.” BoE Governor Bailey repeatedly stressed that he faces a different set of circumstances than the policymakers on the FOMC, and there is “no law which says that the Fed must move first.”
Elsewhere, the picture was more mixed. In Japan, last week’s policy fireworks have dimmed, although the rhetoric sounds firmer. In EM, COPOM’s dovish vote split signaled that the leadership transition might bring more aggressive policy steps, even as the pace of cuts was reduced, and the Banxico stayed on hold after cutting last meeting. While the speeds vary slightly depending on domestic circumstances, policymakers in Europe seem ready to join their EM counterparts and begin dialing back the degree of restriction. That should keep the Dollar stronger for longer.
The issue is US data have also softened somewhat, at least relative to lofty expectations. That matters in part because Chair Powell last week made it clear there is a second route to rate cuts beyond spot inflation prints —a weakening labor market.
The weaker US data therefore puts a limit on the extent to which the “divergence trade” can be priced right now in policy-sensitive crosses like EUR/USD. This policy backstop (and further signs of improvement in RoW activity) should continue to present a positive environment for risk, with fairly wide guide rails, and in turn support cyclicals and carry, especially if next week’s CPI report delivers the inflation relief our economists expect to finally come.
But we still prefer funding those expressions out of EUR, JPY and other low-yielders rather than USD. With markets now pricing close to our modal Fed forecast, the risks into next week’s important print look a bit more balanced.
We are not particularly concerned that recent data disappointments portend something more worrying than some slowdown from the FCI-driven boost in Q1, and we are still wary that a policy-driven repricing from sticky inflation could cause more disruptive and broad-based Dollar strength.
With policymakers in the rest of the world dealing with a very different activity and inflation mix, more substantial Dollar downside seems unlikely.
But, data will dictate whether divergence can really drive the Dollar much higher. For now, the market reaction to small, low-quality misses demonstrates there is a high bar to beat elevated expectations.
I am a little bullish AUD until the local ABS data catches down to the reality of the buggered economy, most notably the labour market and wages.
But, like Goldman, I am not expecting fireworks.
