USD on a modest downward trend since last evening, TWI down 0.2%; despite weak inflation data, the market is still pricing in an 84% chance of a Fed rate hike next month; German inflation slowed more than expected

By Jason Wong

There has been plenty of newsflow to digest but the low volatility environment has continued after the long weekend in the US and UK, with only modest price changes across equities, bonds and currency markets. 

The S&P500 has spent the session in negative territory so far, albeit is currently only down 0.1%, weighed down by the energy sector as oil prices remain soft.  Media reports have highlighted Amazon breaking through the $1000 mark for the first time.

The USD has been on a (modest) downward trend since last evening, with the major currency TWI index down about 0.2%.  US consumer confidence was weaker than expected, slipping off recent highs, while personal spending data were in line, confirming that Q2 will probably show a decent rebound in consumer spending after a soft Q1.  The annual core PCE deflator slipped to 1.5% y/y as expected, the weakest annual inflation in nearly eighteen months.

Despite inflation heading in the opposite direction to the Fed’s target, the market still has high conviction that the Fed will hike rates next month, with general agreement that some of the inflation weakness reflects one-off factors.  Our calculations suggest the market is pricing in about an 84% chance of a 25bps rate increase next month, but beyond June the outlook becomes murkier and the Fed funds curve only has a modest upward slope.  Fed Governor Brainard, a known dove and permanent voter noted in a speech that “if the soft inflation data persist, that would be concerning and, ultimately, could lead me to reassess the appropriate path of policy.” We think those thoughts are probably in line with much of the FOMC committee and further hikes beyond June will likely be dependent on inflation indicators recovering.

German inflation slowed by more than expected, increasing the probability that euro-area inflation data due tonight will also undershoot expectations.  EUR fell to a fresh low of 1.1110 after the report, but then found support.  After staging a recovery, it was boosted further after Reuters reported that ECB policymakers were set to upgrade their economic risk assessment at next week’s meeting.  EUR now sits 0.2% higher for the session at 1.1190.

The softer USD trend has been reflected in the NZD drifting higher since last evening and is close to its highs for the session at 0.71.  If we look at the currency leaderboard, the NZD sits at the top, with a 0.6% increase over the day.  There’s no particular reason for its outperformance and it follows the 2+% lift last week on all the crosses.  A closing of short positions might be a factor.  Despite our fair value estimate sitting around 0.75, we think that the NZD will find the going tougher, with 0.71 on the charts being an area of technical resistance.

The Yen is number two on the leaderboard, quite a feat considering UST yields are lower.  Japan’s labour market data got some attention yesterday, with some measures of labour market tightness like the job-to-applicant ratio at a multi-decade low and the unemployment rate sits at just 2.8%.  Real economic data have been fairly good in Japan of late, but inflation remains elusive, which suggests the BoJ will have to maintain its current policy stance of keeping rates close to zero.  USD/JPY is down 0.5% to 110.75, a reflection of both USD weakness and yen strength.

On currencies, there isn’t much else to report.  NZD/AUD is up through 0.95, even as AUD/USD has recovered to 0.7465.

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