Dollar Soft Despite Growing Risk Off Impulses

Fed officials remain hawkish; U.S. rates market is reflecting concerns about the economy; regional Fed manufacturing surveys for May will continue rolling out

ECB releases its account of the April meeting; U.K. CBI reported a firm May industrial trends survey; SARB is expected to hike rates 50 bp to 4.75%

Japan reported some key data; Australia reported mixed April jobs data; Philippines hiked rates 25 bp to 2.25%, as expected

The dollar is softer despite growing risk off impulses. DXY has given up yesterday's gains and is trading near 103.35. The euro is trading back above $1.05 and may test yesterday's high near $1.0565. USD/JPY is trading below 128 due to the return of risk off sentiment and is likely to test last week's low near 127.50 and the April 27 low near 127. Sterling is trading back above $1.24. Quite frankly, we are puzzled as to why the euro and sterling would be rallying during an intense period of risk off sentiment. We look for the dollar to gain some traction as sentiment worsens. Despite concerns about the economic outlook, we continue to believe that the U.S. is simply in much better shape than the eurozone, U.K., and Japan. While it may be tempting to say otherwise due to today's price action, we believe the dollar smile remains intact.

AMERICAS

Fed officials remain hawkish. Yesterday, Evans is signaling that the Fed will likely hike rates above neutral Specifically, he said that once the neutral rate is reached, "If we go 50 bp beyond that, if we go 75 bp beyond that, then that restrictive setting of policy should be working to bring inflation down." Evans added that "My own assessment of 'neutral' is in the 2.25-2.5% range." Harker also spoke and said "We don't want to overdo it. But we have to act and we are acting." He added that the US may have a few quarters of negative growth, but that is not what he is forecasting. Lastly, Harker said the Fed can engineer a "safe" if not "soft" landing for the economy. Last week, Fed officials were uniformly hawkish and we fully expected a similar tone this week, especially in light of the April inflation data. So far, the Fed has not disappointed.

Markets were already unnerved by Powell's "whatever it takes" moment from Tuesday and these latest comments simply added to the risk off impulses. NASDAQ fell nearly 5% yesterday, while the DJIA fell more than -3.5% and the S&P 500 fell more than -4%. Global equity markets are broadly lower today and U.S. equity futures point to a lower open of over -1%. We must stress again that there is no Powell Put. With the economy at full employment, the Fed's singular focus is on taming inflation. Equity markets cannot and will not be targeted by the Fed. Kashkari speaks today. WIRP suggests 50 bp hikes in June, July, and September will be followed by 25 bp hike in November, December, and most likely February, which would see the Fed Funds rate peak between 3.0-3.25%. The swaps market also sees a terminal Fed Funds rate between 3.0-3.25%. In light of high inflation and Powell's hawkish tone, we continue to believe that the terminal rate will be closer to 3.5% with risks to the upside if inflation proves to be even stickier than anticipated.

The U.S. rates market is reflecting concerns about the economy. While yields are down across the board from the cycle peaks earlier this month, the shape of the curve bears watching. The 5- to 10-year portion of the curve has inverted and the 3- to 10-year portion is closer to inverting. Recall that these portions of the curve inverted back in April before reversing with a burst of steepening. As always, we focus on the 3-month to 10-year curve. While it is down from the 231 bp peak from May 6, it is currently near 184 bp and nowhere near inverting. With the Fed about to embark on aggressive QT in June, we had expected the curve steepening to continue into Q3 before natural curve flattening from Fed rate hikes. We are not yet ready to call an end to the steepening trade. Lastly, we know some analysts are saying that rising U.S. recession risks will end the dollar's rally. While we agree with this call, we do not believe the U.S. is anywhere near recession in 2022. Stay tuned.

Regional Fed manufacturing surveys for May will continue rolling out. Philly Fed is expected at 15.0 vs. 17.6 in April. Earlier this week, Empire survey came in at -11.6 vs. 24.6 in April but this series has been very volatile of late. On the other hand, April IP came in at 1.1% % m/ vs. 0.9% in February. While the manufacturing sector continues to struggle with supply chain issues, we see underlying strength being maintained as we move towards H2. Weekly jobless claims, April existing homes sales (-2.2% m/m expected), and leading index (flat m/m expected) will also be reported. The initial claims data will be of interest as they will be for the BLS survey week containing the 12th of the month. Consensus sees 200k vs. 203k the previous week.

EUROPE/MIDDLE EAST/AFRICA

The ECB releases its account of the April meeting. The bank delivered a dovish surprise at the April 14 meeting but has since pivoted more hawkish. As such, expect the account to be evenly balanced between the hawks and the doves. Consensus at the Governing Council seems to be building for July liftoff, which remains fully priced in by the markets. However, the swaps market is pricing in 150 bp of tightening over the next 12 months followed by another 50 bp of tightening priced in over the following 12 months that would see the deposit rate peak near 1.50% vs. 1.75% at the start of last week. Guindos, de Cos, Verstager, and Holzmann speak today. Expect ECB officials to maintain the hawkish tone that's been established this past month. March eurozone current account and construction output data were reported. Of note, the current account deficit of -EUR1.6 bln was the first deficit since February 2012 and clearly reflects the impact of higher energy prices.

U.K. CBI reported a firm May industrial trends survey. Total orders came in at 26 vs. 12 expected and 14 in April, while selling prices came in at 75 vs. 70 expected and 71 in April. Of note, export orders rose to 19 vs. -9 in April and is the highest since January 2018. This is a rare bit of good news for the U.K. economy but we remain negative on the overall outlook. April U.K. retail sales will be reported tomorrow, with headline expected at -0.3% m/m vs. -1.4% in March and ex-auto fuel expected at -0.2% m/m vs. -1.1% in March. CBI reports its May distributive trades survey next Tuesday. Bank of England tightening expectations have stalled as the data have weakened. WIRP suggests another 25 bp hike is priced in for the next meeting June 16. Looking ahead, the swaps market is pricing in 150 bp of total tightening over the next 12 months that would see the policy rate peak near 2.50%, steady from the start of last week.

South African Reserve Bank is expected to hike rates 50 bp to 4.75%. However, a quarter of the 20 analysts polled by Bloomberg look for a 25 bp move. At the last meeting March 24, the vote to hike 25 bp was 3-2 with the two dissents in favor of a 50 bp move. The bank warned that inflation is likely to breach the 3-6% target range in Q2 and raised its 2022 inflation forecast to 5.8% vs. 4.9% previously. Its repo rate forecasts were tweaked modestly to 5.06% by end-2022 vs. 4.91% previously, 6.1% by end-2023 vs. 5.84% previously, and 6.68% by end-2024 vs. 6.55% previously. That is an even more aggressive rate path than we expected for a country that still has 35% unemployment and is struggling to grow.

ASIA

Japan reported some key data. April trade was reported, with exports coming in at 12.5% y/y vs. 13.9% expected and 14.7% in March and imports coming in at 28.2% y/y vs. 35.0% expected and 31.2% in March. Slowing exports reflect the slowing regional outlook, while slowing imports are a bit surprising given still-high energy costs. March core machine orders were also reported and came in at 7.1% m/m vs. 3.9% expected and -9.8% in February. The y/y rate rose to 7.6% y/y vs. 4.3% in February and was the strongest since November. However, weakness is likely to resume as machine tool orders rose 25.0% y/y in April, the slowest since January 2021. The Q2 outlook remains cloudy, underscoring policymakers' intent to maintain monetary and fiscal stimulus for the time being.

Australia reported mixed April jobs data. Only 4.0k jobs were added vs. 30.0k expected and a revised 20.5k (was 17.9k) in March. However, markets focused on the unemployment rate, which came in as expected at 3.9% vs. a revised 3.9% (was 4.0%) in March. the lowest in nearly 50 years. The RBA has warned that wage pressures are likely when unemployment falls below 4% and so markets will be on heightened alert for accelerating inflation. That said, the RBA is on track to hike rates aggressively after its surprise liftoff this month. WIRP suggests a follow-up 25 bp hike is fully priced in for June 7. Looking ahead, the swaps market is pricing in nearly 300 bp of tightening over the next 24 months that would see the policy rate peak near 3.25%.

Philippines central bank hiked rates 25 bp to 2.25%, as expected. However, over a third of the 21 analysts polled by Bloomberg saw steady rates. Governor Diokno said that "The pace and timing of further monetary policy actions by the BSP shall be guided by data outcomes." The bank also raised its inflation forecast for 2020 to 4.6% vs. 4.3% previously and for 2023 to 3.9% vs. 3.6% previously. April CPI came in at 4.9% y/y, the highest since December 2018 and above the 2-4% target range. The bank also shifted its emergency pandemic bond buying window to a regular facility, with Deputy Governor Dakila noting that this will "strengthen the government securities window's effectiveness as a tool for liquidity provision or absorption." Bloomberg consensus sees a modest tightening cycle of quarterly hikes, at least for now. Next policy meeting is June 23 and as Diokno said, the decision then will depend on how the data come in.

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