Cautious FX response to NFP with CPI and ECB in mind

USD: Another strong NFP report cast fresh doubts on Fed rate cuts

The US dollar has failed to hold on to gains initially recorded following the release of the stronger than expected nonfarm payrolls report on Friday. The dollar index hit a high of 104.69 just after the release of the nonfarm payrolls report but has since given back most of those gains falling back towards the 104.20-level. In contrast, US yields have remained at higher levels following the release of the nonfarm payrolls report which has further encouraged US rate market participants to scale back Fed rate cut expectations. Yields on the 2-year and 10-year US Treasury bonds have increased by almost 10bps as they have moved back to within touching distance of year to date highs. Market participants are no longer as confident that the Fed will begin to cut rates at the June FOMC meeting. It is currently judged as a closer call at around a 50:50 probability. The latest developments have increased the risk that the Fed could lag behind other major central banks when lowering interest rates that would encourage an even stronger US dollar. The dollar index has already attempted to break out of the top of recent trading range last week but failed to hold above the 105.00-level.

The release of the latest nonfarm payrolls report revealed that US employment growth remained strong at the start of this year. Nonfarm employment increased robustly by 303k in March, and has averaged 280k/month over the last four months. It marks a clear pick-up from an average of 201k/month in the previous four months. Stronger employment growth if sustained will make the Fed more cautious over lowering rates. However, the Fed will at least be reassured that stronger employment growth does not appear to be resulting in a tighter labour market in the near-term and posing upside risks to inflation. Average hourly earnings growth has still been trending gradually lower since last summer and the unemployment rate has increased by 0.4 point since the low last April.

The expanding US labour supply that has been boosted by the pick-up in immigration and people returning to the labour force is helping to provide an offset to strong labour demand. For that reason, the Fed has been sticking to their plans to deliver three rate cuts this year even if employment growth has been strong. It is one potential reason why the US dollar failed to hold on to initial strong gains after the nonfarm payrolls report was released. A second potential reason is the close proximity of the releases of the latest US CPI and PPI report for March in the week ahead. After inflation surprised to the upside in January and February, inflation data for March could prove pivotal for Fed policy expectations and US dollar direction through the rest of this month. Another upside inflation surprise could trigger a bigger hawkish reassessment of Fed rate cut expectations and open the door for the US dollar to break higher. Please see our latest FX Weekly report for more details (click here).           

LOW FX VOL PERSISTS – FAVOURS HIGH-YIELD THAT POINTS TO USD GAINS

Source: Bloomberg, Macrobond & MUFG GMR

ECB: Prepping the market for a June rate cut

Market participants see increasing prospects of a divergence in the monetary policy path between the Fed and the ECB and we certainly concur that over the short-term at least there are increased downside risks for EUR/USD. A key determinant of those expectations will come on Thursday when the ECB meets for its monetary policy decision. The inflation data has continued to come in on the weaker side with both the headline and core YoY estimates last week weaker than expected. That should certainly give President Lagarde the scope on Thursday to confirm increasing confidence in the achievement of the price stability goal. The March forecasts on inflation are already essentially very close to officially acknowledging that.

Last week, the minutes of the March meeting were released with one of the conclusions of that meeting being that the “case for considering rate cuts was strengthening”. This was due to officials being “increasingly confident on inflation” coming back to the target level. Still, there were of course some elements of caution too with a reference to inflation being “bumpy” after the summer and that “patience and caution” was still warranted. In addition, measured in seasonally-adjusted terms, the 6mth annualised inflation measure has drifted a little higher in recent months.

The key this week is whether the Governing Council still believe it is “premature” to discuss rate cuts. If the ECB is to set the market up to some degree for a June rate cut then it is certainly possible that Lagarde could signal a discussion took place. Even if that is not the case, Lagarde seems likely to provide some signal of the increased prospect of a June rate cut. With that prospect nearly fully priced, what will be key for rates and FX is what might be said in regard to what follows a possible June cut. On that message we should certainly expect caution. Lagarde has already made reference to the idea of skipping rate cuts at meetings and that the ECB would not be on “auto-pilot”. The reference to inflation being “bumpy” is consistent with that while the ECB also made reference to having expected oil prices to have been lower. If oil prices continue to drift higher that would be a strong reason for caution beyond a first cut in June. The meeting this week of course will follow the US CPI the day before which will be key for momentum into the ECB meeting. We tweaked lower our Q2 EUR/USD forecast (1.0900vs 1.1000) in part to reflect nearer-term downside risks but maintained our view that the Fed would cut in June. That is of course more in doubt today given the NFP data but any sign of weakness in the CPI would likely encourage renewed belief in a Fed cut in June, so we can’t yet dismiss the prospects of the FOMC cutting by then.

EURO-ZONE INFLATION A TOUCH HIGHER ON 6MTH ANNUALISED BASIS

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:30	Sentix Investor Confidence	Apr	-8.3	-10.5	!
US	15:00	CB Employment Trends Index	Mar	--	112.29	!
US	16:00	Consumer Inflation Expectations	--	--	3.00%	!
SZ	16:15	SNB Chairman Thomas Jordan speaks	--	--	--	!!
UK	16:30	BoE Breeden Speaks	--	--	--	!
US	16:30	3-Month Bill Auction	--	--	5.230%	!
US	16:30	6-Month Bill Auction	--	--	5.125%	!
US	18:00	Fed's Goolsbee speaks				!!!

 

Source: Bloomberg