US consumer near tapped-out will curtail USD strength

USD: Retail sales highlights growing economic risks

The US equity market yesterday closed at another record high ahead of today’s holiday with Nvidia becoming the largest company in the world by market cap and underlines the continued importance of tech for US equity market performance. The resilience of the US economy has of course also helped but yesterday’s retail sales data has added to the evidence that the economy is slowing with the US consumer beginning to show signs of exhaustion after a sustained period of strength since the covid pandemic. All measures of retail sales were weaker than expected yesterday for the month of May with the April readings also revised lower. March data was also revised lower and now we have a very clear picture of US consumption coming to a halt.

Looking at the nominal value of retail sales excluding autos and gasoline, retail sales is now actually down 0.2% over the period since the beginning of the year. With wage growth slowing, the labour market softening (on most measures) and consumer confidence falling (U of Michigan), we see increasing risks of this weakness being more evident of exhaustion that will prove more sustained than previous episodes of consumer spending slowdown.

This of course will be key for the Fed and yesterday we had a large number of Fed officials speaking with one point in common – the data will determine the timing of when the Fed can cut rates. Fed Governor Kugler stated it would likely be appropriate to cut rates “sometime later this year” but St.Louis Fed President Musalem stated it could take “quarters” for the data to support a rate cut. Fed Presidents Williams, Barkin and Collins all spoke as well and what was notable from all Fed officials yesterday is that there were fewer comments referencing the possible need to hike rates again.

Rate cut expectations picked up again on the back of the data with 45bps of cuts priced this year and 140bps priced by the end of next year based on the fed funds futures contract in December 2025. This level of easing by end-2025 is the most since March and we believe this will likely curtail the strength of the US dollar. No growth in nominal retail sales on a year-to-date basis to May is certainly compelling evidence of a slowdown and with inflation slowing now as well, a clearer sign of job growth slowdown in the NFP would likely see the Fed alter its thinking quickly that would prompt increased speculation on a possible September rate cut.  

US RETAIL SALES ARE SLOWING – EX-AUTO & GASOLINE SALES FELL 0.2% OVER 1^ST 5 MONTHS OF 2024, CLOSE TO WORST GROWTH SINCE 2020

Source: Macrobond & Bloomberg

EUR: Political risks yes, existential crisis no

The elevated political risks in Europe is certainly holding the euro back and EUR/USD would likely have rebounded more notably yesterday after the weaker than expected retail sales data in the US. Still, the euro has stabilised helped by evidence that investor fears over the rise of RN in France have eased somewhat. Based on price action since the snap election by President Macron we estimate via swap spread moves an approximate 1% risk premium is currently in the price of the euro.

This is quite a contained FX move and less dramatic than the OAT/Bund spread widening to a high of 83bps on Monday, before correcting lower to close at 77bps yesterday. Some semblance of stability has emerged after a Le Figaro newspaper interview in which Marine Le Pen stated that she is “respectful of institutions” and that she would work with President Macron – “there will simply be cohabitation”.

The very limited move in FX in contrast to the OAT spread move does underline the fact that the reaction is more about a reappraisal of fixed income risks based on RN’s and the far-left alliance’s fiscal policies than any reassessment of the existence of the euro-zone block, like we had in 2010-12. A look at yield spreads across the euro-zone also highlights the much stronger position today of the periphery countries that were at the heart of the 2010-12 euro-zone crisis. The 10yr sovereign yield spreads for Greece (120bps), Portugal (75bps) and Ireland (45bps) are considerably narrower than at times of previous episodes of crisis in the euro-zone that underlines the much stronger position of the euro-zone in general. In addition, the ECB now also has its new tool to help contain disorderly moves in yields – the Transmission Protection Instrument (TPI) which the ECB would not hesitate to use if it was deemed to be disrupting the transmission of the monetary stance. Finally, there is also evidence that RN could well back-track on some of its policies, although there is as of yet no formal election manifesto to assess. According to Politico, RN’s website has recently seen the removal of one of its policy documents on defence that included the commitment to establish closer relations with Russia and the immediate withdrawal from NATO. Indeed, Jordan Berdella has suggested waiting until the end of the Ukraine conflict before making any decision on NATO membership.

The RN leadership will be well aware that there has been a direct correlation between the growing support for RN and the softening of much of the extreme policies in relation to EU membership. That could encourage further shifts in policy going forward.

Still, an important explanation of the return of some stability to the markets is likely the consensus view that RN will be constrained given the expected hung parliament outcome. If there is any sense of that view changing in the coming days or if RN do better than expected in the 1^st round on 30^th June, we would still expect the political risk premium to increase and EUR/USD would likely trade below the 1.0500 level going into the second round on 7^th July. Of course we will have the US jobs report before the second round election and that could help curtail euro declines. Our bias remains toward weaker jobs data going forward.

10YR YIELD SPREADS OVER BUNDS – FRANCE, GREECE, PORTUGAL, ITALY

Source: Bloomberg & Macrobond

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	Current Account	Apr	35.2B	35.8B	!
EC	09:00	Current Account n.s.a.	Apr	--	44.5B	!
EC	09:30	ECB's Centeno speaks				!!
UK	09:30	House Price Index (YoY)	--	2.0%	1.8%	!
EC	10:00	Construction Output (MoM)	Apr	--	0.10%	!
GE	11:00	German Buba Monthly Report	--	--	--	!
CH	11:00	FDI	May	--	-27.90%	!
US	12:00	MBA Mortgage Applications (WoW)	--	--	15.6%	!
US	15:00	NAHB Housing Market Index	Jun	45	45	!
CA	18:30	BOC Summary of Deliberations	--	--	--	!!

Source: Bloomberg