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Stronger-than-expected data and hawkish FOMC minutes helped lift US rates and the greenback last week. The fact that the market continues to reduce the extent of ECB easing this year is notable, but this did not prevent the euro from snapping a five-week advance.

The 10-year Japanese government bond yield rose above 1% last week for the first time since 2012, but the US dollar traded above JPY157 for the first time since the BOJ is believed to have intervened earlier this month. Sterling's resilience in the face of the pullback in May's flash composite PMI (52.8 vs. 54.1) and dreadful April retail sales (-2.3%) is notable. Those reports were unable to offset the impact on rate expectations spurred by the firmer-than-expected CPI.

The swaps market does not have the first rate cut fully discounted until November. Before the CPI print, a cut had been priced in for August. The UK two-year yield rose by 16 bp last week, the most in Europe. Ahead of the weekend, sterling posted its highest settlement in more than two months. The draft of the G7 finance minister statement will be noted for its tougher against China's trade practices.

In early June, the EU is expected to announce new tariffs on Chinese-made autos. A key question is whether the dollar's setback before the weekend signaled the resumption of the lower trend that began in mid-April, with the notable exception of the yen. We lean against it, and in the analysis below, identify key chart areas that could signal otherwise. 

Next week's highlights include the preliminary Eurozone May CPI and Tokyo's May CPI. Both are likely to have risen after softening in April. A firmer Eurozone reading will not deter expectations for rate cut on June 6. Nor will a higher Tokyo print impact expectations for the BOJ. Owing to a different basket and methodology, the US PCE deflator, which the Fed targets, is unlikely to show the mild softness of the April CPI.

Looking further ahead, we note that the median forecast for the June 7 US May nonfarm payroll in Bloomberg's survey has fallen from around 225,000 to 180,000 (175,000 in April), of which the private sector is seen accounting for 115,000, which would be the least in six months. If accurate, it still might not reach the threshold of Fed concerns.

United States

Although the "stagflation" framing of the US economic situation seems exaggerated, the incoming data in the week ahead could fan such talk. Growth in Q1 disappointed expectations and looks likely to be revised lower (toward 1.2% from 1.6%), while the April income and consumption are set to slow. Meanwhile, the monthly PCE deflators are unlikely to see the small improvement shown by the April CPI.

Since the March CPI (April 10), the futures market has discounted less than a 50% chance of Fed cut in June. The market prices in no chance of a June cut. Despite some economists arguing for another rate hike, and some apparent desire to hedge such a risk, the Fed funds futures have consistently priced in at least one cut fully.

What has changed is that, starting on April 10, and with the one-day exception when the April CPI was released (May 15), the market has not been confident of a second rate cut this year. Still, the market leans in that direction, with pricing reflecting about a 35% chance of a second cut. At the end of April, the market had nearly completely priced it out. We suspect the pendulum of market sentiment will return to that view.

While we think the US economy is slowing, it appears to be a gradual process and the recent string of disappointing data may have overstated the case. This suggests better US data, likely with the May prints, and the key may be the next ISM services survey (back above the 50 boom/bust level?) and the jobs report (June 7, 225,000?). Note that that the ECB is widely expected to cut rates the day before the US employment data. 

The Dollar Index set the year's high in mid-April near 106.50 and trended lower to reach almost 104.00 on May 16. Since then, it recovered, but stalled near the 20-day moving average, a little above 105.00. This met the minimum retracement objective (38.2%). The next retracement (50%) is closer to 105.30.

Despite the pullback ahead of the weekend, the technical tone remains constructive, and the momentum indicators are turning higher. The five-day moving average looks set to cross back above the 20-day moving average in the coming days. A break of the 104.40-50 area would likely negate this constructive view.

Eurozone

The preliminary May CPI will be reported on May 31. Barring a dramatic upside shock, the ECB is set to cut rates in early June. On the one hand, the base effect warns of the risk to the upside of the 2.4% year-over-year pace recorded in March and April. The CPI was flat in May 2023. On the other hand, the euro was a bit stronger and oil prices were softer.

The bar to the ECB not cutting next week is high, but ECB may try to deliver a hawkish cut as it were, by welcoming the economic green shoots, and playing down the likelihood of a cut at the July meeting. The CPI data will also feed into the ECB's updated economic forecasts to be released at the June 6 meeting.

Encouraged by evidence that a recovery is taking hold and official comments suggesting no consensus after the June ECB meeting, the swaps market had been scaling back expectations of ECB cuts this year. Recall that at the end of last year, the market was discounting 180 bp of cuts. By the end of February, it was halved. After the preliminary May PMI last week, the market slipped to less than 60 bp. 

The euro snapped a five-week advance, slipping by about 0.20% last week. That was only the second weekly loss here in Q2. It recorded a two-month high slightly below $1.09 on May 16 and a week later it approached $1.08. Several technical indicators converge in the $1.0785 area. A break would boost confidence that a high is in place.

The daily momentum indicators have turned lower. A move above the $1.0860-65 area would negate the bearish scenario. In the bigger picture, since the start of last year, the euro has been trading broadly sideways, mostly between $1.05 and $1.10. The average over this period is around $1.0815. This year's average is a few hundredths of a cent higher.

Japan

In terms of revealed preferences, BOJ Governor Ueda appears to be making monetary policy effective again by taking the official foot off the accelerator. The short-run economic fluctuations do not matter much to this strategic objective. And there are good reasons to look through the contraction in the first quarter.

Indeed, more recent data underscore that the downturn was a function of the idiosyncratic factors from which the economy is already recovering. April retail sales and industrial production figures, which are due at the end of the week, should lend confirmation. The April jobs report will be issued then, as well.

The unemployment rate has been (with two exceptions) 2.5%-2.6% for more than two years. It was 2.6% in March. The market may be most sensitive to Tokyo's May CPI due shortly before the real sector national data. Tokyo's CPI is a reasonable proxy for the national figures, which will not be available for a few weeks. Recall that in March, abolishing high school tuition saw the headline and core measures fall below 2% (1.8% and 1.6%, respectively). 

Rising US rates helped lift the dollar above JPY157 for the first time since May 1. BOJ data out next week is expected to confirm two bouts of intervention for what appears to be about JPY9 trillion or around $58-$60 billion -- on par with the intervention seen in 2022. We expect the market to turn cautious as JPY158 is approached, which is where the BOJ's last intervention is thought to have taken place.

Even though the moves have been modest, it has been close to a one-way market. The dollar has retreated in one session in each of the past three weeks. Still, one-month implied volatility is below 8.5%, back to mid-April lows. It was near 11% before the first bout of BOJ intervention is thought to have taken place. The dollar settled above the five-day moving average every session last week. It begins the new week near JPY156.65.

China

The continued deflation in China's producer prices and the relatively low level of capacity utilization warns that industrial profits likely remain weak. The fact that the returns on capital are weak underscores the existence of excess investment. Industrial profits were 3.5% lower year-over-year in March after dropping 19.2% in year-over-year in March 2023.

China reports the April estimate early on May 27. Three days later, the May PMI is due. Recall that the manufacturing PMI was above the 50 boom/bust level back-to-back months in March and April for the first time since the end of Q1 23. The non-manufacturing PMI has fared better. It was above 50 all of 2023, though slowed in Q4 23 and finished the year at 50.4.

It reached 53.0 in March before slipping back to 51.2 in April. The composite ended last year at 50.3. It reached a 10-month high of 52.7 in March and eased to 51.7 in April. The general sense is that more stimulative measures will be needed if the 5% growth target is to be achieved.

The yuan will take a seven-session losing streak into next week. Since coming back from the May Day holidays, the yuan has fallen in all but three of the 15 sessions. We note that the rolling 60-day correlation is at the high for the year (~0.52), while the 30-day correlation is higher (~0.80). To be sure, the argument is not that China has pegged the yuan to the yen, but rather that they share a common characteristic. The yuan (offshore) and yen make attractive funding currencies.

The dollar is approaching last month's high against the yuan (~CNY7.2475). The dollar briefly traded above CNH7.26 against the offshore yuan. Last month's high was around CNH7.2830. Chinese officials may resist more forcefully yuan weakness if the equity market slide is extended. The 2.25% loss in the last two sessions brings the CSI 300 back to late April levels.

United Kingdom

The UK is to report mortgage lending and consumer credit figures, alongside money supply. The markets tend not to be sensitive to these reports. The UK has a bank holiday, and so, like in the US, British markets are closed Monday (May 27). The Bank of England will see another employment report and CPI before the June 20 meeting.

After last week's CPI, retail sales, and preliminary estimate of May PMI, the swaps market downgraded the chances of a cut next month to less than 10% from almost 60% a week ago (May 17). The market was fully confident that the base rate would be at 4.75% by the end of August, but no longer. It is now seen as only a 40% likelihood. The first cut is now fully discounted for November and swaps pricing in consistent with 31 bp of cuts this year, down from a little more than 60 bp on May 15.

Sterling recorded the low last week near $1.2675 after the disappointing retail sales report. However, it recovered and made new session highs after the stronger-than-expected US durable goods orders. Sterling took out the previous day's high and reached $1.2750, just below the week's high; $1.2760, which was also a two-month high.

Sterling has risen in four of the past five weeks. Without $1.2650 yielding, sterling can make a new high, but the momentum indicators warn not to expect a large move. Initial resistance is seen near $1.2800.

Canada

Canada is one of the last G10 countries to report Q1 GDP, but it will be reported on May 31. The economy contracted by 0.5% in Q3 23 (annualized rate), driven primarily by weak consumption, a contraction in business investment, and a drag from trade.

The economy snapped back in Q4. It grew by 1%. The economy appears to have strengthened further in Q1 24: consumption may have quickened, capex appears to have risen for the first time in three quarters, and government spending increased after falling in Q4 23. The contribution from net exports may have been reduced.

The monthly GDP rose by 0.5% in January and 0.2% in February. The Bank of Canada meets on June 5, and the odds of a hike in the swap market has been hovering slightly above 60% in the second half of last week.

For the third time in four sessions, the US dollar was bought on a dip below CAD1.36 at the start of last week. It rose to almost CAD1.3750 on May 23, which corresponds to the (61.8%) retracement of the losses from the year's high set on April 16 (~CAD1.3845). Retail sales disappointed before the weekend. Canada reported its the third consecutive decline in retail sales.

The 0.6% decline excluding auto sales, was the largest drop since last June. Still amid corrective forces, the greenback was sold to a little through CAD1.3650. Initial support is likely to be found in near CAD1.3625. Momentum indicators have turned higher, and the five-day moving average crossed back above the 20-day ahead of the weekend. 

Australia

Australia is set to report April retail sales and CPI in the coming days. The futures market has been all over the board. As recently as early February, the market had two cuts this year fully discounted and around a 2/3 chance of a third cat. By the end of April, it was discounting about a 40% chance of a hike. Expectations have settled down with about a 65% chance of a cut. Retail sales fell 0.4% in March and have not fallen in consecutive months since 2021.

However, over the past six months they have been flat, underscoring the weakness of the Australian consumer. The monthly CPI print (RBA puts more weight on the quarterly figure) peaked at 8.4% at the end of 2022 and fell to 3.4% at the end of 2023. Improvement stalled in Q1 24 and was at 3.5% in March. 

The Australian dollar fell to an eight-day low, slightly above $0.6590 before recovering back to $0.6620 ahead of the weekend. Last week's high was set on Monday near $0.6710. The Aussie was the worst performed in the G10 last week, falling by almost 1%. The momentum indicators have turned lower.

Still, the five-day moving average could fall below the 20-day moving average early next week. It last crossed in late April. The $0.6580 area is the (38.2%) retracement of the gains from the year's low set on April 19 (~$0.6365). On the other hand, a move back above the $0.6650 area would be constructive.

Mexico

The central bank's inflation report is bound to recognize the slowing pace of improvement. With the unemployment rate (March) at a generation low of 2.28% (April's estimate due May 30), officials do not appear in a hurry to cut rates again.

The fact that the Fed is not seen cutting until late this year also gives Banxico room to maneuver. Mexico holds national election on June 2. While Sheinbaum looks to hold on the presidency for the Morena coalition, the outcome of the legislative elections will likely shape her legislative program.

The dollar initially extended this month's slide, slipping briefly through MXN16.63 on May 21 before staging a key reversal (new lows for the move and then settling above the previous session's high). Follow-through dollar buying tested the MXN16.75 area. The dollar's gains (~0.50%) last week, snapped a three-week slide during which it fell by about 3.2%.

Despite the pullback to around MXN16.6750 ahead of the weekend, the greenback's recovery does not appear over. The momentum indicators have turned higher. The next target is around MXN16.90. 

Falling copper prices, a 50 bp rate cut, and promises of more to come all took a toll on the Chilean peso, which was the weakest currency in the world last week, falling by about 1.5% and rivaling the South African rand for the weakest emerging market currency. It was the peso's first loss in six weeks. The peso appreciated by around 8.3% in that run. South Africa holds elections on May 29.

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