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FX Update: Yields on fire with bevy of CB meets ahead.

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  The US CPI and inflation expectations data on Friday jolted the US dollar back higher as the market sharply raised the Fed rate hike trajectory at coming meetings. Liquidity conditions are looking dire for the riskiest assets here and EM- and G10 small currencies are suffering aggravated weakness on the general deleveraging fallout. A string of important central bank meetings up this week, led by the FOMC meeting Wednesday, but the SNB Thursday and BoJ Friday could also provide fireworks.


FX Trading focus: US data jolts US dollar higher ahead of FOMC. SNB, BoE and BoJ also this week.

The market was clearly ill-prepared Friday for signs that US inflation is proving stickier than anticipated. First, the May US CPI data out Friday saw a +0.6% MoM ex Food and Energy reading versus a drop to +0.5% expected, and the headline was a whopping +1.0% vs. 0.7% expected, and this took the headline year-on-year reading to a new multi-decade high of 8.6% rather than staying steady at 8.3%. Second, the preliminary University of Michigan Sentiment reading for 5-10 year inflation expectations jump 0.3% to 3.3%, breaking the 3.0% range high that was only violated once since 2011 and posting the highest reading since two months of 3.4% in 2008, in turn the highest readings since the early 1990’s.

The latter is easily as critical a factor in the FOMC deliberations this week as the UMich inflation expectations series is one of the inputs into Fed models and is suddenly flashing a far deeper shade of red since first reaching the 3.0% range high all the way back in May of last year. It is also possibly setting up an embarrassing situation for the Fed after Powell pushed back against the idea of 75 basis point rate hikes at the May 4 FOMC meeting. The market is already second guessing the Fed here, pricing 119 basis in total for the next two meetings combined, and leaning a bit more for the possibility that July sees a larger-than-50 bps hike. The US treasury yield curve was flattened by the move, with the 2-10 slope reaching zero at one point today. Already the EuroDollar strip is pricing for the Fed to begin easing rates by H2 of next year after the aggressive move higher in short yields on Friday’s data.

With US yields delivering a crushing blow to liquidity and sentiment, the USD has accelerated aggressively higher since late last week and could be ready for more if the Fed “capitulates” to the market’s pricing and makes it clear that it will continue to ratchet its policy mix ever tighter until the inflationary rise is clearly abating.

Chart: GBPUSD
Sterling is weak on its general vulnerability in times of stress. Interesting to note that EURGBP is crawling back toward that key 0.8600 level after the market is marking European yields sharply higher despite a rather cautious ECB, suggesting that the market is telling the ECB it is risking a policy mistake that will take EU yields sharply higher. GBPUSD has rolled over badly and this sets the cycle lows below 1.2200 in focus before most other USD pairs have reached their respective extremes (notable exception: USDJPY). The UK was out with some fresh weak data today, including a -0.3% GDP number for April and a -1.0% drop in Manufacturing Production in April, together with the latest reminder of the dire levels of the country’s trade deficit (-£20.9B in April). If the general risk deleveraging continues here, the focus will quickly shift to the 1.2000 level that the pair has only traded below for about a week during the extreme environment of early 2020 during the pandemic shutdown panic and intraday briefly on a few prior occasions, particularly after the Brexit vote. The market is about 50/50 on whether the Bank of England goes 25 bps or 50 bps at this week’s meeting, but surely has to bite the bullet with sterling at these levels and go with the bigger move?

Source: Saxo Group

The focus on the Bank of Japan should be intensifying rapidly ahead of the Friday BoJ meeting if the Fed confirms this latest rise in tightening expectations and if the longer end of the US yield curve also trades to new highs for the cycle and above the late 2018 mark of 3.26% (already at 3.2% as of this writing). Is the clock ticking on the Bank at least tinkering with its policy levels or will Kuroda double down once again?

I lean for the SNB to go ahead and hike this week together with a small minority of analysts that are now looking for the same. It makes sense given the long wait for the next quarterly meeting in September and as the ECB is currently priced to hike over 150 basis points by year end.  Not entirely sure how much this will impact CHF as it has already rallied a bit and we can hardly expect strong leadership in this hiking cycle, but a hint that it is ready to reach 0% in September could be a strong signal, while the baseline may be a hike of 25 basis points at every meeting for a while.

US data this week includes the US May Retail Sales up Wednesday, an interesting data point to watch relative to soaring gasoline prices and cratering consumer confidence levels (besides the inflation expectations portion of the UMich Sentiment survey, the overall survey posted a shock 8.2 drop to a record low in the 44-year history of the survey at , a full 5.1 points below the GFC low and clear of the prior all-time low mark in May 1980 at 51.7).

Table: FX Board of G10 and CNH trend evolution and strength.
The bringing forward of recession timing anticipation (the Fed priced to cut some time in H2 next year next year, for example) has kept the JPY from spiraling lower in a broad sense, but we still need to watch long yields globally. The USD has risen to the top of the heap and among the weaklings if this environment is set to persist for a while, I would watch for risks to the G10 smalls in general, AUD in particular and for GBP is in a heap of trouble.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Note the very positive Canadian jobs on Friday offering zero support for CAD, as oil prices have corrected and risk sentiment is in the dumps and now USDCAD is trying to flip to a positive trend after quite a comeback. Elsewhere, interesting to note EURAUD bidding for a new breakout and uptrend. The GBPCHF also interesting to track this week as Thursday features both an SNB and BoE meeting.

Source: Bloomberg and Saxo Group

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