Continuation of USD Correction Accompanied by Further Euro Comeback

#OPINIONLEADER#

Markets

Of late markets were mainly driven by global sentiment and by investors pondering the impact of central banks tightening to cap inflation. In this complex, markets are giving ever more weight to activity data. Yesterday’s EMU PMI’s didn’t cause a big reaction. The EMU composite PMI slowed more than expected from 55.8 to 54.9. Still both the manufacturing (54.4) and services index (56.3) stayed at comforting levels, even as the outlook deteriorates. Except for some further euro gains, the direct market impact was modest.

It was US data that further deteriorated an already fragile investor sentiment. The US composite PMI dropped from 56.0 to 53.8 mainly due to a decline in the services measure (53.5). Minutes later, the Richmond manufacturing index nosedived (-9 from 14). Markets rarely react much to housing data. However, the decline in April US new homes sales was too big to ignore (-16.6% M/M), extending a 10.5% setback in March.

US equities touched intraday lows after the data, but recouped part of the losses later closing between +0.15% (Dow) and -2.35% (Nasdaq). Uncertainty on growth also caused a sharp bull flattening move with US yields declined between 14.2 bps (2-y) and 8.7 bps (30-y).

The decline in EMU yields was more modest. ECB’s Lagarde and Villeroy confirmed a lift-off with gradual rate hikes starting in July/ September. However, hawks (Holzmann, Kazaks) kept the debate on a 50 bps hike open. German yields due to the risk-off lost between 5.2 bps (5-y) and 3.2 bps (30-y).

On FX, a continuation of the USD correction was accompanied by a further euro comeback. DXY slid from 102+ to close at 101.85. USD/JPY fell below 127 (close 126.83). EUR/USD confirmed its break beyond 1.0642 to close at 1.0736. Sterling had to fight an uphill battle. A stronger euro, a sharp drop in the services PMI and ‘balanced’ comments from governor Bailey pushed EUR/GBP to the high 0.85 area (close 0.8565).

This morning, sentiment in Asia improves after yesterday’s WS selling. Regional equities mostly gain between 0.5% and 1.0%, the Nikkei underperforming (-0.1%). US yields and the dollar regain modest ground after yesterday’s setback (USD/JPY 127.0, DXY 101.95, EUR/USD 1.071).

Later today, the US durable goods orders (exp 0.6%) and Minutes of the May 4 Fed meeting will be published. We don’t expect them to provide much new insights as the market focus is gradually turning to growth rather than inflation. Maybe also keep an eye at the US mortgage applications. There are again plenty of ECB speakers including Lagarde, Lane, Knot and Holzmann. Will the hawks continue to ‘challenge gradualism’?

On interest rate markets, we look out whether the US 2-y yield can hold above 2.5%. For the 10-y, 2.72% is an important reference. If not, the dollar slide might also continue. For EUR/USD next reference is 1.0806, but that maybe is a bit too far short-term. For now the downside in EMU yields looks better protected compared to their US counterparts.

News Headlines

The Reserve Bank of New Zealand continued to frontload monetary tightening with a 50 bps hike bringing the OCR at the lower end of the estimated 2-3% neutral rate. The RBNZ aims to constrain demand which is supported by a strong labour market, continued fiscal support and strong terms of trade, until there is a better match with still-disrupted supply. While the RBNZ notes strong headwinds coming from heightened uncertainty and high inflation dampening global and domestic consumer confidence, it expects to tighten monetary conditions in a much more aggressive way than projected back in February. The RBNZ foresees an additional 200 bps hikes by the first half of 2023. Previously, the peak policy rate was seen in the second half of 2024 near 3.5%. Higher projected inflation of 6.9% this year (+0.3 ppts) and 4.4% in 2023 (+1.2 ppts) explain the twist. The kiwi dollar extends its recent rebound from the low 0.62 mid-May to 0.65 this morning. New Zealand ST swap rates soar more than 20 bps.

MNB vice governor Virag doubled down on his comments earlier this month, telling state news agency MTI that the central bank plans to slow base rate increases from the current 100 bps to about half that. He made the remarks even as he expects inflation to rise into double-digits in coming months. Virag also said the government should cut the budget deficit, which may help rein in inflation. Hungarian swap yields fell to the tune of 6 bps (+) in short tenors. The forint was able to contain the damage to EUR/HUF 382.82, though that’s still a very weak level historically.