The dollar resumed its recent strengthening last week, challenging our expectations of a possible near-term retracement. The soft patch in Q1 was not as deep in the US as in other major economies (Europe, Japan), and the ongoing fiscal stimulus can offer some shield from potential negative supply shocks. In contrast to the beginning of April, in which higher US rates and USD strength were brought forward by higher oil prices and inflation expectations (higher breakevens), the latest leg of yield increases has also been driven by real rates, as the Fed remains committed to gradual tightening. There seems to be little room for further pricing of near-term Fed hikes, as 79bp are already priced in a one-year horizon. During this tightening cycle, the market has erred on the side of caution and modestly underpriced the Fed, and current pricing seems consistent with our expectation of a total of four hikes this year.
In that regard, this week’s FOMC minutes should confirm the constructive outlook and the Fed’s intent of allowing for a modest overshoot of inflation above target. We look for the discussion surrounding the inclusion of the word “symmetry” when referring to the inflation target. This week’s data should reinforce the resilient performance of the US economy. We look for a 1.5% m/m rise in durable goods orders for April on stronger-than-expected nondefense aircraft (Friday). Other releases include new and used home sales and home price index (Wednesday and Thursday).
The Italian political situation and its effect on BTPs and other EA peripheral bond markets will likely be the single most important driver for the EUR this week. The longer-than-expected time taken to negotiate and finalize the coalition program, the delay in the formation of a government and the first indications of the 5SM and League coalition economic agenda have weighed on Italian assets and the EUR. While our rates strategists do not see the recent BTP weakness as the beginning of a structural widening trend, we think near-term uncertainty will continue to pressure the EUR and increase the risk that the positive tone held by rating agencies on Italy reverse (see Euro Area Rates Strategy: Quo Vadis BTP?, 17 May 2018). Hence, contrary to our earlier expectations of near-term EURUSD consolidation given the rapidity of the recent USD move, we expect the EUR to remain under pressure as long as the Italian political situation remains unresolved. On the data front, we expect EA flash PMIs (Wednesday) to moderate somewhat in May, while expecting the final Q1 18 German GDP (Thursday) print to confirm the downside surprise of the preliminary report (0.3% q/q).
Broad USD strength, as a result of rising long-term UST yields, boosted USDJPY clearly above the recent resistance at 110, which now likely provides some support. Although USDJPY lagged in the broad USD rally since mid-April (relative to European currencies as evident in cross-JPY weakness then), USDJPY now appears to be catching up on the broad USD strength with the re-decoupling of US-ROW growth (see last week’s TWA), well-behaved equity prices, and relative short-rates outlook in favor of the US. The lack of a catalyst in Japan this week leaves USDJPY remaining driven by broad USD dynamics and global risk sentiment.
EURUSD drove cable lower last week as Italian politics weighed on the single currency. Domestic data this week, namely inflation (Wednesday) and retail sales (Thursday), will, nonetheless, be very important for the data-dependent BoE and could provide some support to the GBP, particularly versus the EUR, in our view. We forecast the headline rates of CPIH and CPI to have risen by 0.1pp each in April to 2.4% and 2.6% y/y, respectively, 0.1pp above consensus. Elsewhere, following the weather-related weakness in the March retail sales, we expect a bounce back in April (0.9% m/m, consensus: 1.1% m/m, previous: -1.2% m/m); however, we expect the underlying structural weakness to continue. Finally, recent activity data continue to point to Q1 growth at 0.1% q/q (Friday). Trade data point to a neutral contribution to Q1 GDP following a negative 0.4 q/q contribution in Q4, while dwelling construction points to a -0.11pp contribution of residential housing to investment growth.
The CAD has been range-bound, tied between the broad USD trend, interest rate differentials and supportive oil prices. With a very light domestic calendar, external factors are likely to keep driving the loonie. NAFTA negotiations will continue this week, after the parties failed to announce an agreement in principle on May 18 (a soft US congressional deadline). The recent push in talks has focused on rules of origin, but other sticking points, including the sunset clause and dispute settlement, remain on the table. Time is running out as Mexican elections and US midterms come closer, and it looks increasingly likely that a final NAFTA deal could be delayed to 2019. The only data release is wholesale trade sales for March, and there will be no BoC speeches this week as Council members are on media lock-up ahead of the May 30 meeting.
Amid a quiet data/events calendar, we expect broader risk sentiment and political developments in Italy to drive price action for Scandinavian currencies and the CHF. The CHF in particular looks poised for further appreciation versus the EUR, as long as the political situation in Italy remains uncertain. We have long argued that EURCHF potential upside would require a meaningful EUR catalyst, which looks unlikely in the near term. While we continue to forecast the pair to oscillate around 1.18, we see asymmetric near-term risks to the pair, skewed to the downside. Moreover, while the SNB will likely take note of the current situation, the bar for it to react with FX interventions is high, in our view, with the CHF less significantly overvalued in real terms (see SNB: Watching for signs of policy fatigue, 13 March 2018).
In Sweden, the Riksbank’s H1 financial stability report will be published this on Wednesday and will once again highlight the risk to the economy posed by high household indebtedness. This report will likely be closely watched by market participants amid a soft patch of activity data and the correction in house prices recently. Similar to H2 17, the report will emphasize the need for even more stringent amortization requirements and measures to increase the resilience of the household sector, in our view. Arguably, signals from the housing market continue to worry investors and weigh on the SEK, with Swedish new housing starts data for Q1 declining sharply. On the data front, unemployment data (sa) (Tuesday; consensus: 6.1%, previous: 6.2%) are the only data point of note, while the Riksbank’s conference titled “Central banks in the past present and future”, as part of the celebration of the Bank’s 350th anniversary (Friday), will also be watched.