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Week Ahead – Focus on US Retail Sales as Debt Ceiling Drama Rumbles On

With no central bank decisions on the menu next week, investors will turn to data releases. Top of the list is the US retail sales report, which will help shape expectations about the Fed’s rate path, driving the dollar accordingly. There is also an onslaught of economic data from most major economies to keep traders busy, alongside an election in Turkey and the ongoing drama around the US debt ceiling. 

Can the dollar shake off the blues? 

It’s been a rough year for the dollar so far. Despite mounting signs that the US economy has regained momentum, the greenback has been trading ‘heavy’, struggling to sustain any upward momentum. Most rallies get rejected quickly, even if they are backed up by stronger data.

Behind this sluggishness lies speculation that the Fed is about to start cutting interest rates soon. Markets expect the Fed to slash rates three times later this year in 25bps increments, starting in September. This is striking considering that core inflation seems sticky around 5.5%, way above its target.

Traders seem to be betting that the problems in the banking system will override inflation concerns, forcing the Fed to reduce borrowing costs in order to avoid a domino of bank failures, even if that means tolerating a period of higher inflation.

Another problem for the dollar has been the rally in stocks. Since the greenback often acts like a haven asset, the optimistic tone in markets has limited demand for the reserve currency. The charts tell the same story – the dollar index topped in late September, right before the stock market bottomed.

In other words, the dollar’s yield advantage has been eroded because of rate-cut bets, and its safe-haven qualities are not very popular right now. Therefore, for the greenback to start ‘working’ again, it might need an equity selloff that fuels demand for protection or a stream of encouraging data that dispels speculation of imminent rate cuts.

This puts extra emphasis on US retail sales out on Tuesday, which will reveal how consumers are holding up. Forecasts point to a 0.7% monthly increase in April, a rebound following a decline of similar size last month. This notion is supported by an increase in Visa’s US Spending Momentum Index, yet similar card data from Bank of America point to a spending rise of just 0.3% in April, presenting some downside risks.

Meanwhile, debt ceiling negotiations will continue. The Treasury Secretary has warned the US could face default by early June without a deal, although in reality, it is likely closer to July. Outside of short-term Treasury yields and credit default swaps, markets haven’t cared much about this standoff so far, but that might change as the X-date draws closer.

China and Japan await key data

Crossing into China, the ball will get rolling on Tuesday with retail sales, industrial production, and fixed asset investment – all for April. Investors will be looking at whether the reopening momentum has started to fade, as recent business surveys suggested.

Over in Japan, things will heat up with GDP growth data for Q1 on Wednesday, ahead of the latest round of inflation stats on Friday. The Japanese economy is expected to have grown again entering 2023, albeit just barely.

On the inflation front, inflationary pressures probably continued to heat up in April, mirroring the forward-looking Tokyo CPIs. That would be pleasant news for the Bank of Japan, possibly fueling speculation for policy tightening in the future, perhaps this summer already.

The BoJ’s reluctance to tighten policy has devastated the yen, so any hints that this might change can help the currency regain strength. Governor Ueda has signaled he’s open to tightening, provided that inflation is persistent. For the yen, the dream scenario would be for the BoJ to start tightening right as other central banks stop, during a period of turbulence in global markets.

Risk-linked currencies eyed, Turkey goes to elections

Turning to currencies with strong links to risk sentiment, the British pound will be in the spotlight Tuesday with the release of jobs data for March. The Bank of England disappointed traders this week by not providing any strong clues about future action, so markets are pricing the rate decision next month almost like a coin toss.

In Australia, there’s a barrage of releases starting on Tuesday with the minutes of the latest RBA meeting, where the central bank unexpectedly raised interest rates. The wage price index for Q1 will follow Wednesday, ahead of jobs numbers for April on Thursday.

Over in Canada, the latest inflation stats are out Tuesday, ahead of retail sales on Friday. Market pricing suggests the Bank of Canada is done raising rates, so anything that challenges this perception could inject more volatility into the Canadian dollar, which has been shaken around lately by massive swings in oil prices.

Finally in Turkey, the nation will elect its next parliament and president on Sunday. President Erdogan is lagging behind his main rival Kilicdaroglu, although neither candidate is expected to secure 50% of the votes, which means there will probably be a second round in two weeks.

A strong showing by Kilicdaroglu could help the Turkish lira to appreciate, perhaps with a large gap at the open on Monday, on expectations that a new government will restore orthodox economic policies and allow the central bank to raise interest rates in order to fight runaway inflation.

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