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Summary

United States: Long Holiday Weekend Clouded by Debt Ceiling

• With a deal on the debt ceiling hanging in the balance, the near-term economic outlook remains uncertain. Data released this week suggest the real economy is showing resilience, as new home sales and durable goods orders stabilized, while real personal spending surprised to the upside.
• Next week: Consumer Confidence (Tue), ISM Manufacturing (Wed), Nonfarm Payrolls (Fri)

International: Inflation to Force the Bank of England's Hand

• The U.K. April consumer price index was an unpleasant surprise for Bank of England policymakers. Headline inflation slowed and energy prices receded, albeit by much less than expected. As a result, we now expect the Bank of England to raise its policy rate at both its June 22 and August 3 announcements. We have adjusted up our global growth outlook slightly on the back of improving economic activity, which continues to flow in; however, growth prospects for the global economy this year may be starting to plateau.
• Next week: China PMIs (Tuesday), India GDP (Wednesday), Brazil GDP (Thursday)

Interest Rate Watch: Star Gazing Once Again

• As the FOMC tries to determine what level of interest rates will be sufficient to tame inflation, oneguidepost is the natural rate of interest, or r-star. Estimations resumed this month after being temporarily halted due to the volatility surrounding the pandemic, and suggest the era of a low natural rate of interest remains intact.

Topic of the Week: Is Demography Still Destiny?

• The 2020 Census Demographic and Housing Characteristics (DHC) data were published this week and The population of the United States is not getting any younger. The median age in most states rose between 2010 and 2020 as falling birth rates and domestic migration drove demographic shifts.

Full report here.

U.S. Highlights

• Negotiators appeared close to a deal to raise the debt ceiling and set spending levels. However, the deal does not address Washington’s medium-term fiscal challenges, which were part of the reason Fitch put the U.S. on a negative watch.
• Consumers continued to spend at a healthy clip in April, contributing to sustained inflation pressures. We continue to expect spending to cool as the year goes on, helping to ease inflation, eventually.
• In the meantime, the Fed is in a tough spot. It will need courage to pause and wait for the full impact of its past tightening to show up.

Canadian Highlights

• According to the Survey of Employment Payrolls and Hours (SEPH) March’s employment fell 10k with both goods and services sectors posting declines.
• The number of job vacancies continued to fall with more sectors reporting fewer postings. This improvement, however, made no mark on the measure of labour market tightness, which remained unchanged from February.
• The SEPH also showed a continued deceleration in year-on-year estimates of wage growth but it is partially attributed to base effects and may reverse. All said, this week’s data doesn’t make a strong case for the BoC to come off the sidelines just yet.

U.S. - “Discretion” Is the Better Part of Valor in Washington

Thankfully, negotiators appeared close to a deal to raise the debt ceiling as of Friday morning. It looks like the two-year deal would cap discretionary spending and raise the debt ceiling through the 2024 election, avoiding the worst-case scenarios. However, ratings agency Fitch had cited the “failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges” as a reason for putting the U.S. on a negative watch, and this deal does not change that.

Congress has taken the Shakespearean proverb “discretion is the better part of valor” literally. The Bard’s original intention was a criticism of a lack of honour and courage in focusing on discretion. The debt ceiling deal only tinkers around the edges of the larger issue of a structural deficit on the order of 6% of GDP.

Discretionary spending accounts for only 27% of total federal government outlays, and the federal deficit is estimated to be $1.5 trillion in 2023. As shown in Chart 1, Congress would need to cut discretionary spending nearly to zero to balance the books if they only address discretionary spending. To seriously address the deficit, it needs to take the more courageous steps and look at mandatory spending – namely entitlements like social security and Medicare. Or, it needs to find a way to grow revenues at the same pace as population aging. Alas, courage seems in short supply in Congress these days.

Speaking of discretion in spending, real consumer spending was up a healthy 0.5% month-on-month in April. Spending was driven by robust gains in outlays on both goods and services. Monthly spending data has been very choppy over the past six months but comparing it to real income less transfer payments (which is a key recession indicator used by the NBER), you see that the upward trend in spending is outpacing real income growth (Chart 2).

Thanks to a strong labor market, real income gains have held up. Added to the cushion of excess savings built up during the pandemic, the consumer has been able to keep spending in the face of very high inflation, in turn contributing to demand-driven inflation pressures. Chart 2 suggests that spending is set to slow – even if the labor market doesn’t cool. About 60% of the excess savings cushion has been spent, and spending cannot outgrow income indefinitely before consumers will need to tighten their belts.

We expect that belt tightening to be in greater evidence as the year goes on. After consumer spending grew by 3.8% annualized in Q1, it is tracking a more modest 2% in Q2. We expect it to fall below 1% in the second half of the year, which will help to dampen inflationary pressures. Until then, the Fed is on the horns of a dilemma.

Its preferred inflation gauge, the core PCE deflator, remained around where it has been all year at 4.7% year/year in April. Markets are judging this could mean the Fed should push a bit harder on rates, with market odds tilting slightly in favor of another hike in June. We believe that the Fed will need to hold its courage and pause and assess the impact of the significant monetary policy tightening that has not yet had its full impact on economic growth.

Canada – SEPH Adds Brushstrokes to Labour Landscape

Second quarter bank earnings and investor sentiment around the U.S. debt-ceiling negotiations were the two factors moving equity markets this week, with the TSX tracking 2% lower at the time of writing. Meanwhile, economic data was in short supply. The most important release was the Survey of Employment Payrolls and Hours (SEPH) for the month of March. Relative to the household survey, SEPH is less timely as it provides employment measures with a two-month lag and captures only payroll employees, excluding self-employed. Still, the survey is closely watched as it provides additional insights into earnings and industry-level payrolls, as well as measures of labour demand.

According to the SEPH, employment fell 10k in March, led by declines in the goods producing sector, with construction and manufacturing reporting the largest losses which were only partially offset by gains in utilities – the only industry with an increase in hiring. This is comparable with estimates reported by the household survey for the month of March. However, within the services sector, payrolls declined by 17k, while households reported growth of 35k.

The demand side of the labour market showed marginal easing in March. The number of job vacancies was down by 17k, resulting in a cumulative contraction of 56k since the beginning of the year and 188k relative to May 2022 (when job vacancies reached their peak). Since then, the number of unfilled positions declined by more than 20k in accommodation & food services, manufacturing, trade and professional services – industries that jointly accounted for more than half of the change in labor demand (Chart 1).

The improvement in March, made no mark on the measure of labour market tightness. The ratio of jobs points to unemployed remained at 0.8 – unchanged from February. This is still much higher than an average of 0.5 vacancies per unemployed observed in 2019. Based on the current level of employment, we would need to vacancies to fall by roughly another 300k in order to restore better balance in the labour market and help normalize wage pressures.

Speaking of wages, the SEPH showed a continued deceleration in year-on-year estimates of average hourly earnings to 3.0% in March (from 4.1% in February). However, the loss in momentum is partially attributed to base effects as it's measured against a sizeable spike in March of last year, which could reverse in the following months. In addition, the more recent measure of wage growth as reported by the Labour Force Survey remains elevated at 5% – a significant divergence from the SEPH estimate (Chart 2). Evidently, the path to normalization in the job market won't feel like a downhill journey.

It sure doesn’t for small business owners. According to May's small business barometer, wage costs remain the biggest concern, with 68% of them reporting elevated labour costs as the biggest headwind businesses are facing today. With that, average wage increase plans for the next year were softer at 3.2%. All told, this week's data provides additional information on the labour market situation, but doesn't make a strong case for the BoC to come off the sidelines just yet, even if markets have started to price another 25 basis point hike next month.

We expect next week’s Q1 GDP report to show a strong start to 2023—with real output up 2.5% on an annualized basis. Aside from a significant add from exports (thanks to a rebound in motor vehicle and parts), domestic demand was probably on the softer side. And rate-sensitive sectors continue to be squeezed by tighter monetary policy. This has had the most notable impact on residential investment, which we expect to post another significant decline. Business investment is also expected to have slowed and our own RBC cardholder data signaled softening discretionary goods-sector spending throughout the quarter. Resilience gave way in March. Monthly GDP data is likely to be broadly in line with Statistics Canada’s initial flash estimate for a 0.1% decline in March. Weakness in wholesale and retail trade and residential investment was enough to offset strength in manufacturing sales.

We anticipate another small monthly decline in April. The strike by workers with the Public Service Alliance of Canada (PSAC) is expected to shave 0.3 percentage points from April GDP. But aside from public sector weakness, activity was likely largely flat. The impact of the Bank of Canada’s aggressive rate hikes will continue to be felt with a lag as household debt servicing ratios become more burdensome. Demand is expected to weaken into Q2 as Canada enters a mild recession.

Next week’s monthly GDP release will be the final reading before the Bank of Canada’s June rate decision. An increase in headline CPI in April and four months of exceptionally strong labour market data have increased the risk of an additional hike. However, softening monthly GDP may help solidify the Bank of Canada’s present stance of staying on the sidelines (for now).

Week ahead data watch

U.S. employment numbers will likely come in weaker in May. The unemployment rate is expected to tick slightly higher but remain at historic lows. While U.S. labour markets remain exceptionally strong, early signs of a slowdown are emerging. U.S. job openings and quits are trending lower as wage growth slows.

US

Wall Street is starting to get nervous as we near the X-date.  A US default seemed unimaginable a couple of weeks ago and despite a lot of positive comments from both sides, negotiations will go down to the wire and that means the risk that it falls apart is growing.  Treasury Secretary Yellen will soon provide an update on the X-date and that could show talks might have an extra week from the current June 1st deadline to get a deal done.

Economic data for the week will focus on the labor market, consumer confidence, and ISM manufacturing report.  The US economy is expected to show job growth softened from 230K to 180K in May. Consumer confidence is expected to decline from 101.3 to 99.8 and manufacturing activity is expected to remain in contraction territory.

This week contains a handful of Fed appearances, with Barkin talking about monetary policy on Tuesday, Collins and Bowman attending a Fed Listens event on Wednesday, and Harker speaks twice, once on macroeconomic conditions, and the other time about the economic outlook. The Fed will also release its Beige Book Wednesday. A steady dose of hawkish speak along with solid job growth could make the June FOMC meeting a live one.

Eurozone

Monday is a bank holiday for some countries including Germany and France but the rest of it is filled with economic data and central bank speakers. The standouts on the economic calendar are the flash HICP data on Thursday – which follows individual country inflation numbers earlier in the week – and accounts from the last ECB meeting on the same day. Also on that day, we’ll hear from ECB President Christine Lagarde, which will arguably be more insightful, particularly in light of recent data from the US and UK which showed the economies to be resilient and inflation stubborn. Is that a concern for the ECB and are investors being too optimistic on rates?

UK 

The week starts with a bank holiday and it doesn’t really pick up from there. BoE policymakers have been everywhere the last couple of weeks and it seems most are planning a week out of the spotlight which may be no bad thing. The economic data has not delivered what they wanted forcing investors to reluctantly price in four more hikes over the rest of the year. There’s no data of value next week, with the final manufacturing PMI arguably the highlight.

Russia

Unemployment is expected to tick higher to 3.6% on Wednesday, up from multi-decade lows of 3.5% and perhaps a sign of a slightly weakening labor market. The manufacturing PMI on Thursday is the only other notable release.

South Africa

A quiet week following the SARB decision on Thursday to hike rates by 50 basis points, taking the repo rate to 8.25%. This came after data on Wednesday showed inflation cooling to 6.8%, just above the 3-6% target range but the central bank warned that the risks remain to the upside.

Turkey

The run-off Presidential election on Sunday is undoubtedly the highlight of the next week. The lira hit a record low against the dollar on Friday ahead of the vote, with President Erdogan widely expected to emerge victorious after almost clinching 50% of the vote in the first round. The lira could suffer more if the result is confirmed as it means the monetary policy experiment will likely continue. A surprise victory for Kemal Kilicdaroglu could be very interesting on the open, as a potential return to normal policymaking could have a huge impact on the currency. And it would also occur in thin markets with so many countries enjoying the bank holiday break.

Switzerland

An appearance from SNB Chair, Thomas Jordan, on Wednesday will be the highlight next week but we’ll also get GDP data on Tuesday, retail sales on Wednesday and the manufacturing PMI on Thursday. An unusually busy week.

China

It will be a key PMI week in which the NBS manufacturing and non-manufacturing PMIs for May will be released on Wednesday. Another month of contraction is expected for manufacturing to 49.4, a slight improvement from 49.2 in April. As for services, a dip to 55 is expected from 56.4 in April.

On Thursday, we will have the release of the Caixin manufacturing PMI for May which consists of the coverage of small and medium enterprises. Another month of contraction is expected, slipping to 49.3 from 49.5 in April. If manufacturing and services are lackluster, it will provide further evidence that the growth spurt from China’s re-opening is likely to have disappeared.

India

A couple of key data to watch. Firstly, Q1 GDP on Wednesday where a 5% year-on-year growth rate is expected, above the 4.4% y/y recorded in Q4 2022.

Next up on Thursday, we will have manufacturing PMI for May, a dip in expansion is expected to 55.8 from 57.2 printed in April. If it turns out as expected, it will be the first growth slowdown after three consecutive months of growth expansion. Lastly, on Friday, bank loan growth for May will be released.

Australia

A few data releases to focus on. On Tuesday, building permits for April, 2% month-on-month growth is expected, up from -0.1% in March.

On Wednesday, we will have the monthly CPI indicator for April, which is expected at 6.3%, unchanged from March. On the same day, private sector credit growth for April will be released, with a slight dip to 6.4% from 6.8% in March, expected. If it turns out as forecasted, it will be the sixth consecutive month of a growth slowdown.

On Thursday, retail sales data for April is expected to show zero growth month-on-month from 0.4% in March.

New Zealand

Two key data releases to watch next week. Firstly, ANZ business confidence for May on Wednesday where the consensus forecast is -42 from -43.8 in April. If it turns out as forecasted, it will mark the 23rd consecutive month of negative readings.

Lastly, Q1 terms of trade, export prices, and import prices on Friday. A contraction of 1.8% quarter-on-quarter from 1.8% in Q4 2022 is expected. Export prices are expected to decline further to -2.7% quarter-on-quarter from -0.6% while a slower pace of decline is expected for import prices at -1.3% month-on-month from -2.1%.

Japan

On Monday, the unemployment rate for April is expected to improve slightly to 2.7% from 2.8% in March while April’s jobs/applications ratio is expected to hold steady at 1.32.

After an upbeat flash manufacturing and services PMI data for May, the attention for this week will be on retail sales and industrial production data for April, released on Wednesday. Retail sales are expected to record a slight dip to 7% year-on-year from 7.2% in March, while industrial production is expected to increase at a faster rate of 1.5% month-on-month, from 1.1% in March.

On Wednesday, we will have consumer confidence and housing starts. Consumer confidence for May is forecasted to improve to 36 from 35.4 in April. If it turns out as expected, it will be the 4th consecutive of improvement in consumer sentiment. Housing starts for April are expected to improve to -0.9% year-on-year from -3.2% printed in March.

Given that the Nikkei 225 has just hit a 33-year high, it will be paramount to see the amount of stock investment by foreigners and data for the week ending 27 May will be released on Thursday.

Singapore

Two key data to focus on. Firstly, the PPI for April released on Monday where is forecasted to contract further to -12% year-on-year from -11.3% in March. If it turns out as forecasted, it will mark the fourth consecutive month of contraction.

On Friday, the manufacturing PMI for May is forecasted to improve slightly to 49.9 from 49.7 in April.

Economic Calendar

Saturday, May 27

Economic Events

• The US could announce an Indo-Pacific Economic Framework, or IPEF, if trade talks are successful with Japan, India, and South Korea

Sunday, May 28

Economic Events

• Turkish presidential runoff election between incumbent Recep Tayyip Erdogan and Kemal Kilicdaroglu
• Regional and municipal elections in Spain

Monday, May 29

Economic Events

• US Memorial Day holiday. Markets and federal offices closed
• Major European markets also closed for holidays: the UK observes Summer Bank Holiday, Switzerland and Germany closed for Whit Monday

Tuesday, May 30

Economic Data/Events

• US consumer confidence
• Australia building approvals
• Czech Republic GDP
• Eurozone economic confidence, consumer confidence
• Japan unemployment
• Mexico international reserves
• New Zealand building permits
• Spain CPI
• Sweden GDP
• Switzerland GDP
• Fed’s Barkin interviewed by NABE VP/Morgan Stanley chief US economist Zentner as part of NABE monetary policy webinar series
• ECB’s Holzmann speaks at a meeting of the Austrian National Bank and the European Investment Bank
• EU-US Trade and Technology Council meets in Sweden
• Panama Canal draft limit becomes effective and will impact the travel of large ships

Wednesday, May 31

Economic Data/Events

• US job openings, Fed’s Beige Book
• Canada GDP
• China manufacturing PMI, non-manufacturing PMI
• Finland GDP
• France GDP, CPI
• Germany CPI, unemployment
• India GDP
• Italy GDP, CPI
• Japan industrial production, retail sales
• Poland CPI
• Russia unemployment, industrial production
• South Africa trade balance
• Thailand rate decision: BOT expected to raise rates by 25bps to 2.00%
• Turkey GDP
• NATO foreign ministers start a two-day meeting in Oslo
• Fed’s Harker has a fireside chat on the global macroeconomy and monetary conditions at the Official Monetary and Financial Institutions Forum in Philadelphia
• Fed’s Collins and Bowman give opening remarks at the “Fed Listens” event hosted by Boston Fed
• ECB issues financial stability review
• ECB’s Visco presents the bank’s annual report for 2022
• SNB President Jordan speaks at a monetary policy conference in Lugano, Italy
• BOE’s Mann speaks at the Pictet Family Forum “Central banks, inflation, monetary policy” in Zurich
• Hearing on Riksbank monetary policy in Swedish parliament

Thursday, June 1

Economic Data/Events

• US construction spending, initial jobless claims, ISM Manufacturing, light vehicle sales
• Tentative X-date (when the US gov’t could run out of cash to pay bills)
• China Caixin manufacturing PMI
• ECB Minutes for May 3-4th meeting
• Eurozone HCOB Eurozone manufacturing PMI, CPI, unemployment
• France HCOB France manufacturing PMI
• Germany HCOB Germany manufacturing PMI
• Hungary GDP
• India manufacturing PMI
• Italy unemployment
• Japan capital spending
• UK S&P Global / CIPS UK manufacturing PMI
• ECB President Lagarde and German Finance Minister Lindner speak at German savings banks conference
• European leaders gather at the second European Political Community meeting in Moldova
• Fed’s Harker speaks on the economic outlook at NABE’s virtual monetary policy & outlook webinar
• Sweden’s Riksbank issues report on financial stability
• BRICS foreign ministers meet in Cape Town
• DOE crude oil inventories report

Friday, June 2

Economic Data/Events

• US May Jobs Report: 180Ke v 253K prior; Unemployment Rate: 3.5%e v 3.4% prior; Average hourly earnings M/M: 0.3%e v 0.5% prior
• France industrial production
• Mexico unemployment
• Spain unemployment
• Possible UK rail strike

Sovereign Rating Updates

• United Kingdom (Fitch)
• France (S&P)
• Finland (Moody’s)
• Germany (DBRS)
• United Kingdom (Fitch)

With investors flirting with the idea of one final Fed rate increase this summer and the dollar making a comeback, there will be increased emphasis on the next round of US employment data on Friday. Debt ceiling negotiations will also be front and center as the clock ticks down to a US government shutdown, while in Europe, there’s a batch of inflation numbers to shape the euro’s fortunes. 

Dollar looks to NFP for more juice

It’s been a fantastic month for the US dollar, which smoked the competition with a little help from interest rate differentials and safe-haven flows. With incoming business surveys highlighting the resilience of the American economy, investors have started to recalibrate the Fed’s rate trajectory higher.

Markets are currently pricing in a 40% probability for the Fed to raise rates in June, which increases to 85% when looking at the July meeting. Meanwhile, the rate cuts that were baked into the cake later in the year have been mostly priced out, as concerns of an imminent recession have melted away.

However, Fed officials are split on whether further tightening is needed. Some want to raise rates again, others would rather pause, but the majority is still on the fence, preferring to examine the next round of economic data before making any decisions.

As such, there will be increased attention on the latest employment report due Friday. Forecasts suggest nonfarm payrolls rose by 180k in May, less than the previous month but still a respectable number. The unemployment rate is set to tick up to 3.5%, while wage growth is projected to accelerate slightly in yearly terms.

Nonfarm payrolls have exceeded estimates 12 times in the last 13 months, so economists seem to consistently underestimate the strength of the labor market. This phenomenon might be repeated this time, as the latest business surveys from S&P Global pointed to the fastest increase in employment growth for ten months. They also highlighted rising salary pressures.

A surprisingly strong employment report could cement expectations for one final rate increase this summer, or lead investors to further unwind rate-cut bets, keeping the wind in the dollar’s sails.

Another factor that can boost the reserve currency is a selloff in stocks that fuels safe-haven demand. Paradoxically, the catalyst for such an event might be a debt ceiling deal. After a compromise is reached, the Treasury will scramble to raise its depleted cash levels by ramping up borrowing, unleashing a tsunami of bond issuance that can drain liquidity.

Other data releases include the JOLTS job survey on Wednesday, ahead of the ADP report and the ISM manufacturing index on Thursday. Note that several markets in the US and Europe will be closed on Monday for a bank holiday.

Euro grinds lower ahead of inflation stats

In euro land, the single currency has been under selling pressure for several weeks now. Some of that reflects the resurgent dollar, as the euro and the dollar are basically opposite sides of the same coin. However, there’s also an element of economic weakness creeping in.

In particular, the slowdown in the manufacturing sector has intensified, dragging the bloc’s manufacturing powerhouse - Germany - into a technical recession. That’s a huge problem for the European Central Bank as economic growth seems to be rolling over but inflationary pressures remain scorching hot, leaving policymakers in a bind.

Markets are still pricing in another 60bps of ECB rate increases in the coming months, so the focus will be on incoming data, starting on Wednesday with Germany’s inflation and unemployment numbers for May. Then on Thursday, investors will get a glimpse at the same releases for the entire Eurozone, alongside the latest ECB minutes.

Forecasts point to a cooldown in inflation, something supported by business surveys where average selling prices for goods and services rose at the slowest pace in two years in May. If inflation cools significantly, some of those ECB rate-hike bets could be unwound, spelling more trouble for euro/dollar.

Chinese, Canadian, and Australian releases

Over in China, the latest PMIs will be released Wednesday. The economy has lost steam lately as the reopening boom faded, so these surveys will reveal whether this worrisome trend persisted in May. If so, the currencies of nations that depend on Chinese demand to absorb their exports - such as Australia and New Zealand - could encounter further downside.

Speaking of Australia, monthly CPI data for April is out on Wednesday, ahead of Thursday’s capex data. In Canada, GDP growth numbers for Q1 will see the light on Wednesday.

Finally in Turkey, the second round of the presidential election will be held Sunday.

Markets' focus has been on the debt ceiling negotiations, and while time is running short, the parties seem close to reaching a deal. While risk sentiment recovered towards the end of the week, equities have generally headed lower and yields higher while USD has gained especially vis-à-vis cyclical currencies. Based on the short-end of the US T-bill curve, default worries appear to be concentrated on the first two weeks of June. The first date when the treasury cash balance is expected to decline to dangerously low levels is next Thursday, 1 June, unless Congress can agree on raising the ceiling before then.

And while the negotiations could once again go down to the wire, ultimately we do think a deal will be struck in time to avoid a default. Following the debt ceiling raise, the treasury will soon start rebuilding its cash balance, which is set to tighten USD liquidity conditions towards the latter half of the year. Even so, we see room for the Fed to continue QT into 2024, read more from FX Strategy - Time to focus on QT and USD liquidity, 24 May.

On the macro data front, May flash PMIs continued to paint a relatively upbeat picture, although a two-speed one, of the economy. Both growth and inflation pressures are driven by the services sector, with US indices signalling even accelerating growth. That said, we still expect growth to weaken towards H2, which we are also increasingly seeing in our quantitative business cycle model MacroScope: recovery stalling, 25 May.

FOMC May minutes illustrated divided views among the participants. Fed's recent commentary has highlighted that the doves, and not least Powell, prefer a more cautious stance going forward, while the hawks found it 'crucial' to underscore that cuts would not be likely this year and that further hikes could not be ruled out. Markets have almost fully priced in one more 25bp Fed hike by the July meeting and while we do not expect it to materialize, we see no room for cuts this year either.

Over the weekend, the Turkish presidential election run-off will take place between the opposition candidate Kemal Kilicdaroglu and the incumbent president Recep Tayyip Erdogan, who stands out as a favourite after nearly clinching the victory on the first round (with 49.5% of votes). We discussed Turkey, the war in Ukraine as well as US-China relations in our monthly Geopolitical radar - Spring offensive starting in Ukraine, 22 May.

Next week, the main focus besides the debt ceiling will be on the euro area flash HICP data for May, where consensus is looking for a slight moderation in core inflation pressures. On Friday, we expect to see another relative upbeat US Jobs Report. So far the signals from leading data have pointed towards healthy employment growth, which could be further supported by a renewed uptick in labour force participation. We think non-farm payrolls grew by a solid 200 thousand, and besides employment, markets will closely follow if the April uptick in average hourly earnings growth has persisted into May.

Full report in PDF.

Markets

It was a waiting game for a series of US April data to be released today. They didn’t disappoint, in every sense of the word. Numbers were better or higher than expected across the board, starting with durable goods orders. The headline figure rose a monthly 1.1% compared to a 1% decline penciled in by analysts. Shipments, often seen as a proxy for capital investment in GDP calculations, rose 0.5% vs 0.1% expected. Personal income rose 0.4% m/m, matching expectations but spending (0.8% m/m), including the gauge correcting for inflation (0.5% m/m), easily leaped above the bar. Turning to the main dish, PCE deflators. Headline April PCE accelerated on a 0.4% m/m pace to 4.4% y/y. Core PCE inflation also rose a monthly 0.4% to be up 4.7% compared to the same month last year. The latter since the start of the year fluctuated between 4.6% and 4.7%, suggesting a lot of price stickiness and a very wobbly, drawn-out disinflationary process. All readings, both monthly and yearly, core and headline, topped expectations by a tenth of a percent. Marginal, but telling. Core bond yields in one swipe higher erased all previous losses to the tune of 4 bps to trade a few bps in the green again. The short end of the curve again underperforms as markets now more than fully priced in a 25 bps July rate hike. The 2-y yield briefly topped the 4.60% on a >7 bps gain before paring gains to about 4 bps at the time of writing. Another nice gain as they go into a long weekend (Memorial Day on Monday). German yields were caught in the slipstream higher, wiping out declines to trade >1 bp higher. UK gilt yields take a breather going into a long weekend after an outright impressive surge up to 40 bps over the past few days. The front end sheds 4.6 bps though the very long end (30-y) still adds 1.6 bps. Retail sales in April were stronger than expected, with 0.5% m/m for the headline figure and 0.8% in the core reading (excluding auto fuel). But since they follow up on a downwardly revised March print, the net surprise is negligible.

The Swedish krone stands out on currency markets (see headline below). Taking stock of the kiwi dollar after the central bank over there unexpectedly formally finished its tightening cycle reveals a nasty 3% drop vs the USD. NZD/USD (0.606) dropped below the YtD lows yesterday and is unable to recover from that today. The US dollar recouped some of the losses it started the day with. EUR/USD ekes out a tiny gain to 1.073. The 1.0727/35 support zone is still very near. DXY hovers near but above 104(.1). Sterling is again attacking YtD closing highs around EUR/GBP 0.868 but it doesn’t look like a break is about to happen.

News & Views

Retail sales in Sweden rebounded 2.8% M/M in April, coming on the back two negative monthly readings registered in March and February. Sales in consumables increased by 1.8% M/M. Sales in durables gained 2.7%. During the February-April period sales still decreased 1.6% compared to the previous three-month period. Sales were also still 6.5% lower compared to April last year (was -10.8% in March). Yesterday, Swedish April unemployment data also were better than expected with the unemployment rate easing further from 7.7% to 7.5%. The data might be an indication that the Swedish economy is holding up better than expected. In its April monetary policy report, the Riksbank downwardly revised its forecast for 2023 household consumption from -0.6% to -1.2%. GDP growth was upwardly revised from -1.1% to a -0.7% contraction, but the was due to a better expected performance of next exports. At least for now, it is not sure whether the better April data will be enough for the Riksbank to take a more aggressive anti-inflation approach. The RB in March raised its policy rate by 0.5% to 3.50% and indicated a final 25 bps rate hike in June or September. The soft Riksbank policy approach recently weighed heavily on the Swedish currency. EUR/SEK yesterday traded at a historic low except for brief period in 2009. The currency regained some ground today with EUR/SEK declining from 11.60+ levels to currently near EUR/SEK 11.54. In this respect, Deputy governor Ana Breman this morning aired the idea of the Riksbank increasing the pace of sovereign bond sales if the koruna continues weakening. But is it a viable alternative for a (too) low policy rate?

Investors may have underestimated the pace of disinflation this year if economic data this week is anything to go by, with US figures today further enforcing the view that price pressures are stubborn and spending healthy.

The headline PCE price index brought the biggest surprise, jumping 0.4% on the month against expectations of zero increase, but the core reading also brought an upside surprise, as did spending which jumped 0.8%, double the consensus view.

Suddenly the jobs report next week looks like the last hope for the Fed pausing its tightening cycle next month and if recent data is anything to go by, no one can be feeling particularly optimistic. The economy is showing incredible resilience and if it is turning a corner, it's doing so painfully slowly. A soft landing is becoming harder to achieve and there's an increasing risk that central banks will have to go much further and accept the economic consequences. ​

How sustainable is the recent trend in UK household spending?

The cost-of-living crisis in the UK is not having the dampening effect on household spending that many anticipated and today's retail sales figures showed that once more. Bad weather depressed spending in March and by more than initially thought but it rebounded last month by 0.5%, maintaining the positive trend we've seen in recent months.

Resilience in household spending has been matched by an economy that has outperformed expectations and that positive feedback loop is probably encouraging consumers to keep going. The question now is how long that can last as higher interest rates continue to filter into the broader economy, and as markets price in much higher rates later this year as a result of better activity and higher inflation.

Lira hits new lows as Erdogan expected to coast to victory on Sunday

The lira rose above 20 against the dollar for the first time ever today, just 48 hours before the public goes back to the polls. The run-off between the incumbent, Tayyip Erdoğan, and Kemal Kilicdaroglu takes place on Sunday, and based on the first-round results, the current President looks like a firm favourite.

That is why the lira has crumbled again this past week, with investors forced to accept that an Erdogan victory means years more of experimentation with monetary policy and total disregard for the consequences. A surprise on Sunday, on the other hand, could see a quite dramatic reversal on the open next week.

Oil markets volatile ahead of OPEC+ meeting next weekend

Oil prices are recovering slightly after a volatile week amid conflicting commentary from key members of the OPEC+ alliance. From a "watch out" warning from the Saudi Energy Minister to a suggestion that the group will not cut output next weekend, traders have been left a little confused as to what we can expect.

It may be that Saudi Arabia wants to keep traders on their toes but to make these comments and not follow through could be perceived as weak and see prices drift lower again. Unilateral action may not pack the same punch as a group cut, although you wouldn't put it past them.

Gold hit by stronger US inflation numbers

Gold is paring losses at the end of the week but still looks vulnerable to further declines amid more unfavourable data. The US inflation, income, and spending data were another blow, indicating more resilience in the economy and stubbornness of price pressures. It's a common theme this week and a concerning one for policymakers that hoped they could ease off the brake after a gruelling tightening campaign.

The yellow metal broke below $1,960 on Thursday, a loss of key technical support, before trying and failing to break back above today in what could be viewed as confirmation of the initial move and a bearish signal. If it does continue to drift lower, $1,940 could be an interesting level of support, with $1,900 then being a notable psychological level.

Bitcoin correction continues, albeit slowly

Bitcoin is relatively flat going into the weekend and coming under some pressure in recent days. The cryptocurrency had been in consolidation after breaking lower earlier this month but retested recent lows around $26,000 yesterday, a level it remains above currently. A move below here could see attention shift back to $25,000 around the February peak, although even this would only represent a modest correction of the 2023 rally.

Personal income grew 0.4% month-on-month (m/m) in April, in line with market expectations. This marked a slight acceleration from the prior month's gain of 0.3%. Gains were led by compensation to employees, which rose 0.5% in April – up from 0.3% in March.

Subtracting inflation and taxes, real personal disposable income  held flat on the month, decelerating from 0.2% in March. In year-over-year terms, real disposable income was up 3.4% in April, an acceleration from 3.3% in March.

Personal consumption rose 0.8% m/m, accelerating from the 0.1% gain in each of the two months' prior. April's gain came in above market expectations for a 0.5% reading. Goods spending rose by 1.1% m/m, while services spending rose by 0.7% m/m.

Adjusting for inflation, real spending was up 0.5% from March, coming in above the consensus estimate of 0.3%. Goods spending rose 0.8% m/m, while services were up 0.3%.

The personal consumption expenditure (PCE) price deflator rose 0.4% m/m, and 4.4% on a year-on-year (y/y) basis – slightly above the market consensus forecast (4.3% y/y) and the 4.2% y/y reading in March.

The Fed's preferred measure of inflation – core PCE – rose 0.4% m/m, which was slightly above the consensus forecast and the March reading (both at 0.3%). Our calculations of "supercore" inflation show that it was up 0.5% - an acceleration from the 0.3% gain in March. On an annual basis, core PCE inflation accelerated to 4.7% y/y from 4.6% y/y the month prior. The measure has held in the 4.6-4.7% range since December 2022.

The personal saving rate was 4.1% in April, which was 0.4%-pts below the downwardly revised 4.5% reading in March.

Key Implications

Real consumer spending grew slightly above market expectations in April, leaving behind the sluggish performance of the two months prior and starting the second quarter off on a decent note. That said, consumer sentiment has continued to trend lower in recent months, while household credit standards have also been tightening (albeit at a moderate clip). These factors are in tune with our expectations for a more moderate spending growth profile this quarter. With April's data now in the books, our tracking is for consumption growth to slow from 3.8% (annualized) at the start of the year to around 2% this quarter.

The acceleration in core PCE inflation is not what policymakers are hoping to see. While the continued persistence in inflationary pressures alongside ongoing strength in the labor market suggest the Fed should push a bit harder on rates, uncertainties surrounding the regional banking crisis and the ongoing debt ceiling negotiations are clouding the path for monetary policy. We believe that holding rates steady and assessing the impact of past rate hikes remains the most likely path forward for the Fed. That said, the probability of another hike has increased recently, with market odds as of this morning tilting slightly in favor of another 25-basis point rate hike at the Fed's next meeting in June.

Daily Pivots: (S1) 139.18; (P) 139.70; (R1) 140.57; More...

Focus is back on 100% projection of 127.20 to 137.90 from 129.62 at 140.32 in USD/JPY. Firm break there will extend the whole rise from 127.20 to 142.48 fibonacci level. Nevertheless, on the downside, break of 138.22 support will indicate short term topping, and turn bias back to the downside for 55 D EMA (now at 135.39).

In the bigger picture, rise from 127.20 is seen as the second leg of the corrective pattern from 151.93 high. Stronger rally would be seen to 61.8% retracement of 151.93 to 127.20 at 136.34. Sustained break there will pave the way back to retest 151.93. On the downside, however, break of 133.73 support will argue that the pattern could have started the third leg through 127.20 low.