USD – Dollar May Receive Most Support From Outside Events This Week
We can probably all agree that there are three key themes driving the dollar right now. The first is the Fed’s aggressive tightening outlook, as it responds to core inflation above 6%. Importantly, Fed cycle expectations remain firm, with a quoted terminal rate close to 3.25% next year. The second is the tragedy of the war in Ukraine, which has caused a stagflationary impact that has been felt more deeply in Europe. And the third is China’s enthusiastic pursuit of its Covid zero strategy, which is now triggering a new round of growth downgrades and disruptions to global supply chains.
What is the path for these topics this week? Let’s start with Ukraine. The G7 has pledged to put an energy embargo on Russia as soon as possible and the fact that the US is now sanctioning executives at Gazprombank, the key transit for European energy payments to Russia, seems like a sign that a Full energy embargo is near. This has implications for European growth. The market will also be watching for any fresh messages today from the Kremlin on Russia’s victory day commemoration. Any benign communication here seems unlikely.
Turning to China, investors continue to assess the outlook for China’s economy and asset markets. The onshore renminbi has broken above the important 6.70/USD level today. As we have recently noted, the loss of the USD/CNY anchor added to global currency volatility and affected currencies correlated to China such as the South African Rand and the Brazilian Real. An additional layer here could be investors’ reluctance to hold BRICS currencies as ‘sphere of influence’ geographical preferences begin to emerge. With industrial metals down another notch, it still seems too early to announce the bottom of the renminbi.
Perhaps the best chance for dollar stability this week comes from US April CPI data released on Wednesday. Lower gasoline and used car prices should see headline and core CPI lower from their highs. Any larger-than-expected drop could perhaps suggest that the Fed does not need to be as aggressive in its hike plans. And there are also plenty of speakers from the Fed this week. But some easing of the Fed’s tightening profile seems wishful thinking at this stage and positioning against further dollar strength seems dangerous.
DXY is now trading at the highest levels since 2002. Barring the US inflation figure being much weaker than expected on Wednesday, we should expect it to rise further. At the same time, US 10-year real yields are slipping ever deeper into tightening territory, creating a difficult time for equity and credit markets, favoring risk-averse positioning.