FX markets are a little calmer, but traded volatility levels remain elevated. What interests us today is the February Balance of Payments data in the eurozone and the Bank of Canada rate decision. Later today, we’ll also have a speech from Fed Chair Powell and February data for China’s holdings of US Treasury bonds. In all, expect US Dollar to trade on the soft side
USD: Focus Could Switch to the Fed
Traded levels of FX volatility have edged down a little, but they’re not collapsing. And equally, the dollar has been slow to reclaim any of its recent losses even as equity markets have stabilised. Looking back at last week, we think most asset classes reacted as they should have to the trade shock – apart from Treasuries.
Here, as the dust settles, it looks as though we’ve seen an unwind of highly leveraged long positions as hedge funds wagered on reforms to the Supplementary Leverage Ratio.
If this is the correct interpretation of events – rather than a mass foreign exodus from the US Treasury market – then US yields can settle a little lower and the dollar does not need to rally much. On the subject of foreign selling of US Treasuries, tonight sees data released on Chinese holdings for February. We doubt it would show much of a change in China’s $760bn of holdings, but if we’re wrong, a drop could trigger another bout of both US Treasury and dollar selling.
When it comes to US macro, today should see some decent March US retail sales as consumers front-loaded purchases ahead of incoming tariffs. We doubt the market will want to chase the dollar too much higher on any good news here. Instead, the market will be far more interested in what the Fed makes of the current economic conditions.
Chair Powell speaks on the subject at 19:30 CET tonight. If you haven’t seen it already, the Fed’s Christopher Waller’s speech on Monday is a must-read. It’s clearly dovish. He presents two scenarios: the current effective 25%+ tariff is here to stay (see our own James Smith’s calculations here) or tariffs negotiated back to 10%.
Notably, neither scenario delivers a permanent inflation shock, and on the former scenario, his thoughts are that the Fed should cut rates earlier and more aggressively to avoid the unemployment rate heading up to 5%. With long-term inflation expectations derived through the USD 5y5y inflation swap currently falling to new lows, a similarly dovish speech from Powell tonight could weigh on the dollar.
We suspect any bounce in DXY to stall in the 100.25/50 area before we see a break of 99.00.
Elsewhere, the Bank of Canada announces policy at 15:45 CET. After 225bp of easing and, crucially, the USMCA goods exemption from US tariffs, we think a hold is slightly more likely than a cut today (here is our full preview). But this is a very close call, especially considering that yesterday’s CPI data for March surprised on the downside, which pushed pricing slightly more on the dovish side (11bp priced in this morning).
Like in many USD crosses, short-term rate differentials are playing second fiddle to idiosyncratic USD risks and tariffs in USD/CAD. Accordingly, the pair is quite cheap, below 1.40. The loonie is not as well-positioned as European currencies to benefit from rotations away from the USD, but we expect any USD recoveries to be gradual, if anything, and USD/CAD can still attract sellers around the 1.40 level in the near term.
EUR: Insights Into the Rotation Story
Eurozone Balance of Payments data is typically not a market mover, but today’s release of the February data could add weight to the story of a rotation out of US equities and into the eurozone – as some buy-side survey data suggested at the time. The data won’t break down what has left US equities, but it should tell us what has come into eurozone equity markets.
For reference, in the 12 months to January, eurozone residents put EUR134bn into non-EZ equity markets. This number should in theory fall if eurozone residents are repatriating.
Equally, foreigners bought EUR334bn of eurozone equities over the same period. This number should increase if foreigners (especially US asset managers) are increasing their exposure to Europe, helped by the fiscal stimulus news that month. If the above turns out to be true, investors should have a little more faith in the EUR/USD rally.
EUR/USD may have already put in a short-term low and be heading back through the 1.1425 area to test 1.1500.
GBP: Welcome News on Services Inflation
Sterling is a little weaker this morning as UK services inflation dipped back to 4.7% in March. At the headline level, CPI has dropped to 2.6% YoY, but our UK economist, James Smith, believes it could push back to 4% by the end of the third quarter on energy prices. Far more interesting, he thinks, will be services inflation in April and May.
He believes this could drop still further, even though the Bank of England forecasts a bounce back above 5%. If he’s right, markets will cement their views of three Bank of England rate cuts this year – the next one in May.
EUR/GBP is unwinding some of last week’s spike, but a big EUR/USD bull trend suggests EUR/GBP can find some support near 0.85, and a reversal back to 0.86 is likely over the coming months. GBP/USD is dominated by the soft dollar story and has last yera’s highs of 1.3430 in its sights.
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