• Fed speak. Chair Powell endorsed the upswing in rates pricing by noting the lack of further progress on inflation. US yields rise, equities fall.
• USD support. The rates outlook is underpinning the USD. AUD touched its lowest level since mid-November with USD trends overpowering China GDP.
• Priced in? Markets are now discounting a very ‘hawkish’ Fed interest rate outlook. The lofty USD may need another catalyst to move even higher.
Market sentiment has stayed on the defensive as the outlook for ‘higher for longer’ US interest rates continues to sink in. The major European equity markets fell overnight (EuroStoxx50 -1.4%), and the US S&P500 (-0.2%) had its third straight fall as bond yields rose. US yields climbed another 7bps across the curve with the 2yr (now 4.99%) and 10yr (now 4.67%) rates touching ~5-month highs as US Fed Chair Powell endorsed the upswing in interest rate pricing. According to Chair Powell the recent data shows a “lack of further progress on inflation”. As a result, it will take longer for the Fed to have confidence about the path forward for inflation and hence “it is appropriate” to give “restrictive” policy settings more time to work.
In FX, the USD remains firm with economic developments outside of the US also having an impact. USD/JPY continues to track the upswing in US yields to be at multi-decade highs (now ~154.67). We believe the risk of intervention by Japanese authorities to prop up the weak JPY is elevated. EUR is hovering near multi-month lows (now ~$1.0618) with ECB President Lagarde repeating that a rate reduction is on the horizon if the slowdown in Eurozone inflation stays on track. GBP (now ~$1.2429) also eased. Bank of England Governor Bailey noted that UK inflation dynamics are diverging with the US, supporting assumptions the BoE could move earlier and more quickly than the US Fed. While UK wages defied gravity, signs that the cracks in the broader UK labour market are widening came through with employment contracting and unemployment rising more than forecast. UK CPI is due today (4pm AEST).
Elsewhere, USD/CAD hit its highest level since November (now ~1.3827) with the slowing in Canadian core inflation keeping a mid-year BoC rate cut on the table. USD/SGD (now ~1.3647) remains around the top of the range it has occupied since early-November. And the AUD touched a fresh 2024 low (now ~$0.64) with the acceleration in Q1 China GDP (1.6%qoq) and signs of improving momentum across the commodity intensive industrial side overpowered by the USD trends and negative vibes stemming from yesterday’s slightly weaker CNY fixing reference rate.
As our chart shows, when you compare the blue and red lines there has been a substantial repricing in US interest rate expectations since late-2023. This has been a driver behind the USD’s recovery. While the USD looks set to remain supported by the higher US rates structure near-term, we doubt that further large gains are likely as a lot of good news appears baked in, the ‘hawkish’ rates repricing looks to have largely played out, and based on where the major currencies now sit compared to core drivers, fair-value estimates, or history.
AUD Corner
The AUD has remained on the backfoot. The lift in US bond yields and firmer USD on the back of Fed Chair Powell’s validation of the upward repricing of US interest rate expectations given the questions about the outlook for inflation has continued to sap risk sentiment and pushed the AUD to its lowest level since mid-November (now ~$.64). The AUD has also underperformed on the crosses with falls of ~0.2-0.6% recorded against the other major currencies over the past 24hrs. AUD/EUR has slipped below its 200-day moving average (~0.6040), AUD/CNH is around 5-month lows (now ~4.65), AUD/GBP is tracking near the bottom end of its 2024 range (now ~0.5150), while AUD/NZD is close to ~1.0870 after Q1 NZ CPI showed domestic price pressures remain elevated and improving very slowly.
We feel that the AUD’s underperformance on some of the crosses like AUD/EUR, AUD/GBP, AUD/CAD, and AUD/CNH is overdone. From our perspective, yesterday’s China data was encouraging. China’s economy got off to a solid start in 2024 with GDP growing by 1.6%qiq. Notably, activity across secondary industries (i.e. construction & manufacturing) outpaced tertiary industries (i.e. consumption, services etc.) as stimulus measures gain traction. The data supports our thinking that authorities will rely on infrastructure/construction to shore up the economy. Secondary industries are more commodity intensive (and hence AUD important), and historically when growth across this part of China’s economy outstrips consumption it tends to be a more positive backdrop for pairs like AUD/EUR. This also fits in with the relative interest rate outlook with central banks like the ECB, BoE, and BoC set to move ahead of the RBA, in our opinion, given Australia’s sticky domestic inflation pulse.
The AUD’s next domestic event risk is tomorrow’s March jobs data. After the stellar report a month ago analysts are looking for more modest employment growth and uptick in unemployment. From our perspective, signs the Australian labour market is still on firm footing could give the AUD some support. More broadly, as discussed above, while we believe the USD may remain firm near-term, we think a lot of the upswing (and in turn the AUD’s pullback) has now played out with US interest rate pricing unlikely to shift up much further. Added to that bearish AUD position (as measured by CFTC futures contracts) is high, the AUD is trading at a discount (the average across our suite of fair-value models is sitting at ~$0.6550), Australia’s supportive capital flow position remains in place, and the AUD has struggled to sustainably trade much below where it now is. Since 2015 the AUD has only traded below ~$0.64 ~4% of the time.
