Bad news is bad news again. Stock markets, Treasury yields, and the dollar all declined yesterday when revised data showed the US economy expanding by less than initially estimated in the first quarter. Gross domestic product rose at a 1.3 annualised rate in the first three months of the year, sharply lower than the 1.6 percent originally calculated, and much slower than than the 3.4-percent pace hit in the last quarter of 2023. An inflation measure was also revised down to 3.3 percent from 3.4 percent, and household spending, a critical driver of overall growth, was marked down to 2 percent from the 2.5 percent previously assumed.
Ultimately, we suspect growing evidence of slowing momentum will lend greater credence to the Fed’s steadfast belief in the restrictiveness of current policy settings. Speaking yesterday, New York Fed President John Williams expressed confidence in the path ahead, “With the economy coming into better balance over time and the disinflation taking place in other economies reducing global inflationary pressures, I expect inflation to resume moderating in the second half of this year,” saying “The behaviour of the economy over the past year provides ample evidence that monetary policy is restrictive in a way that helps us achieve our goals”.
Odds on a “hawkish cut” from the European Central Bank at next week’s meeting are rising after inflation in the common-currency area showed signs of acceleration. According to Eurostat, consumer prices climbed 2.6 percent in the year to May, up from 2.4 percent in the prior month, and above market expectations for a 2.5-percent print. Core prices – which exclude food and energy categories – hit 2.9 percent, up from 2.7 percent on an increase in services costs. We expect this to translate into a more aggressive rhetorical stance in coming weeks, with monetary policy officials warning investors not to expect back-to-back cuts at subsequent meetings.
The euro is trading with a firmer bias as markets price in a slower pace of easing in 2024, but it is important to note that for all the talk of monetary “divergence” that has dominated sell-side research notes, the number of rate cuts expected from the major central banks by December has moved down in relative synchrony this year. Although the leaderboard has changed somewhat as the US economy has demonstrated surprising resilience, the dispersion between near-term policy expectations implied in overnight index swap prices is actually slightly narrower than it was in mid January. Our long-expected rise in currency volatility simply hasn’t come to pass.
The Japanese yen remains weak after data was released showing that central bankers spent ¥9.79 trillion yen defending the spot rate in the last month. The intervention disclosed by the Ministry of Finance between April 26 and yesterday was slightly larger than market estimates derived from the Bank of Japan’s accounts, but isn’t big enough to trigger fears of a warchest so diminished as to limit further action. Extraordinarily-wide rate differentials and carry trade activities are keeping the currency under sustained pressure, but short-sellers remain wary of the central bank’s capacity to limit “disorderly moves” lower, so the exchange rate has declined at a relatively gradual pace in recent weeks. After this month’s action, we estimate Japan’s remaining currency reserves at roughly $1.09 trillion dollars, and authorities have a range of other tools available to limit weakness in the yen – including instructing the circa-$1.5 trillion dollar Government Pension Investment Fund to shift its asset allocation activities.
This morning’s personal consumption expenditures report is expected to show both core and headline inflation measures cooling somewhat, rising just 0.3 percent on a month-over-month basis in April. The report should also show personal outlays slowing, income growth decelerating, and savings rates declining as households continue to spend beyond their means. An undershoot, particularly in the core price print, could see equities and risk-sensitive currencies rally as market participants raise the odds on rate cuts before year end. In contrast, a topside surprise might trigger a renewed rally in yields by bolstering fears of a re-acceleration in inflation pressures.
Assuming that US personal consumption numbers don’t overwhelm markets, Canada’s first-quarter gross domestic product report might help stabilise the loonie. Output is seen expanding at a 2.2-percent seasonally adjusted annual rate in the first three months of the year, and a preliminary estimate for April could show growth accelerating into the early spring as last year’s easing in financial conditions translates into a recovery in rate-sensitive areas of the economy. A summer rate cut from the Bank of Canada remains overwhelmingly likely, but without a crisis to focus minds, policymakers may favour the July meeting – which coincides with the next set of business and consumer surveys – as a jumping-off point.
But one of the fundamental drivers behind the Canadian dollar’s recent underperformance became a little more clear with yesterday’s release of first-quarter balance of payments data. In nominal 4-quarter rolling sum terms, Canada’s net basic balance – the broadest measure of capital flows in and out of the country – fell to a historic low in the first three months of 2024 as domestic investors and businesses moved money out of the country, and as foreign investors lost interest in Canadian assets. The current account spent a seventh consecutive quarter in negative territory, net portfolio flows were deeply negative for a second quarter as Canadian investment abroad outpaced foreign investment in Canada, and the sale of HSBC’s operations to RBC widened an already-gaping net foreign direct investment deficit.
Capital is the lifeblood of a modern economy – particularly one as indebted as Canada’s – and net outward flows have negative implications for investment and growth.
