The dollar should be trading higher after yesterday’s US GDP report. The very short-lived USD jump against major currencies denotes how the FX market still has some tendency to give greater weight to negative news on US data compared to USD-positive news. But a lagged re-linking with higher rates and lower equities looks likely.
As discussed by our US economist here, the slowdown in US 1Q growth was quite substantial: in one quarter, the annualized growth rate was more than halved from 3.4% to 1.6% (consensus was 2.5%). Interestingly, consumer spending was quite weak too: 2.5% annualized versus a consensus 3.0%. What matters more for the Federal Reserve, however, is that core PCE inflation came in much higher at 3.7% QoQ annualised, from 2.0% in 4Q and above the 3.4% consensus.
This has direct implications for expectations on March’s PCE figures released today. Given that 1Q PCE numbers are a quarter-on-quarter measure, any revision from October through February may have influenced yesterday’s print. So, we could still get a 0.3% core PCE print today – consensus before the GDP report – although this is obviously less likely. Market expectations are probably close to 0.4% today.
The main drivers of FX all point to a stronger dollar: higher Treasury yields, widening swap differentials in favor of the dollar, and falling equities. There is a good chance that markets will scale back US rate cuts further if core PCE comes in at 0.4% month-on-month today. Pricing dynamics appear skewed to being trimmed to just one 25bp cut by year-end in the short-term (currently -40bp). Our rates team believes a move to 5.0% in UST 10Y is all but possible at this stage.
The FX market has moved autonomously since the GDP release yesterday, but it would not be the first time that the dollar reconnects with rates and equities with a small lag. We think this is likely to happen today or early next week unless PCE data surprisingly sacrifice hopes on inflation today. We believe DXY probably belongs to levels above 106.0 based on current market conditions.
Francesco Pesole
