May has so far brought a weak dollar, strong risk sentiment, and growing expectations for Federal Reserve easing. A data-gripped market may, however, need to find the next catalyst for a big move outside of data. Our US economist notes that existing homes sales and durable goods orders should be soft this week, although that appears to be a consensus call. The same should be true for the S&P PMIs on Thursday, which are anyway secondary in importance to the ISM surveys.
Wednesday’s FOMC minutes (1 May meeting) could be quite interesting. Remember that the May meeting disappointed the hawks and some members (like Neel Kashkari) have since then tried to feed markets the risk of another hike if necessary. The focus will be on the reasons for the committee to stay generally optimistic on disinflation, which can guide the future data-monetary policy reaction function.
Barring surprise references to rate hikes or a very dovish consensus view in the committee, the short-term implications for the FX market may not be huge, and a wait-and-see, low volatile environment may be the norm ahead of the 31 May core PCE print. A stabilisation in the 104/105 area in DXY is our base case for this week, although we see the balance of risks as slightly tilted to the upside as markets may further unwind the post-CPI rally in pro-cyclical currencies. Some upside risks for the dollar may also stem from a tightening in the oil market following the death of Iran President Ebrahim Raisi in an helicopter accident and some health concerns for Saudi King Salman Bin Abdulaziz. So, far the market impact of these Middle East developments has been contained.
Remember that the yen is often an underperformer in low-volatility environment as yen-funded carry trades grow in popularity. There is no denying this is a rather stretched strategy in FX, and a net short JPY positioning worth 42% of open interest as per CFTC data is a testament of this. At the same time, that same short positioning gauge was at 54% a month ago – and should the market start to doubt the sustainability of Japan’s FX interventions, picking a top for USD/JPY will prove tricky. For now, we think that a move back to the 156.50 pre-US CPI region is very much possible this week. If expectations for a slowdown in Japanese inflation in April are confirmed this Friday, a new leg higher can be unlocked in USD/JPY.
Elsewhere, New Zealand’s central bank will announce policy this week. As discussed in our meeting preview, slow disinflation should not prompt a material dovish shift by policymakers despite a recession and looser jobs market.
Francesco Pesole
