Eurozone Q1 GDP growth slowed to 3.1% y/y (0.6% q/q) from the 6-year high of 3.3% y/y reached y in Q4 (0.9% q/q). The growth slowdown from Q4 was partially a result of the VAT tax in Germany , which dragged the nation’s growth rate to 3.6% from Q4’s 3.9%. Sterling hits 1-month and 2-month lows against the dollar and the euro after UK CPI slowed to 2.8% y/y from 3.1% y/y in March, reining expectations of further rate hikes from the Bank of England. Although the CPI figure was right in line with expectations, the slowdown supports the Bank of England forward looking assessment for a medium term retreat in inflationary pressures following short-term acceleration.
U.S. CPI will take center stage offering indication on whether the soft March figures were an aberration or a sign of peak in inflationary pressures. April CPI (due 8.30 am EST) is expected to have slowed to 0.5% from 0.6% while the core rate edging up to 0.2% from 0.1%. The more important figure will be the year-on-year core CPI , expected at 2.4% in April from 2.5% and 2.7% in March and February respectively. Although still above the Fed’s preferred 2.0% ceiling, a back to back monthly slowdown in core inflation should help temper markets’ inflation fears on the basis that a 2007 easing shall remain in the cards. A core annual figure of less than 2.5% is likely to be dollar negative and equity positive but the rest of the “reaction equation” will also depend on the NY Fed “Empire State” manufacturing survey (also due at 8.30 am).
The NY Fed survey is expected to have recovered to 8.0 in May from 3.8 in April and 1.9% in March. Since the April regional surveys (NY, Philly Fed, Chicago PMI) have all been weaker than the national ISM, an improvement in the April NY report would validate the strong ISM number in April and serve as boost to the dollar. A higher than expected U.S. CPI report would pose a considerable threat to U.S. equities as it could delay expectations of a Fed easing and further complicate the Fed’s policy dilemma. A sell-off in U.S. equities could potentially trigger an unwinding of global carry trades, especially if further signs of U.S. slowdown emerge from the NY empire survey. We stick with our expectations for continued signs of cooling inflation, especially as the slowdown in demand for labor and capital will add a significant weight on price growth. FX markets will also shed some attention on the 9 am EST release of the March TICS report on international capital flows, expected to show a total net foreign purchase of $30 bln for U.S. securities after $94.5 bln in February. The sharp March correction in U.S. equities could negatively impact the TICS survey due to a possible plunge in foreign demand for U.S. assets. The day’s other major data release (besides CPI) is the 1 pm release of the Homebuilders Survey expected to have remained unchanged at 33 in May after slowing to 36 in March. Markets’ growing sensitivity to the U.S. housing market was reflected yesterday when the Fed’s Senior Loan Office Opinion Survey reported “weaker demand for most types of loans”, triggering a short-lived sell-off in equities. Euro shrugs Q1 GDO rise, awaiting U.S. CPI EURUSD remains adrift at 1.3530s despite the better than expected Q1 GDP (3.1% vs 3.0%) as the downside risks to the currency remain tied to a potential recovery in U.S. CPI, which could boost the dollar on delayed expectations of a Fed cut. A core CPI figure of 2.5% or more could drag the pair towards 1.35 especially if the NY Empire survey recovers to at least 6.0 or 7.0 from April’s 3.8. Subsequent support stands at 1.3470 followed by 1.3420. But in the event that U.S. stocks sell-off due to a high CPI, we expect the unwinding of the carry trade to maintain the euro within the 1.3500-50 range. A weak CPI and weak NY Fed index is seen lifting the pair towards 1.3560. Key resistance stands at the 1.3590 trend line resistance.
We mentioned in yesterday’s note that “the action continues to be in EURGBP”, forecasting a rally to 68.50 pence. The cross pair has hit a 2-month high of 68.65, but expected to face resistance at 68.65.
USDJPY lifted by weak Japanese data, depends on risk appetite USDJPY is finally seeing some volatility, with the unexpected 4.5% decline in Japanese machinery orders boosting the pair towards the 120.55 high before the slowdown in UK inflation triggered a boost to low yielding currencies at the expense of higher yielding ones. The main source to the USD/JPY downside will be a negative reaction in U.S. equities to resurging inflation fears. A weak figure in the TICS survey could also cause a drag on the pair. We expect the pair to gather fresh strength in the event of a moderate CPI rise -- 2.5% or 2.6% core CPI. Upside initially capped at 120.55, followed by 120.75. Interim support stands at 120, with prolonged downside at 119.70 and 119.30.
Sterling sold across the board on CPI slowdown
Today’s slowdown in the CPI to 2.8% from 3.1% is the latest of a series of sterling-negative figures, following yesterday’s benign PPI and last week’s 0.2% decline in March industrial production. Although the CPI figure remains well above the central bank’s 2.0% target, the scalding down of future rate hike expectations could significantly weigh on the pair. A sterling sell-off would be especially the case in the event of renewed turbulence in global markets as speculators unwind from high yielding plays.
Cable stabilizes near 1.9750 –just above the 38% retracement of the 1.9179-2.0131 rise. Further downside is seen targeting 1.9720. Upside capped at 1.9830 and 1.9855.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
140 Broadway, 30th Floor
New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
