Dollar depreciation enters third month following disappointing US data
18/May/2015 • Currency Updates•
The Dollar sell off gathered speed last week as a puzzling dichotomy developed in US data. Most economic numbers have been surprising to the downside, with the conspicuous exception of labour market indicators.
Nevertheless, interest rate markets continue to push back their expectations for a first Federal Reserve rate hike. This, combined with the still high overhang of stale Euro shorts, is fuelling a very sharp counter rally in most major currencies against the Dollar which is particularly strong among European currencies.
As overhang continues to be cleared out (and last week positioning reports seem to indicate that this is, in fact, happening), we expect the Dollar to stabilise over the next couple of weeks.
The highlight of last week’s Sterling trade was the release of the Bank of England May Inflation Report. The takeaway is mixed. Inflation is expected to remain close to zero for most of the year, possibly dipping into negative as oil prices continue to weigh on price growth. However, there is “little sign” of the country slipping into a prolonged period of deflation.
The central bank is becoming gloomier about the recovery in UK productivity, which has remained subdued in recent years as a result of a disproportionate pick-up in low productivity jobs. This appears to be the driving force behind the central bank’s downgrade of the growth outlook, despite not triggering a similar downgrade in the inflation outlook.
More critically, there were few signs that the MPC is uncomfortable with current market expectations that the first interest rate hike will not come until well into 2016. However, the labour market report, released just a few hours earlier, struck a positive note. It confirmed the modest acceleration in wages that we have been witnessing since 2013; they are now increasing at well over 1% above inflation. In view of this trend, we think it is unlikely that rates can remain at their current rock bottom levels for more than a year.
GDP growth in the first quarter came out at a slightly disappointing 1.6%, against the 2% expected by market consensus (and ourselves). The downward surprise was mostly due to a slowdown in Germany to just 1.1% annualized growth, dragged down by a large drop in net exports. By contrast, Italy, France, and (especially) Spain all showed modest growth, including an acceleration to 3.6% in Spain.
We now look to flash business sentiment PMIs, to be published this week, for clues to whether this slowdown is just a statistical artefact or something to be worried about – we suspect the former, but higher oil prices are a legitimate worry going into the second quarter.
We were looking to April retail sales for confirmation of a rebound in consumer spending after the winter slowdown. It was not to be.
Both headline and core retail sales were unchanged last month. Although overall consumer spending is holding up better, we are puzzled by this poor performance, given that the labour market and worker incomes have performed well recently. Weekly jobless claims continue to post cycle lows, and the jobs opening report published last week was also positive.
While we still expect this dichotomy of data, between labour market and consumer spending indicators, to be resolved in line with the results of the former, we are pushing back our expectations for the first Federal Reserve hike from June to July.