Australian dollar against four dimensional chess


Markets were closed most of the time last night for the Northern Hemisphere Holidays, so little price change to report. Westpac has data wrapping:

Event wrap

German CPI inflation rose 2.4% year-on-year in May, above the expected 2.3% and the highest level since 2018. The reopening and property shortages were the main factors.

Event Outlook

Australia: Force in the Corelogic Home Value Index continued into May, with the daily index pointing to another large gain of 2.2% nationwide, with Sydney heading for a 3% increase. We are waiting housing approvals to post a 10% drop in April, as the HomeBuilder program boost unfolds.

Along with that, we will get a series of GDP partials for the first quarter. first of all, on corporate profits in the first quarter, we expect an increase of 3.5%; this increase will come at a slower pace than sales revenues – government support continuing to moderate. Inventories are forecast to rise 1.0%, up $ 1.6 billion, to still some $ 6 billion below the end-2019 level. Such a result would see inventories add 0.3 percentage points to the activity in the first quarter (subject to revisions). For the year 2020, net exports subtracts 0.8 points, including a 2.1 point drag in the second half of the year. The March 2021 quarter saw another significant subtraction – we estimate in the order of -1.1pt. the Current account surplus is expected to grow from $ 14.5 billion in the fourth quarter to $ 21 billion in the first quarter, representing about 3.6% of GDP, which will be the 8th consecutive quarterly current account surplus.

Finally, the Reserve Bank Council will announce its political decision. The May meeting minutes confirmed that the Board will decide on the next step in its yield curve control and quantitative easing policies at its July meeting. As such, the June meeting will be the one to “mark the time” and discuss the recent data set.

New Zealand: We expect that every month residential construction consents will decline 7.5% in April. This is due to an expected drop in the category of “ bumpy ” apartments after the sharp rise last month. But underlying there is a very solid demand picture in the residential construction sector. We expect annual consent issuance to break new records in April. the GlobalDairyTrade auctions should post prices on water at high levels (WBC f / c: 0.0%)

China: We will look for signs of a supply disruption in Caixin’s manufacturing PMI in May, but sentiment should remain bullish (market f / c: 52.0).

Eurozone: the unemployment rate should remain at 8.1% in April; the relative health of the labor market bodes well for the economic recovery in the second half of the year. May CPI is expected to print around 1.9% per year, and while the figure is inflated by base effects, the underlying pace is still moderate.

WE: An increase of 0.6% in April construction expenses is likely to be driven almost entirely by the residential sector. May ISM manufacturing survey should recover some of the ground lost in April, when new orders and production moderated from high levels (market f / c: 61.0). May Dallas Fed Index should hold about 36.5; prices paid have jumped in recent draws. The FOMC Quarles and Brainard will speak.

Inflation remains the subject by day and on this and its impact on forex, I give you Mizuho:

With incoming economic data so volatile, we expect the Fed to delay the start of formal talks on monetary easing beyond June or August. The first real decrease could start would be from April to June 2022 and the first rate hike would take place in 2024, as the FOMC dot chart released in March indicates. Assuming the Fed maintains its current accommodative parameters for now, we would expect the 10-year US Treasury yield to trade in a narrow range of 1.50-1.75%, pending developments at fall (especially with regard to inflation). USD / JPY stabilized around JPY108, firmly in the recently formed range ofJPY100–110.

The risk of a weaker dollar increases as inflation accelerates

Let’s do some mental gymnastics around this: what if these accommodating forecasts fell off target and rising inflation turned out to be a sustained trend rather than a failure. In this case, central bankers would be forced to make quick decisions to avoid a surge in inflation expectations. We see this as extremely low risk, but consider how it would affect bond yields and the USD / JPY. We expect the Fed to step in first to come out ahead of the markets by announcing that it will adapt its policy to these changed circumstances. This could include the decision to go straight to a rate hike, rather than going through the usual process of starting to discuss a cone, giving fair warnings, and then implementing and completing it. The most likely decision, in our opinion, would be to raise its key rate by 50 bps to 100 bps, instead of the conventional 25 bps. Would such a move encourage investors to buy dollars, given such a decisive shift in the yield spread? The theory says yes, if that theory is all about focusing on widening the gap between US and Japanese bond yields. In practice, we believe this would not be the case.

Economies and markets are dynamic things. A sudden rise in central bank and market interest rates would likely bring the US economy to its knees. That said, consumer prices are a lagging indicator of the business cycle. As the Fed announces that it views the CPI as a key element of policy, it would position itself as a follower of economics as it would have admitted that it is conducting monetary policy through the rearview mirror rather than looking towards the future. Another key consideration is that a sharp rise in interest rates would likely cause the stock market to fall. The Fed would not be allowed to sit and watch while this happened, given that stock prices are a leading indicator of the economy, have a major impact on how positive businesses and consumers are. for the future and are closely watched by politicians. The idea of ​​successive rate hikes to keep inflation under control, while balancing the risk of stagflation, may suit armchair theory, but has virtually no chance of being developed as real policy. If the Fed were to trigger a surprise rate hike, with the almost inevitable damage it would cause to the economy, we would expect the Treasury yield curve to reverse. It is unclear which section of the curve the currency market would look at when assessing the US-Japan yield spread. It is easier to predict that the financial markets as a whole would shy away from risk, given that the days of lukewarm monetary easing had come to an abrupt end. We would expect investors to flock to the safe haven currencies: the dollar, the yen and the Swiss franc. In this scenario, one would not expect buying to focus on the dollar or yen to the detriment of the other. However, it is quite possible that the yen appreciates sharply if a fall in the US stock market reduces the risk capacity of funds and forces them to a major unwinding of carry trade positions involving the sale of the yen. Given all of this, we conclude that it would be very risky to trade solely on the simplistic idea of ​​the dollar being a buy if US long-term bond yields rose due to inflation fears.

Perhaps. But maybe that just gives too much thought. If there is a sustained inflation spurt in the US, so the Fed goes up early, then DXY will go straight up as the markets go straight down. Sometimes you just need two-dimensional chess to figure out what’s coming.

Having said that, I think it’s highly unlikely. It is more likely that as China slows down and commodity prices fall, the entire supply-side bottleneck inflation impulse will reverse in 2022.

The more interesting question, therefore, is what the Fed will do if it is not only right about temporary inflation, but inflation disappoints even its accommodative outlook. This:

  • Fed on hold longer.
  • Yields on long bonds are falling.
  • Stocks initially fall on fears of earnings growth and to remind the Fed that it needs to relax further.
  • Then the growth factor exceeds the value in the rebound.
  • DXY then climbs and the AUD falls anyway with commodities.
David Llewellyn-Smith
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