ING: From Fed dependence to Fed divergence

Francesco Pesole, FX Strategist at ING, commenting on the greenback. The analyst said:

"At the start of this week, the dollar looked cheap, but we thought it would have taken something on the US side or in other key developed markets for it to realign with its strong rate profile. Come Friday, both the US and rest of the world's story have turned more positive for the greenback.

The hot US CPI was the trigger to a substantial dollar rally, but the dovish (even if moderate) shift in the European Central Bank and the Bank of Canada messaging has now made that rally more sustainable. Both banks have given a nod to market bets for a rate cut in June, and rightly so given the considerably more encouraging domestic inflation outlook than in the US. As things stand now, the Federal Reserve looks unlikely to match that same dovishness, and the case for a growing divergence between an immobile FOMC and a bunch of dovish central banks is getting stronger.

That implies a stronger dollar. We argue that there is plenty of evidence now for markets to break the link between the pricing for Fed and other central banks (which ECB President Christine Lagarde said loud and clear yesterday), but we also understand the assumption of “Fed dependence” in rate expectations could last until we actually see cuts in those other major economies. That hardly means dollar downside risks, but if anything, a more gradual or delayed USD appreciation.

Any real downside risks for the dollar seem to be stemming almost only from US data now, and yesterday’s PPI was a case in point. The below-consensus 0.2% month-on-month headline print sent the dollar lower across the board, even though core at 0.2% MoM was expected. Deteriorating sentiment and a slightly delayed ECB impact offered new support to the greenback shortly after, but there are still two points we want to make about March’s PPI. First, the inconsistencies with CPI have been particularly marked this time. For example, medical services PPI was flat versus 0.6% MoM in CPI and car insurance PPI rose 0.1% vs 3% MoM (!) in CPI. Second, a lot of PPI components feed into the core PCE deflator – the FOMC’s favourite measure of inflation. If we have to point to a moment where USD strength risks of being unwound, the PCE release on 26 April is surely a big one.

Today, the US calendar includes the import price index for March and April’s University of Michigan surveys (markets normally move on the inflation expectation component). The Fedspeak agenda includes Susan Collins, Jeffrey Schmid, Raphael Bostic and Mary Daly.

Geopolitics has played a seemingly secondary role for FX for a while now, but rising tensions between Iran and Israel can spill into even higher oil prices – all to the benefit of the dollar in the near term. DXY can comfortably eye 106.00 now, but today may be too early for a move to that level."

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