FX Matters May 2021 | Article – HSBC VisionGo
US inflation debate; weaker USD; GBP outperformed
- Inflation debate builds as US CPI rise for April from a year earlier was the sharpest since September 2008
- The US Dollar Index (DXY) fell 1.6% in May
- The GBP was the G10 outperformer for May, amid relief from election results and stronger economic data
Summary: Inflation – A storm in a teacup or clouds on the horizon?
The USD weakened against most of the major currencies in May with the US Dollar Index (DXY) falling 1.6% over the course of the month. The DXY was particularly responsive to news about inflation and data, which could potentially affect the Federal Reserve’s (Fed) policy. On 7 May, US nonfarm payrolls data for April showed an increase of just 266k against estimates for an increase of 1m. The DXY fell 0.8% for its worst one-day performance since November 2020. However, following US CPI data for April on 12 May, the DXY rallied as inflation accelerated at its fastest pace in more than 12 years. In the second half of May, the DXY retreated again as Fed speakers marked the surge in inflation up to “transitory” factors.
The EUR climbed 1.7% against the USD in May. The rise came despite persistent dovish messaging from the European Central Bank (ECB) speakers, with ECB President Lagarde stating that the central bank should “see through” any transitory increases in inflation. On 7 May, EUR-USD staged its best performance since December 2020, rising 0.8% on the day on the back of worse-than-expected US nonfarm payrolls data. Economic data showed a mixed picture – although Q1 preliminary GDP data registered a quarter-on-quarter decrease of 0.6%, retail sales data for March were more optimistic, up 2.7 over the previous month.
The GBP was the G10 outperformer for May and rose 2.8% for its strongest month since November 2020. On 7 May, the UK held local elections across the country and much attention was paid to the Scottish elections. In particular, the focus was on whether the Scottish National Party (SNP) would win a majority and thereby have a stronger mandate for a second independence referendum. However, the SNP fell slightly short of this majority, and consequently the GBP surged higher on 10 May, rising 1% against the USD. Part of the GBP’s strength may also be attributable to strong economic data, which showed a monthly increase of 9.2% in retail sales for April – far above consensus estimates for 4.5%.
Elsewhere: Gold gets the Midas touch
Gold stormed 7.8% higher in May and jumped back above the level of USD1,900 per ounce for the first time since January. The strength likely came from a combination of a weaker USD, an increase in gold exchange traded fund (ETF) holdings (the first monthly increase since October 2020), and a benign US Treasury yield environment. Gold had its best month since July 2020.
US: Under pressure
The US Dollar Index (DXY) had another rough month and fell 1.6% in May. The DXY had its worst one-day performance on 7 May, falling 0.8% and this was in fact the worst single day performance since November 2020. The sharp fall came after US nonfarm payrolls data severely disappointed market expectations with an increase of just 266k jobs in April compared to consensus estimates for +1m. Likewise, the unemployment rate ticked higher to 6.1%. Taken together, these data points seemed to imply that the Federal Reserve (Fed) remains a long way from its goals of full employment, and would therefore likely remain on hold for longer.
That said, on 12 May, US CPI data for April showed a year-on-year increase of 4.2%, the fastest since September 2008. The month-on-month increase of 0.8% was far above consensus estimates for a 0.2% increase. The DXY rose 0.6% on the day for its best one-day performance of the month amid a short-term surge in US 10-year Treasury yields. Other economic data for April generally showed a mixed picture; on one hand, industrial production rose 0.7% over the previous month, disappointing expectations for a 0.9% increase, and US advance retail sales were flat on a monthly basis, below the estimated 1% increase. On the other hand, initial jobless claims data improved over the course of the month, with the final week showing 406k claims – down from 507k at the end of April.
Through the rest of the month, however, the DXY trended lower alongside a drop-off in Treasury yields. This was likely aided by a number of Fed officials banging the “transitory” drum with regard to high levels of inflation. On 17 May, for example, the Fed Vice Chair, Richard Clarida, stated that upward pressure on inflation was “most likely transitory”. This sentiment was echoed by a range of Fed speakers, but there was some evidence of the Fed moving toward tapering asset purchases with the Fed Vice Chair for Supervision, Randal Quarles, stating the Fed should start taper talk in the coming meetings if the US economy remains strong.
Eurozone: Marching higher
The EUR clambered higher throughout May and ended the month up 1.7% against the USD. The currency closed in on its year-to-date (YTD) highs, touching a high for the month of 1.227 intraday on 25 May against the greenback. The EUR started the month on the advance, and climbed 1.2% in its first five trading sessions. On 7 May, EUR-USD rose 0.8% for its best one-day performance since December 2020. The move higher came after US nonfarm payrolls data for April significantly disappointed market expectations for a 1m increase with a print of just 266k. However, the high inflation number in US CPI data for April released on 12 May likely prompted a sell-off, which led EUR-USD 0.6% lower again.
In the second half of the month, the EUR managed to resume its climb higher, as US Treasury yields moved away from their May highs of 1.7% back below 1.6%. The EUR was therefore able to strengthen amid broader USD weakness. On the data front, Eurozone retail sales data for March showed a month-on-month increase of 2.7%. On 18 May, preliminary Eurozone GDP data for Q1 showed a quarter-on-quarter decrease of 0.6%, which was in-line with expectations. Finally, the Markit Eurozone PMI data continued to paint a broadly optimistic picture, with a composite value of 56.9 – higher than the previous month’s 53.8.
While there was no European Central Bank (ECB) meeting in May, a number of ECB speakers did attempt to talk down both yields and the EUR. On 21 May, the ECB President Christine Lagarde said the central bank should “see through” a period of higher inflation and on 26 May Fabio Panetta, Member of the Executive Board of the ECB, said “we are now seeing an undesirable increase in yields”. The dovish talk from the ECB may partly explain why the EUR failed to make further gains or close above its YTD highs.
UK: Much better than nil points
The GBP was the G10 outperformer of the month, with GBP-USD rising 2.8%. Much attention was given to local elections held in the UK on 6 May, and the GBP traded largely sideways up until this point. Following a weekend of vote counting, results confirmed that the Scottish National Party (SNP) had failed to secure an outright majority of Members of the Scottish Parliament (MSPs), thus reducing the likelihood of an imminent second Scottish independence referendum. On 10 May, the GBP rose 1% against the USD in the aftermath of these results. On 26 May, UK Prime Minister Boris Johnson’s former aide Dominic Cummings testified before MPs on what he viewed as the government’s mishandling in the pandemic. Despite being highly critical of the government’s response, the GBP was unfazed and ended the day down 0.2% against a broadly stronger USD.
The GBP had its worst day of the month on 12 May, falling 0.6% versus the USD in the wake of US inflation data for April, which was much higher than expected. However, GBP-USD reversed these losses as the month went on, and marched higher to close in on its year-to-date highs around 1.4250 on 20 May. The GBP ended the month slightly below this level, at 1.421.
On 6 May, the Bank of England (BOE) held rates and left its asset purchase programme unchanged. However, for the first time since the pandemic began, the vote was not unanimously dovish and BOE Chief Economist Andy Haldane voted to reduce the size of the asset purchase programme. Furthermore, the BOE did reduce the pace of asset purchases to GBP3.4bn per week. Finally, the BOE also upgraded its growth projections, forecasting 7.25% and 5.75% for 2021 and 2022, respectively. Despite the relatively upbeat message from the central bank, the GBP fell 0.1% against the USD on the day.
Economic data in the UK appeared to show some evidence of what Chief Economist Haldane called “a coiled spring”. Industrial production data for March showed a month-on-month increase of 1.8% and retail sales for April increased 9.2% on a monthly basis, dwarfing expectations for a 4.5% bounce. The International Labour Organization (ILO) unemployment rate was also better than expected, falling to 4.8% against estimates for it to remain at 4.9%.
The JPY posted a small loss in May and was the worst performer against the USD in the G10 space. USD-JPY was well contained between 108.3 and 109.80 for most of the month, except for the last couple of trading days when USD-JPY briefly broke the upper end of the range to set a month high of 110.20. Nonetheless, USD-JPY dropped back into the range on the final day of the month, to end at 109.6. The biggest one-day move in May came on 1 May where USD-JPY rose 1% amid a surge in US Treasury yields, brought on by a significant US CPI surprise for April, which saw consumer prices rise 0.8% over the past month against an expected 0.2%. As these concerns abated over the month, USD-JPY fell lower again.
Domestic data showed a relatively mixed picture, with Q1 preliminary GDP data showing a quarter-on-quarter drop of 1.3%, while industrial production data showed a monthly increase of 2.5% in April. Retail sales data for April, however, disappointed expectations and fell 4.5% over the past month. The COVID-19 situation also continued to worsen throughout much of the Asia region, with cases in Japan surging in the early part of the month before additional restrictions started to have an effect. On 24 May, the US issued a warning advising against travel to Japan, potentially adding further concerns for the Summer Olympic Games due to be held in Japan. Despite the tough domestic COVID-19 situation, the JPY continued to be more influenced by international events, risk sentiment, and US Treasury yields.
China: Back below 6.40
The CNY had a strong May, climbing 1.6% for its best month since January and USD-CNY crossed below the much watched 6.40 level. The CNY had its best one-day performance on 7 May, rising 0.5% against the USD alongside strong exports data, which showed an increase of 32.3% from a year earlier (beating consensus of 24.1%) and a strong Caixin Services PMI. The strong start to the month didn’t last though, and on 12 May the CNY fell 0.4% for its worst one-day performance alongside growing inflation fears from the US. Later in the month, the CNY recovered and strengthened further, as renewed positive risk sentiment, lower US Treasury yields and bond inflows on the back of portfolio rebalancing allowed the CNY to climb to a three-year high. On the final day of the month, the People’s Bank of China (PBOC) raised the FX reserve requirement for banks for the first time since 2007, but this seemed to have a limited immediate impact on the currency, with the CNY flat on the day, and the currency having its best month since November 2020.
Canada: Challenging 1.20
The CAD strengthened 1.9% against the USD in May and USD-CAD closed in on the key 1.20 level. Part of the CAD’s outperformance is likely attributable to both rising commodity prices and the Bank of Canada (BOC) tilting its monetary policy stance to become one of the more hawkish G10 central banks. On 20 May, BOC Governor Macklem stated that interest rates are “unusually low” and flagged some of the risks of surging house prices. The CAD rose 0.6% against the USD for its second best day of the month. Economic data showed the recovery would not all be smooth sailing, however, with the unemployment rate rising to 8.1% in April. That said, retail sales data for March looked more optimistic with a month-on-month increase of 3.6%, albeit this was before a significant uptick in COVID-19 infections, which prompted some harsher restrictions in some provinces. The CAD’s strong performance makes it the year-to-date outperformer in the G10 space, up 5.5% since the start of the year.
Australia: “Risk on” underperformer of the month
The AUD eked out a small gain in May of 0.2% versus the USD, notably underperforming a number of its traditionally “risk on” peers such as the NZD, CAD and SEK. The underperformance was also notable, given the continued climb for commodity prices. On 4 May, the Reserve Bank of Australia (RBA) held rates unchanged at 0.1%, but stated that it may consider more bond purchases at the July meeting. The AUD fell 0.7% on the day amid a backdrop of wider USD strength. On 6 May, tensions between Australia and China increased as the economic dialogue between the two nations was halted, possibly adding some weight to the AUD, although it still closed up 0.5% on the day. Economic data showed a mixed picture, with retail sales for April rising 1.1% from a month earlier, while employment data disappointed, with a 31k drop in employment in April.
New Zealand: Still stronger, just slower
The NZD rose a modest 1.5% in May alongside a broadly weaker USD. The modest price action, however, was not representative of some of the twists and turns throughout the month. The NZD started on the front foot, rising 1.6% over the first five trading days of the month, alongside a weaker USD. However, all these gains were wiped out on 12 May as the NZD slumped 1.6% versus the USD amid a severe bout of “risk off” sentiment. In the second half of the month, the choppiness continued, but the NZD did manage to climb again. Economic data showed the recovery remained well underway, with the unemployment rate falling to 4.7%, and retail sales excluding inflation rose 2.5% over the previous quarter. On 26 May, the Reserve Bank of New Zealand (RBNZ) held rates but did forecast that the first rate hikes would come in the middle of 2022, which was earlier than market expectations. NZD-USD rose 0.7% on the day despite the broader USD strengthening.
Norway and Sweden: Chalk and cheese
May proved to be a positive month for the SEK, which rose 2.1% against the USD and was the second best performer in the G10 space. The SEK had its best one-day performance on 7 May when it rose 1.5% against the USD amid a backdrop of a weaker USD. It wasn’t all smooth sailing, however, and on 12 May the SEK dropped 1.3% against the USD amid a wave of “risk off” sentiment. That said, the SEK was down but not out, and climbed higher in the second half of the month. CPI data showed an increase of 2.2% year-on-year and on 21 May the Riksbank Deputy Governor Per Jansson stated that the inflation picture looked “pretty good”, but that there was still “some way to go”. This stronger outlook for inflation perhaps helped support the SEK and explain some of its relative outperformance during the month.
The NOK, on the other hand, was the second-worst performer in G10 and fell 0.1% versus the USD. This relatively anaemic performance for the NOK is notable, as the currency is generally highly sensitive to risk appetite and commodities. The NOK had its worst one-day performance on 19 May, falling 1.2% against a broadly stronger USD and falling Brent prices. On 6 May, the Norges Bank held Deposit Rates at 0% and reiterated its view that the first rate hike will come toward the end of 2021; the NOK rose 0.7% on the day. On 10 May, when CPI data for April showed an increase of 0.3% from a month ago, far below estimates for a 0.5% increase, the NOK fell 0.7% against a flat USD.
Oil: The rally stalls
Brent crude oil prices rose 3.1% in May, although this muted price action belied the general direction of the month. Oil started May on the front foot, and three times during the course of the month Brent traded toward USD70 per barrel, briefly breaking the above the key level on 18 May. However, crude suffered significant losses into the back end of the month as supply concerns returned on news that Iran was close to reaching a deal to have international sanctions lifted. Likewise, increasing COVID-19 cases and restrictions across Asia likely had their part to play in oil prices coming under pressure in the middle of the month. These losses were short-lived, however, with Brent rising 2% and 3% on 21 May and 24 May, respectively, on the back of Iran stating that gaps remain on a possible return to the 2015 nuclear deal. Brent did not quite reclaim the lofty USD70 per barrel it had earlier in the month, but managed to climb over the month as strong economic and oil product demand data from the US helped sustain prices just below the key level.
Gold: Found its mojo
Gold had a strong May, and rose 7.8% on the back of a benign yield environment and a weakening USD. There was only one direction of travel during May, and that was up for the precious metal, with gold falling on just five trading days during the month. Gold had its worst one-day performance on 12 May, falling 1.2% alongside a broadly stronger USD, which came following a US CPI print of 0.8% month-on-month, which was much higher than expected. This decline was but a blip for gold, however, and the precious metal rallied as these inflation concerns abated amid weak US retail sales data and a decline in US Treasury yields. An increase in exchange traded fund (ETF) holdings over the duration of the month was likely another supportive factor, with holdings rising back above 100m ounces for the first increase since January. Physical demand in Asia also appeared to be slightly stronger. At the end of the month, gold broke above the key level of USD1,900 per ounce to close at USD1,906.87 per ounce.
 This report uses Bloomberg prices.
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