08:14 AM EDT, 05/16/2024 (MT Newswires) -- The US dollar (USD) and United States bond yields stayed lower overnight Wednesday with follow-through buying following the contraction in Japan's Q1 gross domestic product (GDP) and an uptick in the unemployment rate in Australia deflating 10-year US yields below 4.36% support, said Societe Generale.

A break below 4.30% (watch jobless claims on Thursday) would bring 4.25% into contention, wrote the bank in a note to clients. The US 2s/10s curve is bull flattening to -40bps rather than bull steepening. The German Bund opened down at 2.405% (swaps 2.68%).

The sequence of lower highs since 24 April suggests the peak in yield could well be behind, stated SocGen. The question then is whether the US dollar has also reached a turning point. The deterioration in the US data trend stretches into a third week and encompasses virtually all of the first tier and most important market-moving data including inflation, labor market and consumption data.

The resilience around key technical levels for example in EUR/USD at 1.0885, cannot be overlooked and illustrates the importance of staying nimble. Investors rightly so are heeding the hawkish messages of the Fed and are understandably reluctant to get ahead of the curve, pointed out the bank. However, one can't ignore that incoming data since the FOMC meeting two weeks ago signals change.

A different picture emerges when SocGen looks at the road in front through the windshield versus the one in the rear-view mirror. There was progress on the inflation components in the April consumer price index (CPI), including for core services excluding housing (+0.42% versus +0.65%), but it's glacial and Federal Reserve speakers will no doubt remind that one data point doesn't make a trend. Austan Goolsbee (non-voter) Wednesday welcomed the CPI print but said "there's still room for improvement."

Multiple readings are required to gain greater confidence and for policy rates to become less restrictive. September is now fully priced for a 25bps cut. Two more CPI (and nonfarm payrolls, or NFP) prints are scheduled before the July meeting, so a first rate cut this summer, in theory, isn't beyond the realms of possibility, but the bar is high, added SocGen.

The bank points out that the moderation of core CPI keeps the door open for a rate cut in 2024, but upside surprises threaten to shut the door. The 0.3% drop in control retail sales was only the second decline since January and dove-tails with the sharp 9.8pt slump in Michigan household confidence. The outperformance of 10y Bunds (-12bps) and Gilts (-10bps) relative to US Treasuries (8bp) was striking but was partly blamed on thin markets and solid buying of European paper by long-term investors. The reinvestment of an estimated 80 billion euros of European debt dropping out of indices may also have flattered the drop in yields.

The contraction in Japan's Q1 GDP means the economy hasn't grown in three quarters and inevitably begs the question of whether the central bank (BoJ) is committing a policy mistake by raising rates too soon. Is a second rate increase this year now off the table, asked SocGen. Tightening policy and ending yield curve control (YCC), supposedly because of greater confidence in inflation (or to defend the Yen?) is "political suicide" for the government.

Borrowing costs are rising and 10-year yields are approaching 1% when the economy is shrinking. The BoJ and the cabinet must hope that the Fed will be in a position soon to cut interest rates, paving the way for the yen (JPY) to strengthen. Except for inventories, each component including personal consumption, investment and exports subtracted from Q1 GDP.

In emerging markets (EM) foreign exchange (FX), the bullish outside day for Mexico's MXN (bearish USD/MXN) potentially brings 16.50 back in contention.

Brazil's BRL has struggled to keep up with its Latin American peers of late, and Wednesday again, failed to make the most of lower US yields and risk-on sentiment. The underperformance could be tied to perceptions that the four MPC members who dissented last week as appointees of President Luiz Inacio Lula da Silva and signal a more dovish-leaning central bank going forward. BCB President Campos Neto tried to calm "nervy" investors Wednesday, asserting that the BCB is committed to the inflation target and domestic disinflation trajectory is intact, noted SocGen.

Lula warned that fiscal perception has worsened, and risk premium has climbed but credible fiscal policy can re-anchor these expectations. Lula replaced the Petrobras CEO Wednesday, reopening the debate about political interference.

Chile's CLP is approaching technically overbought levels but is approaching 900/USD for the first time since early January as copper price blow "hot." Consolidation and mean reversion in the peso are possible but this could be followed by a retest of the January highs closer to 875.