The dollar bullish divergence story appears to have hit a wall.  With US Q1 GDP likely to have contracted by around 1% at an annualized rate in Q1 and Q2 off to a weak start, whispers of a recession can be heard not only in the blogosphere but in the halls of the House of Finance.  The opportunity that the Fed is looking for to hike rates may not materialize.  

At the same time, the deflationary forces in the euro area have subsided.  The combination of the weak euro, low interest rates and the drop in oil prices provided the economic stimulus while policymakers await for the impact of structural reforms.  Now the recovery in oil prices is helped to put a floor under the general price level.    Market-based measures of inflation expectations, such as the difference between conventional and inflation-linked bonds and five-year/five year forwards show recognition of the diminished deflation threat.  Indeed, this realization appears to have been the spark that triggered the correction in European bonds, stocks, and euro.    

One might be forgiven for thinking that the US April CPI figure will contain important new inflation information.  Price pressures are expected to be little changed. Deflation is still likely evident at the headline level, and could actually deepen to -0.2% year-over-year from -0.1%.  Core inflation, which runs slightly higher than the Fed’s core PCE deflator target may ease slightly from the 1.8% year-over-year pace seen in March.  

In contrast, a couple days before the US figures, the euro zone is expected to confirm their preliminary April inflation reading at zero at the headline level and 0.6% at the core level.  US core inflation, which includes housing costs is running nearly three times faster than the eurozone’s which doesn’t (~1.7% vs. 0.6%).  This is an important reminder that international comparisons of macro-economic are hindered by the lack of common methodologies.  

Separately, the US reports housing starts and new home sales.  Housing starts was one of the sectors in which weather seemed to play a depressing role.  They recovered in March and are expected to have accelerated in April.  Existing home sales have been stronger.  In March, they were already running at a faster pace than seen all of last year. April gains may be muted after the strong March rise (6.1%).  Nevertheless, an improving housing market is a net positive for the economy, but post-crisis, the size of the sector is considerably smaller than it was.