Overview: The debt ceiling drama is not over.
The agreement between the negotiating teams of President Biden and House
Speaker McCarthy sets the stage for the next act in the drama: each side must
deliver the votes. A preliminary vote today in the House of Representatives is
likely today ahead of floor vote tomorrow. Still, the market is optimistic, and
risk is favored. Asia Pacific bourses were mixed today. We note that the chip
sector helped lift South Korea's Kospi up over 1%. Europe's Stoxx 600 is
recouping yesterday's marginal loss, and US equity futures are trading higher.
The S&P 500 and NASDAQ are poised to gap higher. Bonds are rallying. European
yields are mostly 4-6 bp lower, though Gilts are lagging. The 10-year US
Treasury yield is off nearly eight basis points to 3.72%.
The dollar is offered. Among
the G10 currencies, only the New Zealand dollar and Swedish krona are nursing
small losses. Sterling is doing best with a nearly 0.5% gain and resurfacing
above previous support near $1.2400. The euro slipped through $1.07 but
rebounded in the European morning. Emerging market currencies are mixed. The
Turkish lira has been hammered for around 1.5%. The Hungarian forint and
Mexican peso lead the advancer. Gold initially fell to two-month lows near
$1932 but has rebounded as the dollar and interest rates have come off. It is
probing the $1950 area. July WTI is posting an outside down session. It is off
around 2.1% today to test the $71 area. Last week's low was closer to
$70.65.
Asia Pacific
China reports its May PMI
tomorrow. Even
though economists expect Beijing to achieve its growth target this year of 5%,
many express disappointment with the pace. They will see the 20.6% decline in
the January-April industrial profits year-over-year as confirmation. Still,
given that industrial profits were off 21.4% in Q1, the April data point,
released over the weekend, is consistent with a rebound in profits at the start
of Q2 (~3.7%). Moreover, the official data suggest that foreign profits are
holding up better than China's private sector and state-owned enterprises.
There appears to have been a
subtle but potentially important shift in Bank of Japan Governor Ueda's
assessment. At the
end of last week, he told the Wall Street Journal that "There appear
to be moves leading towards sustainable inflation." Service prices, which
were still falling a year ago, are now up 1.7% year-over-year. Wage growth,
which former BOJ Governor Kuroda emphasized, has been downplayed a bit by Ueda,
who argued sustainable inflation is a broad measure, and no single data set
captures it. The rise in global rates have also helped push up JGB yields. The
yen is approaching the levels that sparked concern among Japanese officials
last year. This is not to suggest that there is a line in the sand or that
strong foreign buying of Japanese stocks (from insurance companies?) and the
lower oil prices do not change the calculus. Separately, Japan reported its
unemployment rate fell back to 2.6% in April from 2.8% in March. Economists in
Bloomberg's survey expected a 2.7% rate. The job-to-applicant ratio was steady
at 1.32.
The US led the Indo-Pacific
Economic Framework of 13 other nations in the region to boost supply chain
cooperation. Ostensibly,
his s part of the US attempt to fill the vacuum created when it withdrew from
the Trans-Pacific Partnership negotiations (although Trump did the deed,
Clinton and Sanders opposed it in their campaigns). Another prong of the US
economic effort in the region is the Asia-Pacific Economic Cooperation (APEC),
21-coutries and US will host the annual summit in San Francisco in November.
The dollar initially slipped
briefly below JPY140 in early Asian turnover before rallying to a marginal new
high for the year of almost JPY140.95. It was sold into the European morning, where it found support near
JPY140.00. There are $1.72 bln in options at JPY140 that expire tomorrow. The
next important chart area on the upside is around JPY142.50. Watch the five-day
moving average (JPY140.20). The dollar has not closed below it since May
11. Weakness in Australia's April house permit has helped keep the
Australian dollar pinned in the trough it began forging last week
($0.6490-$0.6500). It did make a four-day high in early trading today
reaching almost $0.6560, but the upside momentum was not sustained. There are
about A$510 mln options at $0.6550 that expire today and another A$560 mln that
expire there tomorrow. The weakness of the yen and euro pointed to continued
weakness in the Chinese yuan, which fell to new six-month lows today. The
greenback neared CNY7.10. The PBOC is not protesting the dollar's strength in
the setting of the daily reference rate. Today it was set at CNY7.0818 compared
with the median projection in Bloomberg's survey for CNY7.0811
Europe
The fourth meeting of the
US-EU Trade and Technology Council (TTC) will be held today and tomorrow. It is not working toward a free-trade
agreement. Instead, as with the US efforts in the Asia Pacific, it is said to
represent the next generation. It is about standard setting, and other elements
of cooperation, like with supply chain transparency and AI, and on external
trade issues, like deterring forced labor. The TCC also helps coordinate export
controls on and has found opportunities (e.g., Kenya and Jamaica) to
support infrastructure efforts, which some suggest is a way to counter Chinese
influence.
It will come as no surprise:
Erdogan has been re-elected president of Turkey. The unorthodox policies are widely
understood to be unsustainable and borrowing the future. There is some
speculation that he may bring in more market-friendly officials into the new
cabinet. But this would not necessarily be positive for the lira. After selling
off 0.7% yesterday, the lira is off around 1.25% today, the most since last
July. Spain held local and regional elections over the weekend. They
are important in their own right but also as a bit an of a sense of the mood of
the electorate ahead of the general election. The Socialists suffered a heavy defeat,
and to regain the initiative Prime Minister Sanchez called for a snap election
on July 23. A general election was required by early December. The People's
Party, sometimes joined by the anti-immigration, nationalist Vox party, looks
to have won 8 of the 12 regions that were contested, including Valencia and
Madrid. The PP garnered about 31.5% of the municipal vote nationwide, up from
22% in the previous local election in 2019. Vox doubled its vote to 7%. The
Socialists fell to 28%. Unidas Podemos, which is the Socialist coalition
partner in the national government, also polled poorly. Spanish stocks fell on
Monday (~-0.20%), while Spanish bonds rallied. The nearly 10 bp decline in the
Spain's 10-year was in line with the declines in Germany, France, and Italy.
Today, Spain's 10-year yield is down four basis points, in line with the
regional move. Its stock market is up about 0.65% through late morning and
outperforming the Stoxx 600. In Greece, the governing New Democracy
fell five seats shy of an outright majority in the 300-seat parliament in the
May 21 elections. Rather than seek a coalition government, Prime Minister
Mitsotakis has called for new elections June 25. The other main parties agreed.
The vote will take place under somewhat different rules and give a bonus of as
many as 50 seats to the winner. Mitsotakis, who has led a business-friendly
reform agenda, is most likely to be reelected.
The euro is recovering from
the initial sell-off that brought slightly below $1.0675. It was bought back in the European morning
to a little through $1.0730. Some of early selling pressure may have been exacerbated by
the trading around 1.15 bln euros in options at $1.07 that expire today. There
are options for 2.2 bln euros at $1.0750 that expire tomorrow. We note that the
US 2-year premium over Germany continues to trend higher. It is above 170 bp
today for the first time in a couple of months and has risen for the past six
weeks. The high for the year is a little above 185 bp. Sterling is posting a
big outside up day, having first slipped through yesterday's lows (~$1.2335)
and then proceeded to rally through yesterday's high (~$1.2370). It
reached a four-day high near $1.2430. The intraday momentum indicators are stretched,
suggesting some consolidation is likely in early North America.
America
The deal worked on the debt
ceiling and spending still requires a vote in the House of Representatives and
the Senate. The
negotiators likely anticipate some concessions to individual legislators. Even
if there is more work to be done, and the final shape of the agreement has yet
to be determined, the deal is boosts confidence that a default will be avoided.
The market can now turn more of its mind share to what happens after the debt
ceiling is lifted. The initial focus will be on likely boost in T-bill offering
and the replenishing of the Treasury's general account (TGA). The tightening of
financial conditions that this entails is a function of the T-bill demand. The
increase in T-bill issuance can come from funds that ae currently parked in the
Fed reverse repo facility. The alternative is that in effect it comes out of
bank reserves. Therein lies the tightening that some estimate can be worth a
quarter-point hike.
A deal also removes a
potential wild card for the FOMC meeting. The market went into the long US holiday with almost
a 58% chance of a hike discounted. Ironically, the odds rose sharply even as
the Atlanta Fed's GDP tracker estimate for growth this quarter was sliced to
1.9% from 2.9%. It sees a bigger drag coming from the wider trade deficit,
which also reflects stronger domestic demand (imports rose, exports fell)
picked up in the personal consumption report. Consumption is off to a good
start in Q2. Personal spending rose by 0.8% in April. Only one economist in
Bloomberg's survey of economists forecast more than 0.7%. Fed officials talk
about different measures of inflation, the strength of demand influences their
outlook. The year-over-year measures are sometimes helpful, but now the base
effect may exaggerate the improvement. We have preferred to look at the
annualized rates. In the first four months of the year, it is running at a 4.2%
annualized rate. In the last four months of 2022, the PCE deflator rose at 3.3%
annualized rate. The core PCE deflator is running ever so slightly slower (and
rose nearly 4.1% at an annualized pace in the last four months of 2022. Hence,
the conclusion by several Fed officials that there has been not material
improvement so far this year.
The US reports March house
price data today, the Conference Board's May survey, and the Dallas Fed's
manufacturing survey. These
reports do not often more the foreign exchange market. The Fed's Barkin speaks
today ahead of five Fed officials that speak tomorrow, ahead of the Beige Book.
A close in the Dollar Index below 104.00 could be a preliminary crack in the
rally. The US dollar is trading lower against the Canadian dollar for the
third consecutive session. Recall that ahead of the weekend, the
greenback reached CAD1.3655, a new high for the month. It has dribbled lower to
nearly CAD1.3565 today. A break, and ideally a close below CAD1.3550 would
weaken the US dollar's technical tone. Tomorrow Canada report Q1 GDP. The
median forecast in Bloomberg's survey looks for a 2.5% annualized pace. The
swaps market now looks for a hike by the end of Q3 (to 4.75%). The US dollar
was turned back from MXN18.00 early last week and reached almost MXN17.5350
yesterday. It is trading quietly in a narrow range
(~MXN17.5540-MXN17.6265). The multi-year low set in the middle of the month was
near MXN17.42. This can be tested in the coming days.
June is a pivotal month. The US debt-ceiling
political drama cast a pall over sentiment even if it did not prevent the
dollar from rallying or the S&P 500 and NASDAQ from setting new highs for
the year. It is as if the two political parties in the US are playing a game of chicken
and daring the other side to capitulate. Both sides are incentivized to take to
the brink to convince their constituents that they secured the best deal
possible. No side seems to really want to abolish the ceiling because it has
proven to be an effective lever for the opposition to win concessions over the
years. Still, a higher debt ceiling and some reduction in spending in the FY24
budget are the middle ground.
Many think that this time is different. The partisanship, they say, is so
extreme that a default is possible. They can point to severe distortions in
the T-bill market and the elevated prices to insure against a US default
(credit default swaps). Neither side can be sure it will not be blamed for a default's expected and unexpected consequences. The risk of playing
chicken is that neither driver swerves at the last minute. There are only downside scenarios in a default situation, even if it lasts for a short
term and no bond payment is missed. On the other side of the debt ceiling, bill
issuance will rise, and the Treasury will rebuild its account held at the
Federal Reserve. This could drive up short-term rates and reduce liquidity.
In addition
to fiscal policy, a monetary policy drama is also playing out. The
Federal Reserve began hiking rates in March 2022, and at the May meeting, Chair
Powell indicated that a pause was possible. Although he made it clear that it
was not a commitment, the markets saw the quarter-point move as the last. However, a combination of stronger economic data, sticky price pressures, and some hawkish comments saw the pendulum of expectation swing toward a hike at the June 13-14 meeting (60%). Moreover effective Fed funds rate (weighted average) is about 5.08%, and the
market-implied year-end effective rate is around 5.0%. It was near 4% as recently as May 4, which illustrates the extent of the interest rate adjustment. Even if the Fed
stands pat in June, we expect Chair Powell to validate market expectations that
another hike will likely be forthcoming (July).
There
continue to be worrisome economic signs in the US, including the inverted yield
curves, the precipitous decline in the index of Leading Economic Indicators, an
outright contraction in M2 money supply, the tightening of lending standards,
and a reduction in credit demand. However, at the same time, despite some
slowing, the labor market is strong, with an improvement in prime working-age
participation. Consumption rose by 3.7% in Q1 and appears off to a good start
in Q2, with stronger auto and retail sales in April. Supply chain disruptions
have improved, shipping costs have receded and are back within the 2019
range. The Atlanta Fed's GDP tracker sees growth of 1.9% in Q2, near the Fed's
non-inflation speed limit of 1.8% and though a bit faster than Q1 (1.3%).
Another
drama that has unfolded is the stress on US banks. Banks with increasing low-yielding assets did not offer competitive interest rates with
prime money market funds (only invest in US government/agency paper) and the US
bill market itself. While the banking system lost deposits, several of the
largest banks reported increased net interest income. However, even after
the deposits at small banks stabilized, pressure continued on their shares.
That selling pressure seemed to be exhausting itself. June may be a pivotal
period for this drama too. Still, many regional banks are exposed to the
commercial real estate market, which is under pressure.
Europe
avoided a tragic winter energy crisis, but the drama is that inflation is
providing sticky, and the regional economy looks as if it stalled at the end of
Q1. Indeed, revisions show that the German economy contracted 0.3% in Q1
after a 0.5% contraction in Q4 22. The eurozone and UK economies expanded by
0.1% quarter-over-quarter in the year's first three months. The eurozone
and UK appear stuck in low gear, but the market is confident of quarter-point
hikes by the European Central Bank and the Bank of England in June.
Japan has a
drama of its own. The Bank of Japan is under new management, but it turns out
that its extraordinary policy was not simply a function of former Governor
Kuroda's idiosyncrasies. Several surveys of market participants saw June/July
as the likely timing of an adjustment in the policy settings. However, Governor
Ueda's call for patience suggests little sense of urgency, and some
expectations are being pushed out to the end of Q3. The recent history of
lifting interest rates or currency caps suggests a dramatic market response
even under the best circumstances. Still, the best time to
adjust the cap on the 10-year bond is when it is not being challenged. The BOJ
is the last of the central banks with a negative policy rate. This is
increasingly difficult to justify. The swaps market is not pricing in a
positive rate until early in the second half of the fiscal year, which begins
on October 1.
Geopolitics
are always dramatic. It seems clear that US officials, including President
Biden, had recognized that bringing NATO to 's border was provocative.
After relatively mild responses to 's invasion of Georgia and the taking
of Crimea, the reaction to last year's invasion of e is a big shock to nearly
everyone. The US has led a coalition that has stymied by arming e with weapons, training, money, and intelligence.
Initially, China appeared to be a net loser of 's invasion. NATO is stronger.
US leadership was again demonstrated. Parallels between e and Taiwan were
drawn ubiquitously. There has been a rapprochement between South Korea and Japan,
and both are boosting military spending. The US secured new bases in the
Philippines. However, China is finding its own opportunities.
Just as the
US thinks is in a quagmire, China may think it has the US in one.
President Biden has cast the defense of e as the frontline of the battle
between democracy and authoritarianism. However, American public support is not
particularly strong, and continued unlimited support may become a political
issue in next year's election. Meanwhile, China has moved into the vacuum
created by the US and European sanctions. China has secured into its
sphere of influence, which Beijing could not have dreamed of before the
invasion. Using the swap lines with the PBOC has allowed several developing countries to pay for imports from China. It is similar to
producer-financed sales in market economies. China is exploiting niches that the US and Europe have created purposefully or otherwise. Even taking into
account the problematic debt that has arisen from the Belt Road Initiative, it
is creating and solidifying a trade network that may be of increasing
importance to China going forward.
The sharp
rise in interest rates in May made for a challenging time for risk assets.
Equity indices for developed and emerging market economies fell in May, but
there were notable exceptions. The S&P 500 and NASDAQ rallied to new highs
for the year. Germany's DAX and French CAC set record highs, while Japan's
Topix and Nikkei reached their best levels since 1990. Among emerging markets, Brazil (~6%), Chile (~4%), Poland (~3%), Hungary (~6%), Taiwan (~6%), and
South Korea (~2.3%) are notable exceptions.
Emerging
market currencies mostly fell in May. The JP Morgan Emerging Market Currency
Index fell by 1.3% after slipping about 0.35% in April. It is the first
back-to-back monthly decline since a four-month drop in June through September last
year. It is essentially flat on the year. Latin American currencies continue to
stand out. They accounted for four of the top five emerging market currencies
in May: Colombia (~5.1%), Mexico (~1.9%), Peruvian sol (~1.0%), and Chile (~0.4%). The South Korean won was the exception; its 1% gain put it in
the top five.
BWCI bottomed early last November near
92.80, confirming the dollar's top. It rallied into early February to peak near
98.15. The decline into March retraced about half of the rally, while the
year's low set in late May (~95.25) is within 0.75% of a critical area. This is
consistent with our base case that while there may be some scope for additional
dollar gains, it looks limited as the interest rate adjustment also appears to be complete or nearly so. In our analysis of the different currencies below, we
have tried to quantify where the base case breaks down.
Dollar: The
interest rate adjustment, where the market converges to the Fed rather than vice versa, and the knock-on effect of supporting the US dollar
unfolding broadly aligns with the view sketched here last month. The two-year
yield rose by around 65 bp in May to about 4.65%, the highest since mid-March.
The year-end policy rate is near 5% rather than 4.5% at the end of April. We
suspect that the interest rate adjustment is nearly complete, helped by what
will likely be slower economic growth after the rebound in Q2. The growth
profile may be almost a mirror image of 2022. Then, the economy contracted in
H1 and rebounded in H2. This year, the economy appears to have grown near trend
in H1 and looks set to slow in H2. The odds of a Fed hike on June 14 were around 65% before the Memorial Day holiday (May 29), and it is fully discounted for the July meeting. The Fed's economic projections
will be updated. The 0.4% median forecast for growth at the March meeting seems
too low and will likely be increased. At the same time, the 4.5% year-end
unemployment rate seems too high. Unemployment was at 3.4% in April. The median forecast bring
it down a bit. The debt ceiling wrangling does not put the US in the best
light, but barring an actual default, it will not have lasting impact. Outside
of the T-bill market and the credit-default swaps, investors took this peculiar
American political tradition in stride. Our working hypothesis has been that
the dollar was going to "correct" the selloff that began in early
March as the bank stress struck. In the last full week of May, the Dollar Index
exceeded the retracement target near 104.00. A move above the 104.70 area would
suggest potential back toward the 200-day moving average (~105.75) and the
March high near 106.00. A break below the 103.00 area would suggest a high may
be in place.
Euro: Eurozone
rates could not keep pace with the dramatic swing higher in the US. Germany's
two-year yield rose by about 20 bp in May, less than half what the US
experienced. Yet, the euro's roughly 2.75% decline in May was not only a dollar
story. The proverbial bloom came off the rose. The fact that with a combination
of preparedness and good luck (low oil/gas prices and a mild winter), the
eurozone avoided an energy crisis. The positive economic impulses carried into
February, but by the end of March, economic growth stalled, or worse. After a
second look, Germany contracted by 0.3% in Q1 (initially estimated at zero)
after a 0.5% decline in economic output in Q4 22. The European Central Bank
started later than most G10 countries to begin adjusting monetary policy, and
institutional rigidities may make price pressures more resistant. The ECB meets
on June 15 and the market is confident of a quarter-point hike that would lift
the deposit rate to 3.50%. The staff will also update its economic forecasts. The
terminal rate is seen at 3.75% in late Q3 or early Q4. On June 28, European
banks are due to pay back the ECB around 475 bln euros of loans (Targeted
Long-Term Refinancing Operations). They account for around 6% of the assets on
the ECB's balance sheet and almost 45% of the outstanding TLTRO loans. The
sheer magnitude of the maturity could prove disruptive, and some banks may look
to find replacement funding. The ECB's balance sheet has been reduced by about
3% this year and the repayment of the TLTRO would do more with a single blow. Recall
that end of the of last year, European banks returned almost 492 bln euros. The
euro overshot our $1.0735 objective. We suspect the euro's downside correction
is nearly over, but a break of the $1.0680 area may signal losses back to the
March low near $1.05.
(May 26, indicative closing prices, previous in parentheses)
Spot: $1.0725 ($1.1020)
Median Bloomberg One-month Forecast $1.0890 ($1.0960)
One-month forward
$1.0740 ($1.1040) One-month
implied vol 6.8% (7.5%)
Japanese
Yen: Rising US rates seemed to have dragged the greenback higher
against the Japanese yen. The gains in May took it a little through JPY140, the
highest level since the end of November, and beyond the halfway marker of the
drop from last October's high near JPY152. Just as there may be some more room
for the US 10-year yield to climb above 3.80%, there may be scope for the
dollar to rise further against the yen. The next important chart area is around
JPY142.50. Underlying price pressures in Japan continue to rise, and the
weakness of the yen only adds to the pressure on the BOJ to adjust its monetary
settings. The economy expanded by 0.4% in Q1, well above expectations, and in late
May, the government upgraded its monthly economic assessment for the first time
in ten months. Several surveys found many see a window of opportunity in June
or July for the BOJ to adjust monetary policy. Most of the speculation has
focused on yield-curve-control (YCC), which caps the 10-year yield at
0.50%. We do not think it will be abandoned entirely, and targeting a
shorter-dated yield may be considered. It could lift the overnight target rate
to zero from -0.10%. If experience is any guide, when it comes, the timing will
likely surprise, and it is bound to be disruptive. It will likely weaken the
correlation between the exchange rate and US yields. Lastly, there is much talk
about a snap election in Japan over the summer as Prime Minister Kishida looks
to secure his mandate and support for him, and the cabinet has risen recently.
He hosted the G7 summit and brandished leadership. Politically, it may be the
most opportune time before September 2024 LDP leadership contest, while the
economy is relatively strong, the stock market is near 30-year highs, and he is
perceived favorably.
Spot: JPY140.60 (JPY136.30)
Median Bloomberg One-month
Forecast JPY133.45 (JPY133.05)
One-month forward
JPY139.95 (JPY135.75) One-month implied vol 10.8% (9.5%)
British
Pound: May was a month of two halves for sterling. In the first half of
the month, it extended its recovery off the for the year set on March 8 near
$1.1800. Sterling peaked on May 10 at around $1.2680, its best level since June
2022 and an impressive recovery from last September's record low of about $1.0350.
In the second half of May, sterling trended lower and fell back to almost $1.2300.
Our base case is that the move is nearly over, with the $1.2240 area likely to
hold back steeper losses. However, if this area goes, another cent decline is
possible in this benign view. Stubborn inflation and a firm labor market have
produced a dramatic interest rate adjustment in the UK that may lend sterling
support. The year-end policy rate is seen above 5.50%. This is a 70 bp increase
since the middle of May. The two-year and 10-year Gilt yields were mostly flat
in the first half of May and soared around 75 bp in the second half. The
10-year breakeven (the difference between the inflation-protected security and
the conventional bond) rose a little more than 10 bp in the last couple of
weeks. The Bank of England meets on June 22, the day after the May CPI is
published. The market is debating whether a 25 bp or 50 bp hike will be
delivered. We lean toward the smaller move unless the incoming data surprises.
Spot:
$1.2345 ($1.2565)
Median Bloomberg One-month
Forecast $1.2400 ($1.2480)
One-month forward
$1.2355 ($1.2575) One-month implied vol 8.0% (7.6%)
Canadian
Dollar: The Canadian dollar fell by about 0.60% against the US dollar in
May, making it the best performer in the G10. The Swiss franc was second with
twice the loss. After testing April's low (~CAD1.3300) in early May, the US
dollar recovered and set the month's high (~CAD1.3650) in late May. While interest
rate developments can help explain the broader gains in the greenback, the
exchange rate with Canada seems to be more sensitive lately to the general risk
environment (for which we use the S&P 500 as a proxy) and oil. The price of
July WTI collapsed from around $76.60 at the end of April to a little below $64
on May 4. It worked its way back up to almost $75 on May 24 before stalling.
There has been a significant interest rate adjustment in Canada over the last
few weeks. The 2-year yield rose by nearly 60 bp. At the end of April, the
market was pricing in a cut before the end of the year and now it is fully
discounting a hike. The Bank of Canada meets on June 6. The swaps market has a 33% chance of a hike and a hike is fully discounted by the end of Q3. At the end of April, a June hike was
seen as less than a 10% risk. A move above CAD1.3700 could signal a return to
this year's high set in March near CAD1.3860.
Spot: CAD1.3615 (CAD 1.3550)
Median Bloomberg One-month
Forecast CAD1.3405 (CAD1.3475)
One-month forward CAD1.3605 (CAD1.3540) One-month implied vol 6.0% (5.8%)
Australian
Dollar: The surprising quarter-point hike by the Reserve Bank of
Australia saw the Australian dollar fray the upper end of the $0.6600-$0.6800
range that has dominated since late February. Disappointing employment data,
concerns about the pace of China's recovery, and the sharp selloff of the New
Zealand dollar (following the central bank's hike that could be the last one)
weighed on the Australian dollar. It recorded the lows for the year slightly
below $0.6500. There is little meaningful chart support ahead of $0.6400, but a
move back above $0.6600 would suggest a low is in place. The squeeze on households can e expected to increase in the coming months as mortgages taken on in the early days of the pandemic will begin to float at higher rates. The RBA meets on June
6 and there seems to be little chance of a hike, though the market is not
convinced that the tightening cycle is finished. A small hike (~15 bp) is
possible in Q3. The first estimate of Q1 GDP is due the day after the RBA meeting, but we assume officials will have some inkling. Although there is some talk of the risk of a contraction, it likely grew slowly.
Spot:
$0.6515 ($0.6615)
Median Bloomberg One-month
Forecast $0.6785 ($0.6710)
One-month forward
$0.6525 ($0.6625) One-month implied vol
10.3% (10.1%)
Mexican
Peso: Between the central bank's pause and the broader dollar's
strength, the peso fell on profit-taking after it reached a new seven-year
high in the middle of May. However, the considerations that have driven it
higher remain intact, suggesting its high is not in place. Those forces include
the attractive carry (11.25% policy rate) and a relatively low vol currency
(especially among the high-yielders), the near-shoring and friend-shoring that
has seen portfolio and direct investment inflows, and, partly related, the
healthy international position, with record exports and stronger worker
remittances. The dollar fell to almost MXN17.42 in mid-May and its bounce
stalled near MXN18.00. A break of the MXN17.60 area may signal a retest of the
lows, but in the medium term, there is potential toward MXN17.00. While
Mexico's government has not facilitated an investor-friendly environment, the
market appears to be rewarding the strong and independent central bank and
Supreme Court.
Spot:
MXN17.6250 (MXN18.00)
Median
Bloomberg One-Month Forecast MXN18.1675 (MXN18.26)
Spot: CNY7.0645 (CNY6.9185)
Median Bloomberg One-month Forecast CNY6.8625 (CNY6.8570)
One-month forward CNY7.0500 (CNY6.9060) One-month implied vol 5.4% (4.9%)
EUR/USD has edged higher on Wednesday. In the European session, EUR/USD is trading at 1.0737, up 0.26%. Earlier, the euro dropped as low as 1.0672, its lowest level since March 20.
Spanish CPI lower than expected
Spain, the fourth-largest economy in the eurozone, saw inflation fall to 3.2% in May. This follows a 4.1% gain in April and was below the consensus estimate of 3.5%. The sharp drop was mostly due to lower fuel prices. On a monthly basis, CPI fell by 0.1%, after a gain of 0.6% and below the consensus estimate of 0.1%.
Will we see a similar downturn in German inflation on Wednesday? The markets are projecting that CPI for May will ease to 6.8%, down from 7.6% in April. A deceleration in inflation would be positive news, but the ECB’s target of 2% remains very far away and will likely take years to achieve that goal. That means that more rate hikes are likely. The ECB meets next on June 15th and another hike is likely, as inflation remains public enemy number one and the central bank is intent on preventing inflation from becoming entrenched. ECB President Lagarde will deliver public remarks on Wednesday and investors will be hoping for some insights with regard to rate policy.
Debt ceiling deal on its way to Congress
After weeks of difficult negotiations, President Biden and Republican Speaker McCarthy have reached an agreement in principle on the debt ceiling. The deal is expected to receive approval from both houses of Congress, although some Republicans are expected to vote against the agreement. US yields have moved higher in recent weeks, buoyed by the uncertainty which has pushed investors towards safe-haven assets. The US dollar has also benefitted from the crisis, and the question remains whether a deal will see a spike in risk sentiment that will cool the hot US dollar.
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EUR/USD Technical
USD/JPY is showing little movement on Tuesday. In the European session, USD/JPY is trading at 140.17, down 0.19%.
The Japanese yen continues to underperform and has plunged 2.8% in May. The yen fell as low as 140.93 on Monday, its lowest level since November 21st. The sharp depreciation is raising concerns in Tokyo and Masota Kanda, a top official at the Ministry of Finance (MOF) weighed in on Tuesday. Kanda said officials were not focussing on particular exchange rate levels but said they were monitoring the forex market and “would respond appropriately”. Kanda’s veiled warning should not be ignored, as he blindsided the markets back in December when the MoF intervened in the currency markets in order to prop up the yen.
Japanese releases have been solid, reinforcing speculation that inflation isn’t going anywhere and the Bank of Japan may have to tighten policy. Service and manufacturing PMIs showed slight expansion last week and retail sales and industrial production will be released on Wednesday. Retail sales are expected to remain strong at 7.0% y/y in April, following a prior reading of 7.1%. Industrial production is projected to improve to 1.5% m/m in April, up from 1.1% in March.
President Biden and Republican Speaker McCarthy have reached an agreement in principle on the debt ceiling, after weeks of brinkmanship between Republicans and Democrats. The deal must be approved in both houses of Congress, which is expected to happen despite grumblings from some Republicans. The weeks of uncertainty prior to the deal weighed on risk appetite and the big winners have been US Treasury yields and the US dollar.
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USD/JPY Technical
The Australian dollar is drifting lower on Tuesday. AUD/USD is trading at 0.6538 in Europe, unchanged on the day.
RBA Governor Lowe testifies before a Senate Committee later today. Lawmakers will likely press Lowe about rate policy and the battle against inflation. Earlier this month, the RBA shocked the markets by delivering a 25-basis point hike. At the April meeting, the RBA had paused in order to assess the effect of its aggressive rate-hike cycle, and the markets had expected another pause at the May meeting. Lowe will have to reassure the committee that the RBA is following a plan and is not zig-zagging between hikes and pauses.
Attention will quickly shift to inflation, with the release of Australian CPI on Wednesday. Inflation has been falling, and the downturn is expected to continue, with a consensus estimate of 6.4%, down from 7.0% prior. The RBA has pledged to bring inflation back down to its 2% target, but there’s no doubt that it will be a long and bumpy road. The central bank meets on June 6th and is widely expected to pause and maintain the benchmark rate at 3.85%.
The US debt ceiling agreement is a done deal. Well, almost. President Biden and Republican Speaker McCarthy have reached an agreement in principle which must be ratified by both houses of Congress. Some Republicans have threatened to vote against the deal, but with overwhelming support from the Democrats, approval of the deal is very likely. The weeks of uncertainty prior to the deal weighed on risk appetite, and the big winners have been US Treasury yields and the US dollar.
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AUD/USD Technical
Fig 1: EUR/USD trend as of 30 May 2023 (Source: TradingView, click to enlarge chart)
In the medium term (multi-week), the price actions of EUR/USD are evolving in a downtrend phase since the bearish break down from the multi-month ascending channel support from the 28 September 2022 low 0f 0.9536 on 18 May 2023 as depicted on the daily chart.
The ongoing 390 pips decline from its 1.1095 high of 26 April 2023 (also current 52-week high) to the current intraday low of 1.0701 on 30 May 2023 has traced out an Elliot Wave/fractal analysis's five waves down move (labelled as i, ii, iii, iv & v on the 4-hour chart) with its potential terminal level at 1.0670/1.0630 (defined by a cluster of Fibonacci extension levels).
In addition, the price actions of EUR/USD since its minor swing high of 1.0831 printed on 22 May 2023 have started to evolve into an impending minor bullish "Descending Wedge" configuration coupled with a bullish divergence signal being flashed out on the 4-hour RSI oscillator at its oversold region.
These observations suggest that the ongoing minor downtrend phase from the 3 May high of 1.1092 may have started to get exhausted for EUR/USD bears and in conjunction with the potential Elliot Wave count analysis highlighted earlier, the odds seem to be skewed towards a possible minor short-term corrective mean reversion rebound to retrace a certain portion of this current minor downtrend phase.
Key short-term pivotal support at 1.0630 to maintain this potential minor mean reversion rebound scenario with next intermediate resistances at 1.0725 (the upper boundary of the minor "Descending Wedge") and 1.0850 (former minor swing lows of 10 April/15 May 2023).
On the other hand, a break below 1.0630 exposes the key medium-term support at 1.0520 (also the 200-day moving average.
