Overview: Federal Reserve Chair Powell's offered a
stronger case for a pause in the monetary tightening before the weekend and
this sapped the dollar's mojo. The greenback is mostly consolidating through
the European morning in quiet turnover. The JP Morgan Emerging Market Currency
Index is trying to snap a four-day decline. The South African rand is
recovering from its recent slide and is up nearly 1%. The South Korea won is
benefitting from China's decision to ban Micron chips. On the other hand, the
high-flying Mexican peso is extending last week's 1.1% decline and is the
weakest among emerging market currencies today with a nearly 0.6% decline.
Equity markets in the Asia
Pacific region mostly advance. Australia and New Zealand were notable
exceptions among the large bourses. Europe's Stoxx 600 has edged a little
higher to extend its gains for the third consecutive session. US futures on the
equity indices a little softer. US and European benchmark 10-year yields a 1-2
bp lower. This puts the US Treasury yield near 3.66%. Gold bounced off $1950 at
the end of last week. It is a relatively narrow range in the upper end of the
ranges seen in the last couple of sessions. Nearby resistance is seen in $1984-6
area. July WTI found bids after slipped to a three-day low near $70.65. It
bottomed last week near $70 and peaked before the weekend near $73.60.
Asia Pacific
The larger than expected
deficit projected by New Zealand government has boost the markets' confidence
that a rate hike will be delivered when it meets Wednesday. The increase in spending to ease the
cost-of-living squeeze and fund the reconstruction after extreme weather events
earlier this year will force the RBNZ to take it onboard when it makes it
decision. As of May 12. A week ago, the market was leaning toward a 25 bp hike
in the 5.25% overnight cash target rate. The swaps market now sees a 25 bp hike
as a done deal and the debate is whether it hikes by 50 bp. The market has
discounted about a 20% chance of a 50 bp move. The New Zealand dollar led the
G10 currencies higher last week, rallying 1.45% (the Canadian dollar was a distant
second with about a 0.33% gain). The Kiwi has been in a roughly $0.6100-$0.6400
range for the past three-and-a-half months It pushed above $0.6300 ahead of the
weekend but settled slightly below $0.6285. It is in less than a third of a
cent range today above $0.6260.
The PBOC voiced concerns
about the big swings in the exchange rate ahead of the weekend. The dollar's 0.75% rise against the
yuan last week was the most since late February. The greenback's gains seemed
to reflect its broad gains rather than yuan-specific weakness. However, the
historical (actual volatility as opposed to what is implied in
implied--embedded in option pricing) vol has been elevated recently. The
one-month historical volatility of the offshore yuan reached a one-year low in
late April, a little below 2.40%. When the bank stress emerged in March, the
historic vol was nearly 9%. It was near 4.8% before the weekend. The 100-day
moving average is a little below 5.7%. Last week, three-month historical vol
fell to an eight-month low around 5.4%. The 100-day moving average is close to
6.9%. We suspect that the PBOC was really objecting to the
seemingly one-way market. The yuan has fallen for seven of the past nine weeks.
And since the mid-January, the yuan has depreciated for 12 of the 17 weeks. Separately,
President Biden's assessment that the US-China relationship would improve
shortly came shortly before Beijing announced that Micron failed its
cybersecurity test and banned the company's chips.
The dollar is consolidating
within the pre-weekend range against the yen, which itself was inside last
Thursday's range (~JPY137.30-JPY138.75). It has mostly been in a half of a yen range above JPY137.50,
where there are options for around $965 mln expiring today. Recall that the
dollar's decline before the weekend snapped a six-day rally (and nine of 11
sessions). Continued consolidation is the most likely near-term scenario. The
Australian dollar continue to trade in a mostly two-cent range
(~$0.6600-$0.6800). It has tested both end in the past two weeks and is
little changed in the lower half of the range. It is trading within Friday's
roughly $0.6620-$0.6675 range in quiet turnover. Given the official comments
ahead of the weekend, it is not surprising that the yuan is confined to a
narrow range. The dollar is trading within the previous session's
range for the first time since May 8. Still, the greenback is firm, holding
above the five-day moving average (~CNY7.01). The reference rate was set at
CNY7.0157 compared with expectations of CNY7.0166. Before the weekend, the fix
was at CNY7.0356. The one- and five-year loan prime rates were kept steady
(3.65% and 4.30%, respectively), as widely expected.
Europe
As Fed Chair Powell was
making a case for a pause before the weekend, ECB President Lagarde was
sounding hawkish. "It's
a time when we have to really buckle up and look at this target that we have and
deliver on it. We will take all the measures in order to bring inflation back
to 2%. We will do it, no question about it." She underscored her
signal that unlike the Fed, a pause is not under consideration. The swaps
market has a little more than 90% of a quarter-point hike at the mid-June
meeting, which would bring the deposit rate to 3.50%. There is about an 80% of
another 25 bp hike in late July.
Moody's surprised by
choosing not to update its assessment of Italy ahead of the weekend. It has a negative outlook and there
was some fear that it could have cut its Baa1 rating. That is already one notch
below S&P, Fitch, and DBRS. Moody's rating is lowest of investment grade
credits. The loss of investment grade status would have some repercussions
because private asset managers do not like split rating. However, for ECB
operations, only the highest rating matters and the other three rating agencies
see Italy as a BBB credit. In the middle of last May, the Italy was paying
slightly more than two-percentage points more than Germany to borrow for
10-year. This year's high and low premium was seen in January: ~214 bp to
almost 170 bp. However, since then it has been mostly in a 180-195 bp range.
Italy's two-year premium reached a six-month high earlier this month near 75 bp.
It has peaked around last year's election near 125 bp. The low for the year was
set around 34 bp in early February, a smidgeon above last year’s low.
The euro bottomed last week
near $1.0765, a little shy of the (61.8%) retracement target of its rally since
the March 15 low (~$1.0515) that is found closer to $1.0734. It has not closed above its five-day
moving average since May 5. It is found near $1.0820 today and has risen to
$1.0830 today, about 1/100 of a cent above the pre-weekend high. There are 1.1
bln options that expire today at $1.0825. A move above $1.0840 lifts the tone
and the $1.0885 is an important hurdle to the near-term outlook. Sterling is
within last Friday's range, which was inside last Thursday's range
(~$1.2390-$1.2490). It found a bid in the European morning after recording
session lows in late Asia Pacific turnover near $1.2415. Nearby resistance is
seen around $1.2460-70. Note that Greek bonds have rallied strongly, with the
10-year yield tumbling 15 bp following the weekend election. Prime Minister
Mitsotakis and New Democracy garnered more votes than expected but looks just
shy of enough to secure a one-party government. It will take a few days to sort
it out, but a run-off is likely next month. Separately, Sein Finn became the
largest party in Northern Ireland's local government for the first time.
America
The G7 couched their stance
toward China as "de-risking not decoupling." European official has already tried that
rhetoric and Chinese officials are suspicious. The G7 statement said, "A
growing China that plays by the international rules would be of global
interest." It begs the question of who set the rules and in whose
interest. The US and Europe enjoyed among their strongest periods of growth
with fixed exchange rates, limited capital mobility, and high tariffs. For
various reasons, those rules no longer set well in the US and Europe and they
changed them (See Kicking
Down the Ladder). Moreover, the US (bipartisan) have been critical of the
multilateral lenders and the World Trade Organization. It has called for the
change of the rules, itself. The US and Europe count for a shrinking share of
the world's population and GDP. By some measures of PPP, China's economy is
bigger than the America's. It is key manufacturer, and this was underscored
during the pandemic. It has become a large lender to developing
countries.
Calling on China to play by
the rules that it does not have much of a share in shaping, and seemingly
change when it suits the US/Europe, does not seem to be a high probability
course of generating the desired results. Giving China a greater vote in the World Bank and IMF may
be a practical starting point, but the US (and perhaps, Europe) are reluctant to let the wolf in to the house after the disruption
since China joined the WTO in 2001. In some countries, China appears as a
larger creditor than multilateral lenders. Is it unreasonable for it to resist
taking a larger haircut so that the multilateral lenders (using mostly American
and European money) can preserve their status as super senior creditors?
Expectations for a Fed hike
next month were rising with the help of stronger than expected US data and
hawkish comments from Fed officials. When hawks, like Bullard, talk about higher rates, it is not so
surprising. Perhaps, last week, it was comments by the new Dallas Fed President
Logan that got the market to take notice. Her views were not clear, but she was
unequivocal last week, saying that she was not ready to pause. She has the vote
this year. However, Chair Powell threw cold water on such ideas. In the futures
market, the odds of a hike in June were halved to less than 20% and today are
near 15%. Logan speaks again tomorrow, and the markets would see if her view
tempered after Powell. None of the four Fed presidents that speak today
(Bullard, Bostic, Barkin, and Daly) vote this year on the FOMC.
For a third session, the
dollar is trading within range it established against the Canadian dollar on
May 17 (~CAD1.3435-CAD1.3535). So far today, it is in about a 15-tick range on either side of
CAD1.3500. There are so chunky options at CAD1.36 that expire over the next few
days. The downtrend line off the March and April highs comes in near CAD1.3580
today and falls toward CAD1.3540 by the end of the month. The intraday momentum
indicators favor the upside after finding bid in the European morning. The
dollar is extending its recovery against the Mexican peso that began before the
central bank left rates steady last week. It is trading higher for the
fifth consecutive session. and has moved above the 20-day moving average
(~MXN17.80) for the first time this month. Two developments weigh on it today. First
is concern that the nationalization of a small railroad track to connect ports
may jeopardize the purchase of Citi's retail branches by Grupo Mexico, which
also owned the rail. Second, Mexico raises the alert level of the Popocatepetl
volcano, about 45 miles from Mexico City. A move above MXN17.80 could signal a
return toward MXN18.20.
Reviewed by Marc Chandler
on
May 22, 2023
Rating:
