Mostly
stronger than expected economic data, hawkish rhetoric by several Fed
officials, some signs of progress on the perverse drama over the debt ceiling,
and a solid week for bank shares helped the dollar extend its recent
recovery. The greenback rose to new highs for the year against the Japanese yen
and Chinese yuan. The euro took out April's low (~$1.0790) and sterling traded
briefly below $1.24. The US two-year note yield takes a six-session rally into
the week ahead. In this run, the yield has risen from about 3.90% to almost
4.33%. The odds of a Fed hike next month had risen from practically nothing on
May 5 to about a 15% chance on May 12 to around 40% last week,
according to the CME's calculations before Fed Chair Powell's pre-weekend
comments seemed to offer a stronger case for a pause and saw the odds fall back to 20%.
The dollar approached important chart
points and the debt ceiling machinations could very well go up to next week's
Memorial Day, US holiday. Taking a step away from the abyss by talking does not
signal an end to the drama, but signals the next act. Still, after the debt
ceiling is resolved, the increase in T-bill issuance and building the
Treasury's account (TGA) will tighten liquidity and likely boost rates. This
would seem to be supportive of the dollar. Further out, two headwinds loom.
First, a deal on the debt ceiling likely means some spending cuts (fiscal drag), and second,
the resumption of student loan debt servicing may also crimp consumption and
draw down savings.
May's flash PMI is the main economic
report for many large economies in the weekend. It may be more important for
Europe, which seem to have lost the momentum seen at the start of the year. In
the US, the FOMC minutes may help the market have a better sense of where the
Fed sees the peak. The risk is that is higher than the market assumes, given
the recent comments. Meanwhile, in this cycle, the US CPI steals most the
thunder from the PCE deflator (which the Fed targets), but due to
methodological differences, the underlying measures may be stickier. Due to
base effects, the UK's April CPI is likely to fall sharply, while Tokyo's May
headline and core CPI may slow slightly, but the risk is still on the upside
for the measure that excludes fresh food and energy.
United States: There are two highlights in the week
ahead, the FOMC minutes and the PCE deflator. At the May meeting, the FOMC
lifted the Fed funds target range by 25 bp to 5.00%-5.25%, as widely expected.
Without committing to it, Chair Powell suggested the Fed could pause in the
rate hike cycle that began in March 2022. The minutes will be scrutinized for
hint at where the bar is for a pause. The pricing in the Fed funds futures
strip sees about a 1-in-5 chance of a hike next month. The year-end effective is
now seen at 4.66%, compared with 4.39% a week ago. The current effective (weighted average in the Fed funds market) stands at 5.08%. The magnitude of rate cuts still seems to be more a tail risk than a base case. Turning to the April PCE deflator, a 0.3% rise is expected at both the headline and core
measures. If so, the headline rate may tick up to 4.3% from 4.2%, while the
core rate may slip to 4.5% from 4.6%. A 0.3% increase in the core rate would
put the annualized rate through April at 4.6%. Due to the methodological
differences, the risk is that core PCE is stickier than the core CPI with
greater weight of airfares, accommodations, and financial services. Note that
before the Fed's two-day meeting concludes on June 14, it will have another
employment report (June 2) and CPI (June 13) in hand. Initial estimates suggest nonfarm payrolls may rise by around 175k.
The Dollar Index posted a second strongly
weekly rally. It rose by slightly more than 0.65% after seeing gains pared
ahead of the weekend and rallied almost 1.5% the previous week. A series of
stronger than expected data, hawkish Fed comments, and a sharp rise in US rates
helped spur the technical correction. In the first week of the rally, it
approached the (38.2%) retracement objective of the losses since the banking
stress emerged in March (~102.75). In the past week, it surpassed the (50%)
retracement mark (~103.35). The next retracement (61.8%) is slightly below
104.00. For the record, the March high was near 105.90. On the downside, 103.00 frayed ahead of the weekend, but it still closed above it and a break of 102.60 warns that DXY rally is faltering.
Japan: In addition to the preliminary May PMI, Tokyo reports
May CPI. The capital's CPI gives strong indication for the national figure that
is reported with a few-week lag. The headline and core rate (excludes fresh food)
for Tokyo converged at 3.5% in April and may have slipped slighted in May. However,
the measure that exclude fresh food and energy set a new cyclical high in April
of 3.8% and may have ticked up. Reports suggest processed food prices are still
rising. BOJ Governor Ueda appears to have made a subtle but potentially
important change in the rhetoric. It is the switch to "patiently"
from "persistently". For example, in the press conference that
followed last month's meeting he said: "My honest feeling is that I want
to continue with monetary easing with a little more patience."
The dollar rose to new highs for the year
against the yen last week, spurred, we argue, by the rising US rates. It enjoys
strong momentum, perhaps too strong. It has risen in nine of the past 11
sessions and has frayed the upper Bollinger Band (~JPY138.60). The next
important technical target is around JPY139.60, which is the halfway mark of
the dollar's sell-off from last October's high (almost JPY152) to the
mid-January low (~JPY127.25) and near the JPY140 level of psychological
importance. Initial support may be in the JPY136.80-JPY137.10 band.
United Kingdom: The highlight of the week for the UK
will likely be a dramatic slowing CPI. Recall that in April 2022, CPI jumped by
2.5%. This will drop out of the 12-month comparison and replaced with something
considerably less. A 0.8% increase, the same as in March, would see the
year-over-year rate fall to 8.4%-8.5%. That would be the lowest since March
2022. However, the improvement should not be exaggerated. Leaving aside the
base effect, UK's CPI rose at an annualized rate around 5.2% in Q1. The 10-year
breakeven (the difference between the conventional Gilt yield and the
inflation-protected security) is a around 3.60%. The year's high was recorded
in April slightly above 3.80%. April retail sales will also draw attention. Recall
that after rising in January (1.2%) and February (1.1%), UK retail sales fell
1% in March (excluding gasoline). Last year, Retail sales rose in only two
months (June and October). Like the eurozone, the UK economy began the year
well (January GDP rose 0.5%) but faded as the quarter progressed (flat February
and a 0.5% contraction in March). The issue is the level economic activity in
Q2. While the composite PMI slipped in March (52.2 vs. 53.1 February), it rose
to 54.9 in April, its best level since April 2022. The median forecast in
Bloomberg's monthly survey is for the UK economy to stagnate this quarter and
expand by 0.1% in Q3 and 0.2% in Q4. Previously, economists, like the Bank of
England expected small contractions.
Sterling's advance that took it from near
$1.18 on March 8 to a its $1.2680 two months later is over. In the middle of
last week, the five-day moving average fell below 20-day moving average for the
first time since March 14. Sterling returned to late April levels slightly
below $1.2400. Position adjusting ahead of the weekend lifted sterling back to
$1.2485. In terms of corrective targets, $1.2345 is the (38.2%) retracement of
the rally since March 8 and about a cent lower is the next halfway mark. The
momentum indicators are trending lower. The $1.2500-25 area offers initial
resistance.
Eurozone: Perhaps of the countries in which a
flash estimate of PMI is made available, the eurozone is the most sensitive to
it. It is not uncommon for the central bank to cite survey data in its economic
assessment. And, as we have noted, the preliminary estimate is sufficiently
close to the final version that it steals most of its thunder. The manufacturing
PMI has been below the 50 boom/bust level since last June. In April, it stood
at 45.8, the lowest the early days of the pandemic. And still, the 4.1%
collapse of industrial output in March took one's breath away. The key to the
immediate outlook may not be in manufacturing, but in services. The services
PMI bottomed at 48.5 last November and steadily improved to 56.2 in April, its
best level since April 2022. The composite has tracked the services PMI. After
spending H2 22 below 50, the composite has held above the threshold for the
first four months of the year. April's 54.1 reading was the highest since last
May.
The euro was sold through the April low
(~$1.0790) last week. The low was $1.0760 ahead of $1.0735, the (61.8%) retracement of the
5.7-cent rally off the mid-March lows (~$1.0515). A break of that area targets
$1.0650. That said, the momentum indicators are getting stretched. The first
tell that the move is faltering is a close above the five-day moving average
(~$1.0830), which it has not done since May 5. That was nearly the high before the weekend and after Powell.
China: The Chinese economy appeared to continue
to recover in April, but at a slower than expected pace. Many look for the PBOC
to ease policy but it left the one-year medium-term lending facility rate
steady at 2.75%, though it did inject about CNY25 bln more than was maturing.
Still without a cut in the rate, banks have little incentive to reduce the loan
prime rates this week. China's 10-year is near its lowest level since last
November (~2.70%). The CSI 300 is up about 1.9% year to date, while the yuan
fell to new lows for the year last week. The divergence of interest rates and
the dollar's broad strength took a toll on the yuan which Chinese officials did
not seem strenuously object via the setting of the daily reference rate. However,
ahead of the weekend, with the dollar extending its gains above CNY7.0 and
having its best week in three-months against the yuan, the central bank sent a
warning shot to the market. It urged Chinese banks to help curb the large
swings in the foreign exchange market. The dollar pulled back ahead of the
weekend. It was pulled lower against the yuan as it fell against the euro and
yen. It held above CNY7.0. The US 10-year premium over China widened for the
third consecutive week. It was near 65 bp at the end of April and rose to
nearly 100 bp last week the most since early March. The CNY7.08-CNY7.10 area
may off the next resistance area for the greenback.
Canada: Stronger than expected April CPI last week
helped spur a shift in market expectations for Bank of Canada policy. The
underlying measures eased to 4.2%, but the headline CPI rose by 0.7% and the
year-over-year rate ticked up (4.4% from 4.3%). It was the first increase since
last June. The interest rate and derivative markets swung toward a rate hike,
but Bank of Canada Governor Macklem pushed back, saying the downtrend was
intact. The swaps market had about an 85% chance of a hike by the end of Q3,
but at the end of the week, settled with a little less a 60% probability. The
cut that had been anticipated for the year-end has unwound completely. Canada's
two-year yield has surged from 3.60% on May 11 to 4.15% on May 18, its highest
level in two months. Soft March retail sales ahead of the weekend saw the
two-year yield pull back toward 4%. The Bank of Canada meets on June 6. The
most important high-frequency data point may be Q1, and March GDP on May 31
followed by the May jobs report is the following day.
The US dollar was confined to about an
80-point range on either side of CAD1.3480 last week. The greenback peaked in
March near CAD1.3860, and the line connecting it, the secondary high in late
March (~CAD1.3805), and the late April high (~CAD1.3670) begins next week near
CAD1.3580 and finishes the month closer to CAD1.3545. For the past two sessions,
the pair have been confined to the range set in the middle of last week
(~CAD1.3435-CAD1.3535). The momentum indicators are not generating a strong
signal. Our bias is lower but a break of CAD1.34 is needed to suggest anything
important.
Australia: The poor April employment report extended
the Australian dollar's pullback from the upper end of its trading range
(~$0.6800) to the lower end (~$0.6600). Yet the market leans toward a small
hike to finish the tightening cycle by the end of Q3. The current cash target
rate is 3.85% and the futures market implies a 4% rate by the end of September.
It is the most since mid-March. Moreover, it was higher after the
jobs disappointment than it was before it. The pricing could be consistent with
a 15 bp move or a 60% chance of a quarter-point hike. Over the past two weeks,
the Aussie has tested both sides of its trading range, and although the upper
end was frayed intraday, it held on a closing basis. The range should be
respected until proven it is no long worthy. We are not convinced that the
greenback's recovery is over, and this means that market may test again the
$0.6600 area. The year's low was set in mid-March near $0.6565 and a break of
this would confirm a downside break out.
Mexico: The central bank halted its rate cycle
after 15 hikes. It signaled an extended period in which the overnight target
rate will be kept at 11.25%. Banxico shaved this year's inflation forecast to
4.7% from 4.8%. It was at 6.25% in April. It left the end of next year's
forecast unchanged at 3.1, where it also sees core inflation. It will take away
some of the interest the inflation readings for the first half of the month,
due May 24. Mexico reports April trade figures the following day. A $4.8 bln
trade deficit was recorded in Q1 23, slightly small the shortfall in Q1 22.
However, there capital flows, especially worker remittances and tourism can
offset the trade deficit. In Q4 22, Mexico recorded a $1.1 bln trade deficit
and a nearly $4.6 bln current account surplus. The underling positives for the
peso remain: carry (high interest rates and a relatively low vol)
near-shoring/friend-shoring (direct investment inflations) and a strong equity
market. At the same time, it is important to note that the market (asset
managers and speculators) is over-weight/long Mexico. Mexico is increasingly
integrated into the US economy and a recession in the US, which has been
discussed for more than a year, would weigh heavily on Mexico. The momentum
indicators warn that a period of consolidation is likely for the peso. Initial
resistance is seen in the MXN17.75-MXN17.80 area and a move above there targets
MXN18.00.
Reviewed by Marc Chandler
on
May 20, 2023
Rating:
