Dollar Steadies After Fed’s Push Back

by
Marc Chandler
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Overview: The market was gearing up for a June Fed hike and officials and this helped lift the greenback. However, the Fed Governor Jefferson, nominated to be the next vice-chair, pushed back against it. His views are thought to reflect the Fed's leadership. Philadelphia Fed's Harker, who is a voting member of the FOMC also backed a pause. This is not quite what we expected when we suggested the US interest rate adjustment was complete or nearly so. Still, it broke the dollar's upside momentum, though follow-through dollar selling today has been limited. It is narrowly mixed, with the Swiss franc and euro leading G10 with 0.15-0.20% gains. The dollar slipped through JPY139 briefly but as US rates have come back a bit firmer, the greenback has recovered to almost JPY140. Emerging market currencies are also mixed, but of note the Turkish lira, South African rand, and Chinese yuan are sporting softer profiles.

The House of Representatives approved the US debt-ceiling bill late yesterday and now goes to the Senate, which is expected to pass it will less drama. Asia Pacific equities were mixed, but Europe's Stoxx 600 is snapping a three-day slide and is up about 0.75%. US equity futures are trading with a firmer bias. Benchmark 10-year yields are 1-2 bp higher in Europe and the 10-year Treasury yield is up about three basis points to 3.67%. If sustained, it would be the first increase since last Thursday. Gold is little changed as it consolidates the recover that took it from near $1932 on Tuesday to almost $1975 yesterday. It held above $1950 on the early attempt at support and is around $1960 in late European morning dealings. July WTI dropped from about $73.35 Tuesday to a low yesterday near $67. It is little changed now near $68. API reportedly estimated US stocks rose 5.2 mln barrels and there continues to be speculation that some OPEC members may extend voluntary production cuts at the weekend meeting.

Asia Pacific

It is not that China's May PMI was out of line with other major economies, experiencing a contraction in manufacturing and expanding services. Rather, after the end of the zero-Covid policy, many had hoped for a stronger and more sustained recovery. Headwinds from longer-term structural challenges are cited as the reason for the disappointment. Earlier today, Caixin manufacturing PMI unexpectedly rose to 50.9 from 49.5. It was expected to be unchanged. Yet, because it relies on a smaller sample and does not match the "official" PMI many are dismissive, suggesting no change in sentiment. After falling by 1% yesterday, the CSI 300 edged up by 0.2% today. Even before the disappointing industrial profits and PMI, there had been speculation of some more monetary support in the form of interest rates reductions and/or a cut in required reserves. In addition, there are reports suggest Beijing is considering new tax incentives for high-end manufacturing. This seems to be a reflecting both economic support and concern about supply chain security.

Japan's preliminary Q1 GDP estimate of 0.4% (quarter-over-quarter) was boosted by stronger-than-expected business investment (0.9% vs. forecasts for a contraction). Today's Q1 cap spending report showing an 11% surge was nearly double the median projection in Bloomberg's survey and warns of the risk of an upward revision to Q1 GDP. It is the biggest quarterly increase since Q2 18. Separately, the final May manufacturing PMI slipped to 50.6 from the flash estimate of 50.8, but still up from 49.5 in April and the first reading above 50 in seven months. Lastly, the weekly MOF portfolio flow report show the foreign buying spree of Japan assets went into reverse from the nearly JPY1.98 tln (~$14.3 bln) to a liquidation of JPY267.5 bln. Japanese investors continued to return to the global bond market after divesting heavily last year. Their appetite for foreign stocks remains soft. Japanese investors bought JPY1.03 trillion foreign bonds and sold JPY657 bln of foreign stocks.

Australia's May manufacturing PMI final reading was 48.4, up from 48.0 of the flash estimates. It was at 48.0 in April and stood at 50.2 at the end of 2022 and was 55.7 in May last year. Governor Lowe of the Reserve Bank of Australia said, like other central bankers, that it is data dependent. But it begs the question of which data. The monthly CPI rose in April for the first time this year. April jobs and retail sales were weaker than expected. There has been a significant adjustment in Australian short-term rates in May as the market reassesses the outlook for central bank policy. The two-year yield rose from 3.0% on May 1 to 3.65% at the end of last week. It is now a little below 3.60%. The odds of a quarter-point by the end of Q3 has risen from no chance to fully discounted. The Australian dollar fell by about 1.7% in May, its fourth consecutive monthly loss.

The gyrations in US rates first saw the dollar fall to a five-day low slightly below JPY139 and then rebound back to almost JPY140. There are ae options for JPY590 at JPY140 that expire today and another JPY560 mln at JPY139. While the dollar may push back above JPY140 in the North American session, we look for it to hold below yesterday's high near JPY140.40. The Australian dollar is straddling the $0.6500 area and has thus far been confined today to about a fifth of a cent band on both sides. A move above $0.6540-60 would help stabilize the tone. A break now below $0.6480 signals more work is needed to forge a low. The greenback extended its gains against the Chinese yuan to reach nearly CNY7.1240. It is the fourth consecutive gain and 16 of the past 19 sessions. The PBOC set the dollar's reference rate at CNY7.0965. The median projection in Bloomberg's survey was CNY7.0975. We had anticipated the dollar to rise into the CNY7.07-CNY7.11 area. The next target may be in the CNY7.17-CNY7.20 area.

Europe

Germany, France, and Spain all reported softer than expected May CPI. Italy was the disappointment among the large EMU member, with a 0.3% month-over-month gain. It had been forecast (median in Bloomberg's survey) to fall by 0.2%. Due to the base effect, the year-over-year pace eased to 8.1% from 8.7%. The aggregate figure showed unchanged monthly rate and a 6.1% year-over-year pace, down from 7.0% in April and amid forecasts for a 6.3% rate. The core rate ticked down for the second consecutive month, though at 5.3% it remains near the peak of 5.7% set in March. Separately, Eurostat reported that EMU's unemployment rate remains at its record low of 6.5%.

The eurozone final manufacturing PMI was edged slightly higher from the preliminary read of 44.6 to 44.8. It was at 45.8 in April and 47.8 at the end of last year, and 54.6 in May 2022. Germany's final reading was at 43.2 (from 42.9 flash and 44.5 in April), the weakest since May 2020. France's final manufacturing PMI reading slipped back to 45.7 from the initial estimate of 46.1 and 45.6 in April. Spain's manufacturing PMI slowed to 48.4 from 49.0, a little better than expected, while Italy's ticked down to 45.9 from 46.8. There is no sign that the contraction in manufacturing is ending.

The UK may have avoided the worst-case scenarios of a protracted recession, it is not out of the woods. Inflation is stubborn. It is running at a 7.5% annualized clip through the first four months of the year. That compares with a 4.2% pace in the US and 6.3% in the eurozone. Nationwide reported today that its house price index in May is off 3.4% from a year ago, the biggest decline since 2009. The UK's manufacturing sector is remains under pressure. The PMI has been below 50 since last August. Today's final reading slipped to 47.1. While better than the flash estimate of 46.9, it is the lowest this year. There has been a dramatic increase in UK rates. The two-year yield rose from about 3.66% on May 4 to 4.57% at end of last week. It is near 4.35% today. The swaps market has a quarter-point hike fully discounted for the June 22 meeting and has about a 10% chance of a 50 bp move. The year-end rate is seen near 5.35%, up from 4.80% as recently as mid-May.

After falling to $1.0635 yesterday, the euro stabilized with the help of the broader dollar pullback on the decline in US rates. It has been confined to about a third of a cent below $1.07, where options for nearly 2.2 bln euros expire today. There is another set for 1.15 bln euros at $1.0730. It may take a soft US jobs report tomorrow for the euro to begin repairing the technical damage inflicted when the market had a nearly 70% chance of a quarter-point Fed hike discounted. The intraday momentum indicators warn that the market may sell euros like it did yesterday when it briefly poked above $1.07. For the third consecutive session, sterling has run into offers in the $1.2450 area. That said, it has held $1.2400, just above the five-day moving average. Even if the $1.2450 area yields, the $1.2475-$1.2500 area may offer formidable resistance. On the downside, the $1.2300 area offers support.

America

The unexpected surge in the April US jobs openings (10.1 mln after an upwardly revised 9.75 mln in March helped sustain the dollar's firmer tone and injected some volatility in the debt market. The April results were above all the estimates in Bloomberg's survey. Openings were led by retail trade, health care, transportation, and warehousing. Job openings fell in hotels and food services, business services, and manufacturing, still overall the ratio of openings to the number of unemployed, often cited by Fed officials rose to 1.8 in April, the highest in three months. Hiring increased, while layoffs slowed (led by construction, leisure, and hospitality). The quits rate (voluntary jobs leavers as a share of total employment) fell to more than a two-year low. A caveat with this survey has seen a sharp drop off in the response rate. It is around 30%, half of what it was before the pandemic.

There is a slew of US economic data due today. The market may be most sensitive the ADP private sector jobs estimate (even though it does a poor job tracking the BLS monthly estimate) and the ISM manufacturing survey. Weekly jobless claims on the eve of the national figures loses some of its potential impact. The final manufacturing PMI will not contain much new information. Because auto sales trickle out over the course of the day, they do not have as much market impact as their importance would suggest. After a strong rebound in April to 15.9 mln vehicles on a seasonally adjusted annual basis, the most since May 2021, they are expected to have softened in May. That said, the median projection in Bloomberg for a 15.3 mln pace would be a 20% increase over May 2022. The Atlanta's Fed's GDP tracker will be updated today. It was slashed last week to 1.9% from 2.9%.

The market may be delivering the Fed a fait accompli for a hike at the June 13-14 meeting, but the Fed pushed back yesterday. Governor Jefferson and Philadelphia Fed President Harker (voter) talked about the benefits of a hawkish pause. Fed Chair Powell opened the door to a possible pause at the May 3 FOMC meeting and made a robust defense of it a couple of weeks later. A combination of better-than-expected data, including strong demand and resilient labor market, and hawkish comments be several Fed members, including a couple of middle-of-the road officials, has spurred a significant adjustment. The market was pricing in about a 2/3 chance of a quarter-point hike on June 14 before Jefferson and Harker spoke and knocked the odds back below 35%. We had argued that the interest rate adjustment in the US was over or nearly, and the US two-year yield has fallen 25 bp since the high from the end of last week. The interest rate adjustment was a key part to the dollar's three-week rally, and we had expected the dollar to become better offered when the interest rate support softened. That said, it often happens with a lag.

Canada and Mexico see the manufacturing PMI, which tend to have limited market impact. Mexico also reports the IMEF surveys, the central bank minutes when it paused (completed?) its rate hiking cycle. Mexico also reports April work remittances. In Q1 23, they have averaged $4.65 bln a month. In Q1 22, remittances, which mostly come from the US, averaged $4.17 bln. Worker remittances have emerged an important source of capital inflows into Mexico. Consider that in Q1 19, worker remittances averaged $2.65 bln a month. Banxico Governor Rodriguez signaled the intention to keep the cash target rate at 11.25% for the next couple of months before even discussing a rate cut. The central bank raise this year's GDP forecast to 2.3% from 1.6% it projected in March, while shaving the year-end inflation forecast to 4.7% from 4.9%. 

Stronger-than-expected Q1 Canadian GDP (3.1% annualized after Q4 22 was revised to a 0.1% contraction) lent the Canadian dollar support amid the strong greenback performance. However, the risk-of mood, exemplified by the sharp drop in the S&P 500 seemed to deter much CAD buying. The swaps market marginally increased the chances of hike next week to about 35%. It was less than 10% in early May. Canada's two-year yield has risen from 3.46% on May 4 to 4.33% at the start of the week. The US dollar held slightly below last week's high (~CAD1.3655) but found support near CAD1.3575. It has given way to a marginal new low toward near CAD1.3560. A break of the CAD1.3550 area could signal a return to CAD1.3500. The risk-off mood soured the demand for the Mexican peso. The US dollar rose to a three-day high, slightly above MXN17.77. A move above MXN17.80 would re-target the MXN18.00 area that was tested (and held) on May 23-34. The peso is trading quietly at little changed levels. Initial dollar support is seen around MXN17.63.