Firm US Dollar as Market is Feeling More Comfortable with May Hike

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Marc Chandler
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Overview: The dollar fell most of last week but reversed higher before the weekend. It has seen some follow-through gains, albeit limited against most of the G10 currencies today. Despite some seemingly dovish comments by a few Fed officials last week, the Fed funds futures is pricing in the greatest chance for a hike at the early May meeting since the banking stress erupted last month. The greenback is also trading with a firmer bias against most emerging market currencies. The Philippine peso leads the EM complex lower with more than a 1% pullback. The central bank said that is inflation continues to slow (April CPI due May 5) it will pause its tightening (next meeting May 18).

Anticipation of a robust GDP figure tomorrow helped lift Chinese equities by more than 1% today to lead the advance among Asia Pacific equities. The MSCI Asia Pacific Index reacted its best level in two months. Europe's Stoxx 600 is edging higher to extend is winning streak for the sixth consecutive session. US equity futures are narrowly mixed as the earnings season gets under way. Benchmark 10-year yields are mostly 2-3 bp higher in Europe. The 10-year Treasury yield is up a couple of basis points to almost 3.54%, its best level since April 3. Gold peaked last week slightly shy of $2049 and found support ahead of the weekend around $1992.50. No follow-through selling has been seen today and the yellow metal is firm near $2010. June WTI is trading quietly within the pre-weekend range (~$81.65-$83.00). Sentiment is constructive amid concerns over a squeeze of supplies.

Asia Pacific

Japanese markets and the yen do not appear to have been impacted by the pipeline object thrown at Prime Minister Kishida as he was campaigning for LDP candidates ahead of next weekend's run-off in several local elections. Among the seats being filled is the one that former Prime Minister Abe held before his assassination last summer. No injuries were reported, and the suspect was quickly caught. Kishida's public support has risen in recent weeks. The latest ANN poll (April 15-16) found the approval rating of the cabinet has risen 10.2 percentage points to 45.3% from a month ago. There is speculation that a strong showing for the LDP will encourage Kishida to call for a general election. Japan leads the G7 this year, and the summit next month will be in Kishida's hometown, Hiroshima. Japan's economic highlights this week include the trade March trade balance (deficit) and national CPI figures. The trade deficit is expected to be more than 2.5x larger than the March 2022 deficit of JPY465 bln. The headline CPI may slip to 3.2% from 3.3%, but the measure excluding fresh food and energy may rise to a new cyclical high (3.6%). At the end of the week, the preliminary April PMI will be reported. The composite finished last year at 49.7 and spent Q1 above the 50 boom/bust level. 

The arrest of two human rights activists in Beijing on their way to a meeting with the EU's ambassador to China may undermine the "goodwill" efforts by President Xi in what some in the media have called a "charm offensive". Some accounts see the arrests in the context of EU's foreign affairs minister Borrell's blog posts a few hours before the arrests cautioning China against using force to change the status quo in Taiwan. Borrell was supposed to visiting Beijing at the end of last week, but the trip was cancelled after he tested positive for Covid. Separately, the Germany's Finance Minister Linder called Macron's push for European strategic autonomy "naive" especially in light of Russia's invasion of Ukraine. Germany's Foreign Minister Baerbock was in Germany last week and reiterated the "one-China" policy but also expressed concern about Beijing's provocations toward Taiwan. Meanwhile, Germany is reviewing a controversial decision to allow a Chinese state-owned company to buy a 24.9% stake in one of Hamburg's port terminals, which is now regarded as "critical infrastructure."  When Chancellor Scholz was mayor of Hamburg, he supported selling a 35% stake to the Chinese company, but last year compromised as the national coalition pushed back.

The US 10-year yield is holding near its best level in couple of weeks and this has helped lift the dollar to the upper end of its four-week trading range against the Japanese yen. It reached slightly above JPY134.20 in late Asia Pacific turnover before stalling. The greenback has not traded above JPY135 since mid-March. It opened near JPY133.65 and has remained above it so far today. The Australian dollar poked above $0.6800 before the weekend, its best level since late February before reversing lower and sold through marginally through $0.6700. Follow-through selling has been limited to $0.6690 so far today, which corresponds to a (61.8%) retracement of last week's rally. There are A$2.7 bln of options struck at $0.6700 and another set for A$420 mln at $0.6675 that expire today. Nearby resistance is seen around $0.6720. The US dollar recovered from a three-week low near CNY6.8320 before the weekend to around CNY6.8720. Follow-through buying lifted it briefly to CNY6.8810 before consolidating. Last week's high was near CNY6.8920. The PBOC kept the benchmark one-year medium-term lending rate steady at 2.75%, as expected and injected CNY170 bln one-year loans into the banking system, which was CNY20 bln more than expiring. The dollar's reference rate was set tightly against expectations (CNY6.8679 vs. CNY6.8686).

Europe

A ruling by France's Constitutional Council cleared the last hurdle to President Macron's controversial push to increase the pension age by two years to 64. The Constitutional Council did reject some parts, but did not appear to be substantive, and the law was written into the "Official Journal" over the weekend. It is to be effective starting in September. Macron argues raising the pension age will help boost employment rates and put the public retirement system on more sound fiscal footing. Many unions have protested and advocated other ways to strengthen the system. Moreover, Macron antagonized many by making an end-run around parliament when it became clear he lacked the votes in the National Assembly. The opposition made two arguments that could lead to a referendum, and the Constitutional Council rejected one of them. It will issue a decision about the other argument on May 3, after what is looking like dramatic protests on Labor Day, May 1. 

With the help of a more resilient economy, the Tories have gained in the UK polls but the gap with Labour remains double-digit. Local elections on May 4 will offer insight into the mood of voters. The head of the Conservative Party warned that the Tories may lose more than 1000 seats. Some 8000 council seats (230 councils) will be contested in England. While Prime Minister Sunak has restored fiscal orthodoxy after Truss's heterodox drama, and secured a Northern Ireland protocol, the labor dispute with several civil servant groups continues, including nurses, who reject the government's "final offer" by a vote of 54% to 46% last week. Two other health unions (GMB and Unite) are voting on their pay offers and the results are not expected until April 28. 

The euro reversed low after reaching about $1.1075 before the weekend. It settled slightly above the previous session's low, but selling today took it to almost $1.0960. The $1.0955 area is the (50%) retracement of last week's gains and the next retracement (61.8%) is near $1.0925. The euro has found a bid in the European morning, but the $1.10 area looks to offer resistance and there are options for 1.15 bln euro struck there that expire today. There is also at $1.0935 for 980 mln euros that also expire today. Sterling posted a key downside reversal before the weekend by making a new high (~$1.2545) before reversing and closing well below the previous session low (~$1.2480). Selling today has dragged sterling to $1.2375, to fray the 20-day moving average for the first time since mid-March. Nearby support is seen near $1.2340 and then $1.2280.

America

Last week, a few Fed officials sounded as if they were inclined to pause at the May 3 FOMC meeting. However, when everything was said and done, the Fed funds futures show the market perceived a greater chance of a hike than previously. In fact, the slightly better than 85% chance is the most since before the banks stress emerged last month. The odds have steadily risen for three consecutive weeks. It was seen to be almost 25% chance on March 24 and nearly 58% a week later. It was near 70% after the employment data on April 7. Emergency borrowing from the Federal Reserve slowed for a fourth consecutive week, including the first reduction in the use of the new Bank Term Funding Program. Still, emergency borrowing is elevated at $139.5 bln in the week ending April 12 (the sum of discount window and BTFP use). Bank deposits rose by $60 bln in the week ending April 5 and small-medium sized banks also saw an increase. Commercial and industrial loans rose by nearly $6.7 bln in the week through April 5, which followed a two-week record drop of $68 bln. The KBW bank share index rose nearly 3.2% last week. Ahead of the weekend, it reached a high since March 16, about 10.4% above its low on March 24.

There is talk of a potential deal on the US debt ceiling. Some Republicans are talking about extending a suspension of it for a year or so, which would bring to back to the fore amid next year's presidential campaign (primary season). The Democrats may accept it, but they do not want to distract from other issues. There is some idea that Biden administration will seek to rebuild its coffers and have sufficient room to maneuver to make it through the November 2024 election and pad the Treasury's general account (TGA) so that the government can pay for the approved spending. Meanwhile, the cost of hedging against US default risk (one-year credit default swaps) peaked in mid-March near 96.7 euros and finished last week near 92.4 euros. At the end of last year, the cost was a little above 15 euros. Still, the liquidity and accuracy of the price discovery process is an open question as the market found out last month with a single European bank's credit default swap.

The US dollar recovered from a two-month low near CAD1.3300 to almost CAD1.3400 before the weekend. There has been no follow-through gains today and the greenback is trading in a quietly between about CAD1.3345 and CAD1.3385 today. The CAD1.3400 area is technically important. It corresponds to the (38.2%) retracement of last week's decline and houses the 200-day day moving average. A move above it would target CAD1.3430 and then CAD1.3460. The US dollar settled last week at session lows near MXN18.00. Selling today took it to almost MXN17.93, but it is straddling MXN18.00 in the European morning. Last month's multi-year low was slightly below MXN17.90. A move now above MXN18.12 would likely signal a consolidative phase.