The Greenback Continues to Struggle

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Marc Chandler
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Overview: There is a nervousness that hangs over the capital markets. Although US banks shares recovered at the end of last week, many continue to see the sector’s challenges as the harbinger of a dramatic reversal in the Fed’s stance. America’s debt ceiling looms large and could be a few weeks away. China led Asia Pacific bourses higher, and, ironically, its bank shares extended their rally. Japan, returning from last week’s holiday was notable exception. Relative strength of the yen seemed to offset the modest regional gains, weighing on Japanese equities. Europe’s Stoxx 600 is extended the gains from the end of last week, helped by 1% gain in bank shares after a 3.1% rally before the weekend. US equity futures are narrowly mixed. Follow-through gains among bank shares would help lift sentiment. The 10-year US Treasury is a couple of basis points firmer near 3.46%, while European benchmark yields are 2-3 bp higher. UK markets are closed for the coronation celebration.

The greenback continues to struggle to secure traction and is lower against all the G10 currencies but the Japanese yen. Sterling has made a marginal new 11-month high. The Bank of England is widely expected to hike the base rate later this week. Emerging market currencies are mostly firmer, and the JP Morgan Emerging Market Currency Index is extending its advance for the fourth consecutive session. Gold is firm but consolidating in a $5-range on either side of $2019. June WTI continues to recover after last week’s climactic sell-off to $63.65. It reached $71.80 before the weekend and is approaching $73.00 today. The $73.50 area is about the halfway point of the sell-off that began from the April 12 high near $83.40.

Asia Pacific

Japan's market reopened for the first time since last Tuesday. When it was on holiday, the MSCI Asia Pacific Index rose by about 0.7%. On the other hand, the yen rose about 1.3% against the dollar amid falling US rates. The Nikkei fell by about 0.7% today. Japanese bank shares fell by 1.25%. Earlier today, the preliminary PMI services and composite were revised higher. The services PMI was revised to 55.4, up from the flash reading of54.9 and 55.0 in March. It revised away the first decline since last November. Similarly, the composite PMI stands at 52.9 rather than 52.5 and is unchanged from March. Tomorrow, Japan reports March labor cash earnings and household spending figures. Despite wage increases in the spring negotiating round, in Q1 22, cash earnings averaged 1.4% year-over-year. If the median forecast in Bloomberg's survey is accurate, the average in Q1 23 is about 0.9%. Household consumption tells a similar story. The year-over-year increase in Q1 22 was 1.9% and, assuming the median forecast of 0.8% in March this year, the Q1 23 average is about 0.7%. The Bank of Japan's next meeting is June 16. Many observers look for an adjustment of monetary policy at the June-July meetings due to underlying price pressures (excluding fresh food and energy), which are making new cyclical highs.

China reported that the dollar value of its reserves rose by almost $21 bln last month (to $3.2 trillion), which the State Administration for Foreign Exchange (SAFE) attributed to the decline in the dollar and the rise of global assets. The dollar fell by about 1.65%-1.85% against the euro and sterling but rose by 2.5% against the yen in April. It was also a bit stronger against the Australian and Canada dollars (~1.2% and 0.3%, respectively). Benchmark 10-year yields were narrowly mixed last month. On the other hand, China's gold holdings capture attention (and imagination). It acquired about 8.1 tons of gold to extend its buying streak for the sixth consecutive month. During this run, it has acquired around 130 tons, worth about $8.8 bln. This brings its total gold holdings to about 2076 tons, with a value of about $140 bln. The latest US Treasury data was for February, and it estimated China held a little less than $850 bln of US Treasuries. In light of Russia's experience of having its reserves and assets out of the country frozen or seized, some countries see domestic holding of gold as an insurance policy against US sanctions. The World Gold Council reports that Singapore, China, and Turkey have been among the largest buyers of gold. 

The dollar is steady to slightly firmer in a JPY134.65-JPY135.30 range. A push above the JPY135.65 area could help lift the technical tone. It peaked last week slightly above JPY137.75. On the downside, support is seen in the JPY134.30-50 area. The Australian dollar is nearing the upper end of its two-month range near $0.6800. It had tested the lower end of the range around $0.6600 at the end of April and was helped by the unexpected rate hike last week. A convincing break of $0.6800 would initially target the $0.6860 area. The intraday momentum indicators suggest a breakout may not happen today, but the daily momentum indicators are constructive. The dollar is little changed against the Chinese yuan. It remains in the range set on April 25, roughly CNY6.89-CNY6.9340. The reference rate was set at CNY6.9158, close to the market expectation based on the movement of the dollar since the mainland session ended before the weekend of CNY6.9150.

Europe

The results of the local elections in the UK were among the worst-case scenarios for the Tories, who lost over 1060 council seats (around the same as in 2019). Labour picked up almost half of the Tories' losses and a couple of municipalities that were also at stake. The Lib-Dems picked up more than 400, and the Greens did well, garnering about 240 council seats. The Tories are being squeezed as Brexit fades as a mobilizing force, but the fissures remain. Parts of the north that has swung to the Tories are returning to Labour, and in the south, some of the remainders have drifted to the Lib-Dems. The Tories need something more than Sunak's competent technocratic approach if it is going to avoid a rout in the next general election. 

German's industrial production fell 3.4%, more than twice the decline economist forecast. It comes after last Friday's surprisingly sharp drop in factory orders (-10.7%). Last week, France reported a 1.1% decline in industrial production. Coupled with the weakness in Germany's March retail sales, one gets the impression of very weak momentum coming into Q2 and sets the stage of another quarterly contraction in GDP (recession?). As with the factory orders, the auto sector was especially weak. Still, it seems like there may be a seasonal adjustment issue. Meanwhile, there is a diplomatic brouhaha between France and Italy. President Macron's pension reforms are unpopular, and the rare use of executive authority allowed him to side-step parliament. This seems to be creating an opportunity for Le Pen. But rather than strike out at it, France's Interior Minister was critical of Italy's Prime Minister Meloni and claimed she lied to voters about solving the migration problem. Italy's Foreign Minister and former head of the EU Parliament, Tajani, canceled his planned trip to Paris. Ironically, on a recent trip, Meloni complimented UK Prime Minister Sunak's immigration policies, which have clashed with the French on Channel crossings. The British wanted to have their own forces to patrol French beaches but agreed to fund a larger French presence.

The euro is firm but remains in well-worn ranges (~$1.1015-55) in quiet turnover. Last week's high was around $1.1090. The intrasession lows frayed the 20-day moving average (found just below $1.10 today) but dip-buying rather than long liquidation greets the pullbacks. The intraday momentum indicators warn of another attempt on the upside in the North American morning. Although UK markets are closed today, sterling edged to a new high (since last June), drawing close to $1.2660. The next important upside target is the $1.2760 area, which corresponds to the (61.8%) retracement of sterling's decline from the June 2021 high near $1.4250. The intrasession momentum indicators favor another attempt at the highs later today provided support near $1.2620 holds. 

America

Many observers scoffed at Fed Chair Powell's comment last week that he thought a soft landing was more likely that the shallow recession that the Fed's staff had projected later this year and that many economists have been anticipating for more than a year. He also opined that the banking system was sound. To be sure, things may have looked bleak in the immediate aftermath of Powell's press conference last Wednesday afternoon. KBW's large bank index fell 3.8% the following day, and the small bank index fell 3.5%. Still, Friday, for the thirteenth consecutive month, US jobs growth exceeded expectations. The unemployment rate fell back to the cyclical low (3.4%) set in January, and hourly earnings rose by 0.5% in April, matching the biggest increase since March 2022. Bank share indices gapped higher and fully recouped Thursday's decline. The regional bank index settled at a four-day high ahead of the weekend, and the large bank index closed at a three-day high. The "one-day island bottoms" is an encouraging technical sign.

To be sure, job growth is slowing, and the labor market is moderating, but from the Fed's point of view, it remains strong. The US has created 1.14 mln jobs in the first four months of the year. In the Jan-Apr period in 2022, the US filled 1.94 mln positions. But that might not be the relevant comparison. Consider the pre-Covid experience. In the first four months of 2018 and 2019, the US created 904k and 760k jobs, respectively. Prime age (25-54) employment reached a 22-year high. 

In March, the median Fed forecasts in the Summary of Economic Projections saw the unemployment rate finishing the year at 4.5% and foresaw the economy growing by 0.4% year-over-year. These projections increasing seem too bleak, and we suspect they will be revised higher in next month's iteration of the Fed's Summary of Economic Projections. The pricing in the Fed funds futures strip implies a year-end effective rate of 4.32%, meaning three and possibly four quarter-point cuts. It had finished April near 4.51%. While possible, it seems improbable. We would subjectively see the odds of another rate hike as greater than 75-100 bp of cuts this year.

The US dollar stalled near CAD1.3640 last week and fell sharply in the last two sessions last week reaching CAD1.3370. While some in the press played up Bank of Canada Governor Macklem's warnings about inflation, the swaps market showed little reaction. We suspect the rally recovery in US equities and oil help fuel the Canadian dollar's recovery. It has been extended today to about CAD1.3340, leaving little in the way of a test on the two-month low set in mid-April near CAD1.3300. Still, the intraday momentum indicators are stretched. The greenback has slipped to a new low since 2017 against the Mexican peso near MXN17.75. The low from 2017 were in the MXN17.45-65 area and that represents the next target, even if not meaningful support. Today will likely be the second consecutive session that the greenback will not trade above MXN18.00. Separately, note the results of the election at Chile's Constitutional Council looks like another set by for President Boric, which may encourage investors. The Chilean peso rallied 1.5% last week.