The Dollar Consolidates after Powell Sapped its Mojo

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Marc Chandler
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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 changed 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 seemed reluctant to let the wolf in to the house after the disruption since China joined the WTO in 2001. In some countries, China appears is 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.