May Day Fed Day

by
Marc Chandler
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Overview: Much of Asia and Europe are off for the May Day labor holiday. The dollar is mostly softer in the thin activity. However, the dollar has edged higher against the yen and approached JPY158. The euro initially fell to $1.0650, a six-day low and where a billion euros in options expire later today. It has recovered to almost $1.0675. Emerging market currencies are subdued. Central European currencies, the South African rand, and Mexican peso are sporting slightly firmer profiles.

Asia Pacific equity markets that were open today (e.g., Japan, Australia, New Zealand) fell after the large losses seen in the US yesterday. European equities are closed but the UK's FTSE is slightly firmer. US index futures continue yesterday's retreat. The 10-year UK Gilt yield is near 4.38%, up three basis point today to a new three-month high. The US 10-year Treasury yield is hovering slightly below 4.70%. The US two-year yield reached a new high for the year yesterday after the Employment Cost Index report almost 5.05%. It near 5.03% now ahead of the bevy of US data before the outcome of the FOMC later today. Gold fell to almost four-week lows near $2281 before catching a bid today and recovering through $2290. The upside in North America looks limited today. June WTI has extended its recent losses and near $80.50 is at its lows since late March amid rising US inventories and some hopes of a cease-fire in the Middle East. The June contract has not closed below $80 since mid-March.

Asia Pacific

Even with the March rise in Japan's industrial output, it will be a drag on Q1 GDP. Similarly, housing starts slipped slightly in Q1 (~2.2%). Japan's Q1 GDP is due mid-May and the median forecast in Bloomberg's monthly survey looks for a 0.2% contraction after growing 0.4% in Q4 23. Household energy subsidies will be halved in May before ending in June when income tax cuts will be implemented. The net effect will likely be higher inflation and stronger growth.

The BOJ projected yesterday that commercial banks' deposits with it likely dropped by JPY7.56 trillion. Last week, money-market brokers had projected a JPY2 trillion decline. The JPY5.5 trillion difference is consistent with intervention of around $34.6 bln, and the upper end of estimates. Many observers argued that after Friday's dollar advance to nearly JPY158.45, that Japan would have to intervene or lose credibility. However, we argue that the only thing worse that not intervening would be failed intervention. Intervening ahead of the FOMC meeting outcome (hawkish hold widely expected) and the US jobs report (median expectation in Bloomberg's survey is for a 240k increase in nonfarm payrolls) strikes us a risky undertaking. 

The dollar gradually edged higher yesterday, and by the end of the North American session, it had recovered more than half of the intervention-inspired losses, reaching almost JPY157.85 The (61.8%) retracement objective is near JPY158.00, which dollar has held ever slightly below, so far today. A move above JPY158 targets the high from the end of last week (~JPY158.45). We suspect support is building near JPY157. The Australian dollar recovered from the year's low set on April 19 (~$0.6365) to slightly above $0.6585 on Monday. Disappointing Australian retail sales and a broadly higher greenback saw the Aussie fall to $0.6475 yesterday and $0.6465 earlier today. It gave back a little more than half of its bounce. The next retracement is near $0.6450. There are options for more than A$1 bln that expire there on Friday. Initial resistance is seen near $0.6485-90. Disappointing New Zealand labor data (larger than expected rise in Q1 unemployment and an unexpected loss of jobs) saw the Kiwi extend yesterday's losses initially but recovered fully before stalling near $0.5890. Chinese mainland markets are closed for the rest of the week. The trading band as of Tuesday for the dollar against the onshore yuan was CNY6.9642-CNY7.2484. The greenback traded mostly above the band against the offshore yuan yesterday. It is in a range today of about CNH7.2435 to CNH7.2550. The April peak was set in the middle of the month near CNH7.2830.

Europe

The May Day holiday thins European activity today. Tomorrow, the eurozone will see the final April manufacturing PMI reading. Recall that the preliminary estimate showed the third monthly decline. It fell to 45.6 from 46.1 in March. It had jumped to 46.6 in January after finishing last year at 44.4. The new information will be from the periphery, and here the signal is clear. Italy and Spain manufacturing sectors are faring better than Germany and France. German and French manufacturing sectors are contracting, according to the PMI, while Spain and Italy are expanding. That said, German and French national figures on industrial production have fared better than the PMI appears to suggest. German industrial output (which includes construction) rose 2.1% in February after a 1.3% gain in January. The March data is due May 8. French manufacturing output fell 1.5% in January and rebounded by 0.9% in February. The March update is due at the end of the week.

Despite stronger than expected Q1 growth in the eurozone and firmer than expected April CPI, the euro struggled to sustain even modest upticks against the dollar yesterday, especially after US labor costs (Q1) rose more than anticipated. The euro fell to the lower end of its recent range near $1.0670. The losses have been extended to $1.0650 today. There are options for a little more than a billion euros that expire today at $1.0650 and another set expire for roughly the same amount on Thursday at $1.0670. The $1.0660 area corresponds to the (61.8%) retracement of the bounce from this year's low set on April 16 (~$1.06). Sterling fell a little more than the euro yesterday, but it recorded an inside day, as it managed to hold above Monday's low (~$1.2480). However, follow-through selling today saw it slip to almost $1.2465. It recovered to almost $1.25 in early and thin European turnover, where it appears to have run of steam. A band of support extends toward $1.2450, and a break could target $1.2400. The daily momentum indicators look constructive, but the market seems to lack much conviction. 

America

On tap today, ahead of the FOMC meeting outcome is the ADP private sector job estimate, JOLTS report on job openings, March construction spending, and the ISM manufacturing report. Auto sales will trickle out over the course of the session. It is too early in the quarter to have much confidence in GDP projections, but the Atlanta Fed is beginning off at 3.9%, and will update after today's reports. The market is less sanguine and the median forecast in Bloomberg's survey is for 1.5% growth.

The market is focused on two aspects of the FOMC meeting. First, nearly everyone looks for a "hawkish pivot" that will be expressed in the statement and reinforced by comments by Fed Chair Powell. The recent string of inflation and consumption data have shaken the growing confidence Powell had previously noted that inflation was moving back toward its target. The pendulum of market sentiment has already swung hard. In middle of January, the Fed funds futures strip has nearly 170 bp of cuts discounted for this year. Currently, there are a little less than 30 bp discounted (one quarter-point cut and a 20% chance of a second cut). Now, it is arguably data dependent. A disappointing employment report at the end of the week could signal that the pendulum has swung far enough for the time being. Recall that in Q4 23, US headline CPI rose at a 2% annualized rate and the core rate rose by about 3.2% annualized. In Q1 24, the headline rate rose at more than twice the Q4 23 pace (or ~4.4%) and the core rate accelerated to an annualized pace of around 4.8%.

The second issue is the Fed's balance sheet. In the past, the Fed estimated that ample reserves are between $2.8 trillion and $3.4 trillion. As of last week, reserves stood at $3.8 trillion. The Fed has already signaled that it will likely taper the balance sheet unwind. Remember, the Fed is not selling assets from its balance sheet. Rather, it is simply not replacing the full maturing amount. Ostensibly, the Fed has said it will allow up to $95 bln a month in maturing Treasuries and Agencies not to be replaced. In practice it has averaged about $77.6 bln a month this year through this month after it averaged around $102 bln in the last four months of 2023. The Fed could announce intentions to formally begin slowing the unwind, with the first step being reducing it by around half. We suspect it can be implemented as soon as the middle of next month.