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The Dollar Reverses Early Gains

The Dollar Reverses Early Gains

Overview:  The debt ceiling drama is not over. The agreement between the negotiating teams of President Biden and House Speaker McCarthy sets the stage for the next act in the drama: each side must deliver the votes. A preliminary vote today in the House of Representatives is likely today ahead of floor vote tomorrow. Still, the market is optimistic, and risk is favored. Asia Pacific bourses were mixed today. We note that the chip sector helped lift South Korea's Kospi up over 1%. Europe's Stoxx 600 is recouping yesterday's marginal loss, and US equity futures are trading higher. The S&P 500 and NASDAQ are poised to gap higher. Bonds are rallying. European yields are mostly 4-6 bp lower, though Gilts are lagging. The 10-year US Treasury yield is off nearly eight basis points to 3.72%. 

The dollar is offered. Among the G10 currencies, only the New Zealand dollar and Swedish krona are nursing small losses. Sterling is doing best with a nearly 0.5% gain and resurfacing above previous support near $1.2400. The euro slipped through $1.07 but rebounded in the European morning. Emerging market currencies are mixed. The Turkish lira has been hammered for around 1.5%. The Hungarian forint and Mexican peso lead the advancer. Gold initially fell to two-month lows near $1932 but has rebounded as the dollar and interest rates have come off. It is probing the $1950 area. July WTI is posting an outside down session. It is off around 2.1% today to test the $71 area. Last week's low was closer to $70.65. 

Asia Pacific

China reports its May PMI tomorrow. Even though economists expect Beijing to achieve its growth target this year of 5%, many express disappointment with the pace. They will see the 20.6% decline in the January-April industrial profits year-over-year as confirmation. Still, given that industrial profits were off 21.4% in Q1, the April data point, released over the weekend, is consistent with a rebound in profits at the start of Q2 (~3.7%). Moreover, the official data suggest that foreign profits are holding up better than China's private sector and state-owned enterprises.

There appears to have been a subtle but potentially important shift in Bank of Japan Governor Ueda's assessment. At the end of last week, he told the Wall Street Journal that "There appear to be moves leading towards sustainable inflation." Service prices, which were still falling a year ago, are now up 1.7% year-over-year. Wage growth, which former BOJ Governor Kuroda emphasized, has been downplayed a bit by Ueda, who argued sustainable inflation is a broad measure, and no single data set captures it. The rise in global rates have also helped push up JGB yields. The yen is approaching the levels that sparked concern among Japanese officials last year. This is not to suggest that there is a line in the sand or that strong foreign buying of Japanese stocks (from insurance companies?) and the lower oil prices do not change the calculus. Separately, Japan reported its unemployment rate fell back to 2.6% in April from 2.8% in March. Economists in Bloomberg's survey expected a 2.7% rate. The job-to-applicant ratio was steady at 1.32.

The US led the Indo-Pacific Economic Framework of 13 other nations in the region to boost supply chain cooperation. Ostensibly, this is part of the US attempt to fill the vacuum created when it withdrew from the Trans-Pacific Partnership negotiations (although Trump did the deed, Clinton and Sanders opposed it in their campaigns). Another prong of the US economic effort in the region is the Asia-Pacific Economic Cooperation (APEC), 21-coutries and US will host the annual summit in San Francisco in November.

The dollar initially slipped briefly below JPY140 in early Asian turnover before rallying to a marginal new high for the year of almost JPY140.95. It was sold into the European morning, where it found support near JPY140.00. There are $1.72 bln in options at JPY140 that expire tomorrow. The next important chart area on the upside is around JPY142.50. Watch the five-day moving average (JPY140.20). The dollar has not closed below it since May 11. Weakness in Australia's April house permit has helped keep the Australian dollar pinned in the trough it began forging last week ($0.6490-$0.6500). It did make a four-day high in early trading today reaching almost $0.6560, but the upside momentum was not sustained. There are about A$510 mln options at $0.6550 that expire today and another A$560 mln that expire there tomorrow. The weakness of the yen and euro pointed to continued weakness in the Chinese yuan, which fell to new six-month lows today. The greenback neared CNY7.10. The PBOC is not protesting the dollar's strength in the setting of the daily reference rate. Today it was set at CNY7.0818 compared with the median projection in Bloomberg's survey for CNY7.0811


The fourth meeting of the US-EU Trade and Technology Council (TTC) will be held today and tomorrow. It is not working toward a free-trade agreement. Instead, as with the US efforts in the Asia Pacific, it is said to represent the next generation. It is about standard setting, and other elements of cooperation, like with supply chain transparency and AI, and on external trade issues, like deterring forced labor. The TCC also helps coordinate export controls on Russia and has found opportunities (e.g., Kenya and Jamaica) to support infrastructure efforts, which some suggest is a way to counter Chinese influence.

It will come as no surprise: Erdogan has been re-elected president of Turkey. The unorthodox policies are widely understood to be unsustainable and borrowing the future. There is some speculation that he may bring in more market-friendly officials into the new cabinet. But this would not necessarily be positive for the lira. After selling off 0.7% yesterday, the lira is off around 1.25% today, the most since last July. Spain held local and regional elections over the weekend. They are important in their own right but also as a bit an of a sense of the mood of the electorate ahead of the general election. The Socialists suffered a heavy defeat, and to regain the initiative Prime Minister Sanchez called for a snap election on July 23. A general election was required by early December. The People's Party, sometimes joined by the anti-immigration, nationalist Vox party, looks to have won 8 of the 12 regions that were contested, including Valencia and Madrid. The PP garnered about 31.5% of the municipal vote nationwide, up from 22% in the previous local election in 2019. Vox doubled its vote to 7%. The Socialists fell to 28%. Unidas Podemos, which is the Socialist coalition partner in the national government, also polled poorly. Spanish stocks fell on Monday (~-0.20%), while Spanish bonds rallied. The nearly 10 bp decline in the Spain's 10-year was in line with the declines in Germany, France, and Italy. Today, Spain's 10-year yield is down four basis points, in line with the regional move. Its stock market is up about 0.65% through late morning and outperforming the Stoxx 600. In Greece, the governing New Democracy fell five seats shy of an outright majority in the 300-seat parliament in the May 21 elections. Rather than seek a coalition government, Prime Minister Mitsotakis has called for new elections June 25. The other main parties agreed. The vote will take place under somewhat different rules and give a bonus of as many as 50 seats to the winner. Mitsotakis, who has led a business-friendly reform agenda, is most likely to be reelected. 

The euro is recovering from the initial sell-off that brought slightly below $1.0675. It was bought back in the European morning to a little through $1.0730. Some of early selling pressure may have been exacerbated by the trading around 1.15 bln euros in options at $1.07 that expire today. There are options for 2.2 bln euros at $1.0750 that expire tomorrow. We note that the US 2-year premium over Germany continues to trend higher. It is above 170 bp today for the first time in a couple of months and has risen for the past six weeks. The high for the year is a little above 185 bp. Sterling is posting a big outside up day, having first slipped through yesterday's lows (~$1.2335) and then proceeded to rally through yesterday's high (~$1.2370). It reached a four-day high near $1.2430. The intraday momentum indicators are stretched, suggesting some consolidation is likely in early North America. 


The deal worked on the debt ceiling and spending still requires a vote in the House of Representatives and the Senate. The negotiators likely anticipate some concessions to individual legislators. Even if there is more work to be done, and the final shape of the agreement has yet to be determined, the deal boosts confidence that a default will be avoided. The market can now turn more of its mindshare to what happens after the debt ceiling is lifted. The initial focus will be on the likely boost in T-bill offering and the replenishing of the Treasury's general account (TGA). The tightening of financial conditions that this entails is a function of the T-bill demand. The increase in T-bill issuance can come from funds that ae currently parked in the Fed reverse repo facility. The alternative is that in effect it comes out of bank reserves. Therein lies the tightening that some estimate can be worth a quarter-point hike.

A deal also removes a potential wild card for the FOMC meeting. The market went into the long US holiday with almost a 58% chance of a hike discounted. Ironically, the odds rose sharply even as the Atlanta Fed's GDP tracker estimate for growth this quarter was sliced to 1.9% from 2.9%. It sees a bigger drag coming from the wider trade deficit, which also reflects stronger domestic demand (imports rose, exports fell) picked up in the personal consumption report. Consumption is off to a good start in Q2. Personal spending rose by 0.8% in April. Only one economist in Bloomberg's survey of economists forecast more than 0.7%. Fed officials talk about different measures of inflation, the strength of demand influences their outlook. The year-over-year measures are sometimes helpful, but now the base effect may exaggerate the improvement. We have preferred to look at the annualized rates. In the first four months of the year, it is running at a 4.2% annualized rate. In the last four months of 2022, the PCE deflator rose at 3.3% annualized rate. The core PCE deflator is running ever so slightly slower (and rose nearly 4.1% at an annualized pace in the last four months of 2022. Hence, the conclusion by several Fed officials that there has been not material improvement so far this year. 

The US reports March house price data today, the Conference Board's May survey, and the Dallas Fed's manufacturing survey. These reports do not often more the foreign exchange market. The Fed's Barkin speaks today ahead of five Fed officials that speak tomorrow, ahead of the Beige Book. A close in the Dollar Index below 104.00 could be a preliminary crack in the rally. The US dollar is trading lower against the Canadian dollar for the third consecutive session. Recall that ahead of the weekend, the greenback reached CAD1.3655, a new high for the month. It has dribbled lower to nearly CAD1.3565 today. A break, and ideally a close below CAD1.3550 would weaken the US dollar's technical tone. Tomorrow Canada report Q1 GDP. The median forecast in Bloomberg's survey looks for a 2.5% annualized pace. The swaps market now looks for a hike by the end of Q3 (to 4.75%). The US dollar was turned back from MXN18.00 early last week and reached almost MXN17.5350 yesterday. It is trading quietly in a narrow range (~MXN17.5540-MXN17.6265). The multi-year low set in the middle of the month was near MXN17.42. This can be tested in the coming days. 


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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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