Limited Follow-Through Dollar Buying After Yesterday’s Gains

Overview: The dollar sprang higher yesterday but follow-through buying today has been limited. The little more than 0.5% gain in the Dollar Index was among the largest since mid-March. And yet, the debt ceiling anxiety and weak US bank shares persist. Today's talks at the White House have been postponed until early next week. Both sides are incentivized to bring it to the brink to demonstrate to their constituencies that they got the best deal possible. Both the large and regional bank indices made new lows for the week yesterday. The KBW large bank index fell 1.25% Wednesday and Thursday. Barring 2.7% rally today, it will finish lower for the fourth consecutive week and the 8 of the last 10 weeks. Year-to-date, it is off about 27.6%. The regional bank index is down a little more than 37%. It tumbled nearly 2.4% yesterday and has fallen every day this week after rallying 4.7% last Friday. Coming into today, it is off almost 6.6% this week after falling practically 8% last week.

The NASDAQ made a new high for the year yesterday, but the coat tails were short. Even the Dow and S&P 500 failed to close higher. Still, the futures are trading higher today. Most large Asia Pacific bourses fell today led by the 1.3% fall in China's CSI 300. Japan, Australia, and India bucked the regional trend. Europe's Stoxx 600 is rising for the first since Monday, and it might be enough to turn the week positive to snap a two-week decline. Benchmark 10-year yields are a couple basis points firmer in the US and Europe. Gold is making new lows for the week in Europe as its test the $2000 area. Support is seen in the $1975-$1980 area. June WTI peaked in the middle of the week near $73.90 and made a new low for the week earlier today slightly above $70. If it does not recover above $71.35, it will be the fourth consecutive weekly loss, the longest decline since last June-July. 

Asia Pacific 

The G7 finance ministers are expected to issue a statement shortly. The focus appears to be on strengthening sanction enforcement against Russia and resist "economic coercion" (China). In the run-up to the meeting and ahead of heads of state summit at the end of next week in Hiroshima, the US appears be trying to moderate its rhetoric so as not to alienate allies in what seems to many to be an aggressive, confrontational approach. The US's new rhetoric emphasizes national security issues over deliberate attempts to "encircle" or "contain" China. Looking for dual use (civilian and military applications) that would aid in the sanctions, several foreign research entities have been blocked from access to such data, which in turn as further antagonized China's critics. German Chancellor Scholz tried out the rhetoric about "de-risking,” but Chinese officials are not convinced that the change in words reflects a different substantive policy. Germany appears poised to tighten its restrictions on Chinese direct investment, and reports suggest Italy may announce a withdrawal from China's Belt Road Initiative before the end of the month. China's strategic hope of creating some space between the US and Europe has faltered since the Russia invasion of Ukraine, despite French President Macron's best Gaullist efforts.

The dollar is recovering from the week's low against the yen set yesterday near JPY133.75. It stalled in late Asian turnover at JPY134.90, ahead of JPY135, where options for $1.3 bln expire today. Initial support may be found around JPY134.50. The greenback settled at JPY134.80 last week. The Australian dollar peaked on Wednesday, almost reaching $0.6820, its best level since late February but failed to close above $0.6800 and sold-off sharply yesterday to about $0.6690. It slipped a little further today and dipped below $0.6685. With a few exceptions, it has been in the $0.6600-$0.6800 trading range for the better part of two-and-a-half months. A break of the $0.6665 area suggests a test on the lower end of the range, now that the upper end has held (again). Nearby resistance is seen around $0.6720. Separately, falling inflation expectations in New Zealand has seen the Kiwi punished. It posted a key downside reversal yesterday and follow-through selling has pushed it another 1% lower today. It peaked yesterday at $0.6385, its best level since mid-February and is trading near $0.6230 now. The greenback traded above CNY6.95 today for first time since March 10. In fact, the dollar has risen every session this week against the yuan for the first time since February. The five-day advance comes on the heels of a five-session fall. Disappointment about the re-opening and renewed pressure on China's high-yielding bonds, and perceptions of the increased likelihood of more monetary support are the ostensible weights on the yuan. The PBOC set the dollar's reference rate at CNY6.9481 today, a little above the CNY6.9473 median projection in Bloomberg's survey.

Europe 

As widely expected, the Bank of England hiked the base rate by 25 bp yesterday, and although Governor Bailey suggested that policy could be near an end if inflation weakens, the swaps market is pricing in almost an 80% chance of another hike at the June 22 meeting. That said, there is good reason to expected UK inflation to have eased sharply last month. Last April, headline consumer prices in the UK soared by 2.5%. This will drop out of the 12-month comparison. Say, for the sake of the argument, it is replaced with a 0.5% monthly increase, the year-over-year rate could fall to around 8% (from 10.1% in March). UK inflation rose at an annualized rate of about 5.2% in Q1. 

The Bank of England also revised away its forecast for recession, owing, it said, to the resilience of the labor market and the decline in energy prices. Still, the overall impression is one of stagnation. Growth this year is seen at a 0.25% compared with its previous forecast of a 0.5% contraction. Next year's growth improves to 0.75% from a 0.25% contraction that had been anticipated. Today, the UK reported an unexpected contraction of 0.3% in March GDP after a flat February. The economy expanded by a revised 0.5% in January, up from 0.4% (following a 0.5% contraction in December 2022). In March, manufacturing's 0.7% increase was offset in full by the unexpected weakness in services (-0.5%). The Q1 estimate, also released earlier today, showed 0.1% growth in Q1, which translates into a 0.2% expansion year-over-year. Private consumption was flat and government spending was surprisingly weak (-2.5% quarter-over-quarter). Strength was seen in fixed capital formation (1.3%) and total business investment (0.7%), and it looks as if net exports was a smaller drag.

Turkey goes to the polls this weekend in what promises to be a close election. Erdogan as the power of the incumbency and he has exercised it. Among other things, this week he announced a 45% pay increase for government workers. The standard bearer opposition candidate Kilicdaroglu enjoys a slight lead in the polls. His prospects improved by the withdrawal of Ince in the presidential contest, but whose Homeland Party will still compete in the parliamentary elections. Local equities rallied on Ince's decision. A victory for Kilicdaroglu and the Republican People's Party, which he has led since 2010, in the 600-seat parliament would likely unwind many of Erdogan's unorthodox policies, and the economic adjustment could be painful. A honeymoon for investors may be short-lived. The lira, which is near record lows, has been supported by intervention estimated near $200 bln since late last year. The lira has depreciated dramatically under Erdogan's 20-year rule. It fell more than 40% last year after a nearly 79% drop in 2021. It is off about 4.3% this year. Moreover, to stem the capital flight, Erdogan's government has taken on the currency risk from domestic accounts. Lira depreciation will cause more fiscal deterioration. At the same time, there will also be significant geopolitical implications as Erdogan rule estranged it from the NATO and the US.

 The "buy the dip" strategy in the euro gave way this week. The single currency has fallen through the 20-day moving average (now ~$1.0990) and the five-day moving average (~$1.0955) has crossed below the 20-day moving average for the first time since mid-March. It is pinned near yesterday's low (~$1.0900) and has not been above $1.0935. The $1.0875 area corresponds to the (38.2%) retracement of the rally from that mid-March low. A break of that could signal a test on $1.08, as late longs move to the sidelines. Sterling set a new high since the middle of last year near $1.2680 on Wednesday and fell slightly through $1.2500 yesterday. It is holding above there today. A recovery through $1.2565-85 would suggest the bulls are still in control. That said, sterling settled near $1.2635 last week, and this week's loss (~0.80% around $1.2530) would be the largest in three months. 

America

US initially weekly jobless claims rose by 22k last week, the most in two months. The 264k people filing for benefits for the first time is the highest since October 2021 and is broadly consistent with other labor market indicators showing some easing conditions. Nevertheless, the labor market continues to be more resilient than the Fed expected. The median forecast in March was for the unemployment rate to be at 4.5% at the end of the year. It stood at 3.4% in April. While possible, such a sharp rise seems improbable, and it ought not to be surprising if the median forecast next month is for a somewhat lower unemployment rate. The median forecast in Bloomberg's survey has the unemployment rate at 3.9% at the end of the 2023.

Separately, the US April producer price increases were slightly less than expected, with both the headline and core rates rising by 0.2%, for year-over year gains of 2.3% and 3.2% respectively. The US 10-year yield fell for the second consecutive session yesterday and the two-day net decline of around 13 bp unwinds most of the 18 bp increase in the previous four sessions. The two-year note yields also fell for the second consecutive session. The net decline of around 13 bp offsets a little more than half of the increase seen over the previous three sessions. 

Emergency borrowing from the Federal Reserve rose in the most recent week. Discount window borrowing rose by about $4 bln to $9.32 bln. The Bank Term Funding Program was tapped for around $7.7 bln to $83.1 bln, and borrowing from it can be for up to a year. In addition, by accepting Treasuries and agency mortgaged backed securities as collateral at face value inject more liquidity than would otherwise be the case. Its use should and may become de-stigmatized as people get used to it. Meanwhile, quietly and without much fanfare, foreign central bank holdings of Treasury and agency bonds at the Federal Reserve rose for the sixth consecutive week through early May. The $88 bln increase more than replaces the two-week $68 bln-liquidation in the second half of March. 

The greenback jumped almost 0.9% yesterday against the Canadian dollar, the most in two months. The 2.3% slide in WTI appeared have weighed on the Canadian dollar amid the broader US dollar gains. The US dollar briefly above CAD1.3500, where the 20-day moving average is found and has eased to CAD1.3480. Almost $800 mln in options at CAD1.3500 expire today. The greenback can pull back toward CAD1.3430-55 without impacting the technical tone. The US dollar is consolidating in its trough against the Mexican peso. It set a new multi-year low yesterday near MXN17.5355. So far today, it is straddling the MXN17.60 area. The lower Bollinger Band is a little above MXN17.57. The daily momentum indicators are stretched. The central bank meets next week and seems likely to pause in its tightening cycle with the overnight target rate at 11.25% and headline inflation slowing to 6.25%. The greenback settled last week near MXN17.7620.