by Marc Chandler
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True to the historic pattern, the US debt ceiling was used by the party not in control of the executive branch to exact spending concessions. Despite the extreme partisanship, the brinkmanship tactics, and fears that this time would be different, there was no default. As Bismarck once quipped, "Laws are like sausages and it is best not seen them being made." Still, as a consequence, the rebuilding of the Treasury's account and bill issuance is seen tightening financial conditions, while the end of the moratorium on student loan servicing and spending cuts point to a coming fiscal drag.
The Federal Reserve's leadership seemed to have been on a purposeful campaign to indicate that it wanted to standpat at the June 13-14 FOMC meeting and the market accepted the push back. The odds of a hike fell from near 70% to around 25% before the May jobs report (and finished the week near 25%). For the 14th consecutive month, job growth exceeded expectations (median forecast in Bloomberg's survey). However, the establishment survey was considerably stronger than the household survey (339k vs. -313k) leading to a sharp rise in the unemployment rate (3.7% vs. 3.4%). The constructive explanation of the divergence offered by the White House was that it was a definitional issue and if the establishment survey definition held, the household survey would have shown a 394k increase. The more pessimistic explanation was the the establishment survey was flattered by the birth/death rate adjustment (the start and closure of businesses) that added about 230k to the job growth. The Fed has entered the quiet period ahead of the next FOMC meeting so if post-jobs data guidance is to be forthcoming, it may come from their favorite journalists.
The week ahead highlights include Australia and Canada central bank meetings. Even if neither hike rates, the rhetoric may turn more hawkish as officials prepare for a possible hike in Q3. China's trade data is politically sensitive, but a larger trade surplus is likely even though exports had been contracting on a year-over-year basis from last October through February. After increasing in March and April, like fell again in May. Weak price pressures may encourage speculation of a rate cut or a reduction in reserve requirements later this month. Lastly, we note July WTI rallied from $67 on May 31 to nearly $72.20 before the weekend to adjust positions for the possibility that a few OPEC countries voluntary extend their cuts, apparently to make room for the extra production coming from Russia, Iran, and Venezuela.
United States: The data cycle is in between the employment and inflation. The highlights include ISM services and April consumer credit. Most of the information from the PMI is found in the flash reading and the final services and composite elicit little market reaction typically. The same can be said for factory orders and the final durable goods estimate. The merchandise trade balance, reported in late May, anticipate the deterioration of the overall balance in April. Goods exports softened while imports rose, and although this cut net export component to Q2 GDP, the strength of imports suggest robust demand. On the other hand, April consumer credit may have expanded near the Q1 average (~$21.6 bln), but it appears to be on a slowing trend. It rose at an average of $30.4 bln in Q1 2022 and in April last year, it rose by $28.9 bln.
Our working hypothesis sketched out in the monthly outlook (here )that bulk of the interest rate adjustment is behind us. It had been a key driver for the dollar's recovery since mid-March and by implication, it too is over or nearly so. We did not expect the Fed's Governor Jefferson, nominated to be vice-chair would push against creeping rate hike expectations for June. But he pushed on an open door, as it were, with the US two-year yield off around 20 bp from its peak on May 26 before Jefferson spoke. Still, the reaction to the employment report saw the two-year yield snap a three-day slide and jump more than 15 bp to 4.50%. The two-and-a-half month high was set on May 26 near 3.64%. The post-debt ceiling resolution is seen tightening financial conditions as T-bill issuance is boosted starting this coming week. We suspect that this year's growth is peaking here in Q2, and that the headline CPI may fall toward 3.5% by the end of H1. The base effect will make comparisons in H2 more difficult.
The Dollar Index reached a 104.70, a 12-week high on May 31. It was sold to 103.75 before the jobs data. The post-jobs rally stalled near 104.10 A move above 104.20 would help lift the technical tone. We expect the bounce to be sold especially as the May CPI moves into view (June 13), but a marginal new high (~105.00?) cannot be ruled out.
China: China holds the most currency reserves in the world with a little more than $3.2 trillion in April. Most of the recent month-to-month changes reflect valuation adjustments. In May, the decline in the exchange rates of the other reserve currencies against the dollar and the mixed performance of global bonds seems broadly consistent with around a $50 bln decline in the dollar value of China's reserves in May. The PRC also reports May's trade surplus. In the first four months of this year, China recorded a cumulative trade surplus of slightly more than $294 bln. The trade surplus in the first four months of 2022 was a little less than $203 bln. Despite the improvement from a year ago, which was adversely impacted by Covid lockdowns, exports and imports fell in April (month-over-month, -6.4% and -9.8%, respectively). While the trade balance is politically sensitive, disinflation may be more significant for the policy outlook. China's CPI peaked at 2.8% last September and in April was at a two-year low of 0.1%. The soft CPI is often attributed to weak demand but that seems to be an exaggeration given the high weighting of food in the basket. Also, the excess capacity in some industries, like autos, has spurred a bit of a price war, which also dampens some goods price pressures. The year-over-year measure in producer prices turned negative in Q4 22 and has accelerated to the downside this year. In April there were off 3.6%, the most since Q1 2016. Weak prices may fan speculation of a cut in rates and/or reserve requirements as early as this month. Targeted fiscal measures may also be under consideration, according to press reports.
The dollar's gains after the jobs report suggests the yuan will begin the new week under some pressure. The dollar rose to around CNY7.1235 on June 1, a new high for the year, before falling to CNY7.0560 before the jobs data. It settled the week near CNY7.0880, but the dollar's subsequent price action suggest the yuan will start of the new week on a soft note. One of the best guides for the dollar's direction against the yuan is its performance against the euro and yen.
Japan: Japan's retail sales appear to be doing fine and have risen for five months in a row through April. On the other hand, real household spending has bene weaker falling in March (-0.8%) and February (-2.4%). Nominal spending fell too (-0.6% in March and -2.8% in February). Note that real cash earnings (labor) have been falling on a year-over-year basis since April 2022, while nominal earnings rose a 1.3% year-over-year in March, after a 2.0% increase year-over-year in March 2022. Real consumption rose by 0.6% in Q1, according to the initial GDP estimate (that will be updated on June 8), which was the strongest in three quarters. Stronger-than-expected capex in Q1 warns of the risk that Q1 GDP could be revised higher. Japan's external account does not draw the same attention it previously did. Japan enjoys a current account surplus of around 2% of GDP but has reported a trade deficit on a balance-of-payments basis since August 2021 with one exception. Seasonal factors are strong in April and the trade balance almost always (18 of 20 years) deteriorates in April from March. The deficit stood at JPY454.4 bln in March.
If our assessment is valid and the US interest rate adjustment is nearly complete, then the pressure may come off the exchange rate, which has seen the yen fall its lowest level since last November. After falling for 12 of 15 sessions through May 26, Japanese officials stepped on a low rung of the intervention ladder, expressing the desire that rates reflect fundamentals (whatever that really means) and threatened "appropriate steps if needed." The timing of Japanese officials is inspired like when they intervened within days of the peak in the US 10-year yield late last October. After falling in the first four sessions last week, reaching JPY138.45 on June 1, the dollar rose back toward JPY140 after the employment data and rise in US rates. A move above the targets a re-test on the JPY140.95 high. The next important chart area is around JPY142.50. In the bigger picture, the dollar still appears to be carving out a top.
Eurozone: April retail sales is the main new news on the economic front in the days ahead. Retail sales look likely to have bounced back after falling 1.2% in March and 0.2% in February. This coupled with another look at Q1 GDP is unlikely to move the proverbial needle ahead of the ECB meeting on June 15. The swaps market is pricing in slightly more than a 90% chance of a quarter point hike at the meeting, which will also see the staff update its forecasts. The market leans strongly toward another hike in July and it is fully discounted at the mid-September meeting. The US two-year premium over German has risen from near 112 bp in late April to 170 bp last week and we expect it to stall shortly (~180 bp).
The euro rallied from $1.0635 in the middle of last week before rallying to almost $1.0780 ahead of the employment data. The jump in US rates helped cap the euro and send it back a to almost $1.0700. Initial resistance at the start of the new week may be encountered near $1.0730. On the downside, a break of the $1.0690 area would mean more back-and-filling is necessary to forge a solid base, which the momentum indicators suggest is forming.
United Kingdom: The UK has a light economic calendar in the week ahead outside of the final service and composite PMI. The May construction PMI offers fresh news. It has been above the 50 boom/bust level since February. It was stuck at 48.8 last December and this January. Reports suggest the Prime Minister is considering "voluntary" price controls and is looking at the French arrangement (announced in March and has been extended from June to continue through September). Under the French plan, supermarkets identify items (staples) that will be subject to a price freeze or even cuts. Reports suggest that often products of the store's own brand are identified.
Sterling recovered from about $1.2310 on May 25-26 to reach $1.2545 ahead of the US employment data. This met the (61.8%) retracement of the decline from the year's high on May 10 (~$1.2680). The pullback ahead of the weekend snapped a five-day advance, the longest of the year. It tested the $1.2440-50 support band. Nearby support is seen around $1.2400. The momentum indicators have turned higher and suggest that buyers may re-emerge on the pullback.
Canada: There are two highlights in the coming week. First, on June 7, the Bank of Canada meets. It adopted a "conditional pause" back in January and that is increasingly being challenged by stronger than expected data and sticky inflation. Canada's 3.1% annualized growth in Q1 was the fastest in the G7. April's 0.7% rise in headline CPI was well above expectations and brings the annualized rate in the first four months of the year to 6.3%. In the last four months of 2022, Canada's CPI rose at an annualized rate of almost 1%. The swaps market shows about a 30% chance of a hike this week up from less than 10% in early May. As recently as May 12, the market was pricing in nearly 50 bp in cuts before the end of the year and now it is nearly fully reflected a 25 bp hike. Second, on June 9, Canada reports May employment. The Bank of Canada meeting and statement may make for a minimal market reaction to the jobs data. In the January through April period, Canada created almost a quarter of a million jobs, of which 165k were full-time posts. The unemployment rate has stood at 5.0% since last December. At the end of 2019, it was at 5.6%. The participation rate was at 65.6% in March and April. It was at 65.8% in December 2019.
The US dollar reversed lower from the mid-week test on CAD1.3650, the upper end of its two-month trading range. It held CAD1.3400 before the US jobs data and bounced to CAD1.3450. Additional resistance is near CAD1.3465, but the CAD1.3500 area is more important. The daily momentum indicators have turned down, though CAD1.3400 offers solid support.
Australia: The Reserve Bank of Australia meets on June 6. Inflation and inflation expectations were stronger than expected and have encouraged investors to look for another hike, even if not immediately. Expectations have swung from a small chance of a cut to about a 1-in-4 probability of a hike. Moreover, a quarter-point hike is nearly fully discounted for the August 1 RBA meeting. In the past month, the year-end rate implied by the futures market has risen from about 3.55% to above 4.0%. Indeed, it has risen for the past five consecutive weeks. The day after the RBA meets, Australia reports Q1 GDP. The median forecast in Bloomberg's survey is for a 0.4 quarterly expansion, lifted by household consumption and net exports. Australia's trade surplus jumped to A$40.2 bln (~$27 bln) in Q1 from A$29.3 bln in Q1 22. The April trade balance will be reported June 8.
The Australian dollar set the low for the year at the of May slightly below $0.6460. It staged an impressive two-day rally that lifted it almost two cents. It stalled after the US jobs report but found new bids in the knee-jerk sell-off that to back to nearly $0.6600, the bottom of the old two-month trading range. The momentum indicators turned higher, and the technical tone looks constructive. A move above $0.6640 signals a re-test on the $0.6700, the middle of the previous trading range and 200-day moving average (~$0.6695).
Mexico: Neither May's CPI nor April's industrial production figures are likely to lead to the central bank to reconsider the pause announced at the May meeting. Headline CPI (June 6) may slip toward 6%, which would be the lowest since September 2021. The core rate may moderate as well. It could slow toward 7.4% from nearly 7.7% in April. It would be the fourth consecutive monthly moderation. Although Mexico's economy expanded by 1% quarter-over-quarter in Q1, and auto production was strong (+44.5% in Q1 to 346.1k vehicles, the most in a quarter since Q1 19), the monthly industrial output showed a net decline (~-0.4%) in Q1. The nearly 0.90% decline in March was the largest since September 2021. A modest recovery should not be surprising. Separately, note that on June 4, there is an election in the most populous state, Mexico State. In addition to its importance in its own right, it will see a test for of the strength of the ruling Morena Party, which was founded by President AMLO. The incumbent Gomez from the Morena Party is running well ahead of her rival in polls.
The dollar fell to a marginal new seven-year low against the Mexican peso after the US jobs report, edging fractionally closer to MXN17.42. The broader recovery of the US dollar and jump in US rates helped it recover against the peso. It settled the band of congestion seen earlier in the pre-weekend session between MXN17.50 and MXN17.55. It can rise toward MXN17.65 without improving the technical outlook. The momentum indicators are falling since the greenback approached MXN18.00 on May 23. The lower Bollinger Band is near MXN17.3880. The price action suggest that new dollar lows are being greeted with some profit-taking amid what has been a crowded trade. Surveys suggest international fund managers are overweight Mexico, and speculators it the currency futures have the largest net long peso position in three years. Below the MXN17.40 area, it is difficult to see meaningful chart support until closer to MXN17.00.
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