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US Debt Ceiling Drama Ends with a Whimper, Focus on US Jobs and Fed

US Debt Ceiling Drama Ends with a Whimper, Focus on US Jobs and Fed

Overview: Another bizarre US debt-ceiling episode is over. President Biden will sign the bill that was approved by the Senate late yesterday. It is a bit anticlimactic for the market, for which the US jobs data is the key focus now. Outside of the fiscal drama, the Federal Reserve leadership has effectively push against market expectations for a hike later this month. The odds were around 70% earlier this week, and ahead of the jobs report, is near 30%. The dollar's three-week rally has been snapped. It is sporting a softer profile ahead of the data and is lower against all the G10 currencies. It is also weaker against nearly all the emerging market currencies today, with the notable exception of the Turkish lira and Hungarian forint. The Chinese yuan is posting its first back-to-back gain in a month and its 0.55% gain, if sustained, would be the largest in more than two months.

Asia Pacific equities rallied, led by a dramatic 4% gain in HK and mainland shares that trade there. All the large bourses were higher. Europe's Stoxx 600 is up 1% and US futures have a firmer bias. European benchmark yields are mostly 2-3 bp higher today, but Italian bond yield is flat. The 10-year US Treasury yield is almost two basis points higher at 3.61%. The weaker dollar is helping gold extend its recovery from around $1932 on Tuesday to $1983.50 today. It is poised to snap a three-week decline. Ahead of the weekend OPEC meeting, the July WTI is pushing higher. It reached a three-day high near $71.55 before steadying. The week's low was set Wednesday near $67. 

Asia Pacific

China's Caixin services and composite PMI will be reported early Monday in Beijing. Yesterday, Caixin's manufacturing PMI unexpectedly ticked up. Might the service PMI surprise too? The median forecast in Bloomberg's survey is for a decline to 55.2 to 56.4. It was at 57.8 in March, the highest since November 2020. China may also report May reserve figures. Based on valuation shifts, a decline of around $50 bln seems reasonable.

Early Monday, Japan and Australia's final services and composite PMI will be reported. Japan's service PMI has risen for six consecutive months through the preliminary May reading of 56.3, a record high. The re-opening of Japan post-Covid and the return of tourism has given the economy an added boost. A weak yen and a restoration of flights in East Asia are helping, as well. The flash estimate put the composite at 54.9 (from 52.9 in April). Given the small decline in the final manufacturing PMI (from the flash estimate), if the services PMI is not revised higher, the composite will slip. Unlike in Japan, Australia's manufacturing PMI was revised higher (to 48.4 from 48.0 preliminary estimate). The initial estimate of the services PMI was that it unwound a chunk of April's surge (from 48.6 to 53.7, the largest rise in a little more than a year). The initial estimate showed the composite tracking the service reading, falling to 51.2 from 53.0, which was a jump from March's 48.5. The central bank meeting is next week's highlight for Australia. The firmer inflation has boosted ideas that the RBA, which paused, is not done raising rates. The futures market prices in about a 33% chance of a quarter-point hike next week. A week ago, it was perceived to be practically no chance of a hike.

The dollar's four-day decline against the yen is at risk today. The dollar settled at the end of last week near JPY140.60 and recorded a low yesterday near JPY138.45 before closing at JPY138.80. It is in a JPY138.60-JPY139.10 range today. The key driver is the US 10-year yield and its reaction to the US jobs data. There are options for $640 mln at JPY138.25. The dollar's rally that carried it from dip below JPY130 (March 24) to almost JPY140.95 earlier this week looks over and we expect a bounce in the dollar (that could extend to ~JPY139.50) will be sold. After falling to a new low for the year earlier this week (~$0.6460), the Australian dollar has rebounded smartly and is setting a new 8-day high in the European morning near $0.6635 and piercing the 20-day moving average. It has nearly retracement half of the decline since the May 10 peak near $0.6820. A move above $0.6640 targets the $0.6680-$0.6700. The generally softer US dollar spilled over to activity against the Chinese yuan. The greenback snapped a three-day rise yesterday with a minor 0.15% decline. The move gained steam today and the dollar is off about 0.55% and is below CNY7.06. The dollar's pullback today is the most since late March. For the third consecutive session, the PBOC set the dollar's reference rate below expectations (CNY7.0939 vs. CNY7.0948, the median projection in Bloomberg' survey.


Europe's final May PMI will be reported early Monday. Similar to China, but for different reasons, after a strong start to the year, the eurozone economy appears to have stalled. The manufacturing PMI rose in November-January, but has fallen since, and has not been able to grow (above 50) since last June. The services PMI improved from December through April before slipping in May (preliminary 55.9 vs. 56.2). The composite spent H2 22 below 50 and reached 54.1 in April, before slipping in May. The preliminary reading of 53.3 was a three-month low. The UK's manufacturing PMI fell for the three months through May. It has not been above 50 since last June. The service PMI has been climbing higher in a sawtooth pattern, alternating between gains and losses. It rose to 55.9 (from 52.9) in April and the preliminary reading for May slipped to 55.1. Reflecting the weakness in manufacturing, the composite PMI pulled back more than services in May (53.9 vs. 54.9).

There is a risk that later today, S&P could cut its rating for French credit from AA, given its negative outlook and Fitch's downgrade to AA- in April. Fitch cited the high government debt and the dim prospects for future reforms after the strong (and violent) public push back against the recent pension reforms. The question is not if S&P should downgrade France, clearly the fiscal health has deteriorated, but whether it matters. Operationally, for the ECB, the highest rating is what counts and DBRS and Moody's have maintained their rating of AA. Also, the French premium over Germany on 10-year yields is unchanged around 55 bp since Fitch's announcement. The two-year differential is also virtually unchanged a little below 20 bp. Separately, Fitch is reviewing UK AA- credit rating today. It has a negative outlook. S&P has the UK as an AA credit with a negative outlook. Moody's sees it as an AA- credit and also has a negative outlook.

The euro bottomed Wednesday near $1.0635, and it reached almost $1.0780 today. It is in a narrow range of about a fifth of a cent, mostly above yesterday's close (~$1.0760). Nearby resistance is seen in the $1.0800-30 area. The daily momentum indicators have turned higher and month-long slide (from nearly $1.11 on April 26) appears complete. A break of $1.0725 now would be disappointing. Sterling is rising for the sixth consecutive session today to reached $1.2545. It has retraced (61.8%) of its losses from the May 10 high (~$1.2680) to last week's low (~$1.2310) near $1.2540 today. The five-day moving average looks set to cross back above the 20-day moving average early next week. It is holding in a quarter-cent range (~$1.2520-$1.2545) ahead of the US jobs report. A break of $1.2450 would be disappointing.


Most of the recent string of reports, albeit different covering different elements and time periods, were stronger than expected, speaking to the ongoing resilience of the US labor market. Still, at the same time, below the surface, it does appear the tightness of the labor market is easing. Job growth is slowing on a trend basis. Year-to-date, nonfarm payrolls has risen by 1.14 mln. In the first four months last year, the US created almost 1.94 mln jobs. Or consider that the three-month moving average fell to 222k in April, the lowest since January 2021. If the median in Bloomberg's survey is accurate (195k), the three-month moving average is likely to have fallen toward 200k in May. The unemployment rate has stopped falling and has bouncing between 3.4% and 3.6% for six months. Average hourly earnings rose by 0.5% in April. This seems a bit of a fluke and was the highest since last July. A reversion back to the recent average of 0.3% could see the year-over-year rate ease back to 4.3% where it was in March from 4.4% in April. The average year-over-year pace this year has been 4.5% compared with 5.7% in the Jan-Apr 2022 period.

Amid talk of foreign central bank demand for Treasuries drying up, we looked at the Fed's custody account for foreign central banks. During the last nine weeks through May 31, foreign central banks have bought US Treasuries every week without fail. During this buying spree, the longest since April-June 2020, they have bought more than $110 bln. At $2.986 bln, the holdings are the largest since last September. The Federal Reserve also offers custody service for the Agency securities as well. Over the past two months, they have risen slightly (~$2.3 bln). 

The Canadian dollar is extending its gains today. The US dollar peaked in the middle of the week near CAD1.3650, just shy of last week's high has approached CAD1.3405 today. Coming into today, the greenback has fallen in four of the past five sessions. A break of CAD1.3400 could signal a test to the low of end of this year's range (CAD1.3260-CAD1.3300). The intraday momentum indicators suggest a bounce is likely in early North American activity and initial resistance is in the CAD1.3450 area. Note that in a soft US dollar environment, the Canadian dollar often lags on the crosses. Meanwhile, the greenback made a new two-and-a-half week low near MXN17.5150. Recall that the multi-year low was set in mid-May near MXN17.42. Mexico State, the more populous state holds elections on Sunday. It is likely to confirm that AMLO's Morena Party is the force to be reckoned with in next year's general election. Mexico touches on several key investment themes, including high interest rates and near-shoring/friend-shoring. The peso is the strongest currency in the world so far this year, appreciating about 11.3%. 

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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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