• The debt ceiling drama is set to come into focus; Fed easing expectations remain in place; the Fed released its quarterly Senior Loan Officer Survey and its semiannual Financial Stability Report; Mexico reports April CPI
  
• ECB hawks remain vocal; minutes from the April Riksbank meeting tilted hawkish
  
• Japan reported soft March cash earnings and household spending; BOJ tightening expectations are still running high, however; Australia sees solid fiscal numbers in its annual budget forecasts; China reported soft April trade data; China launched a crackdown on local consulting firms after passing new counter-espionage legislation last month

The dollar is getting more traction as banking sector concerns ebb. DXY is slowly clawing back some of its losses and is trading higher for the second straight day near 101.510. A break above 101.878 is needed to set up a test of the May 2 high near 102.404. The euro is trading lower near $1.0980 and is on track to test the May 2 low near $1.0940. Sterling is holding up relatively better and trading flat near $1.2620. Here, a break below $1.2525 is needed to set up a test of the May 2 low near $1.2435. USD/JPY is having trouble making a clean break above 135 but should eventually move higher. However, a break above 136.15 is needed to set up a test of the May 2 high near 137.75. What’s driving this latest dollar bounce? The latest H.4.1 and H.8 reports as well as the Fed’s Senior Loan Officer Opinion poll all support our view that the banking sector is far from crisis. Yes, loan standards and credit are tightening (see below) but nothing beyond what one would expect in an aggressive Fed tightening cycle. Furthermore, solid jobs data last week feeds into our narrative that Fed pivot bets are misguided. These two major negative headwinds are starting to fade and so we believe the dollar has put in a near-term bottom. CPI and PPI data this week will be key to a sustained dollar bounce.

AMERICAS

The debt ceiling drama is set to come into focus. That’s because President Biden will host House Speaker McCarthy and other Congressional leaders at the White House today to try and hammer out a compromise. Over the weekend, 43 Senate Republicans led by Minority Leader McConnell signed a letter saying they wouldn’t support a clean debt ceiling increase, which means Senate Democrats could not overcome a filibuster if they passed it. To get an idea of the mistrust that’s developed, Republican Senator Kennedy said “I don’t believe June 1 is the ceiling. I think that’s a political ceiling set by Secretary Yellen to put pressure on people. I think the ceiling is more like the end of July or sometime in August.” If the two sides can’t even agree on the x-date, how can they be expected to reach a compromise before that day is upon us? The debt ceiling standoff is starting to impact the bond market. Treasury sold $57 bln of three-month T-bills yesterday at 5.14%, the highest yield since 2001.

Fed easing expectations remain in place. At the start of last week, the swaps market was pricing in a Fed Funds range between 4.0-4.25% in 12 months. Now, it's seen in the 3.5-3.75% range in 12 months while three cuts still priced in by year-end. Fed officials are likely to continue pushing back against this dovish take. Jefferson and Williams speak today. Yesterday, Chicago Fed President Goolsbee noted that “This whole argument about the debt ceiling comes at the worst possible time. It just makes it extremely difficult to figure out what will be the conditions for economic growth and the job market.” He added that “We’re more than a month away from the next FOMC meeting. I don’t think we can decide what we should do with rates now, we have to see what’s happening with these conditions.”

The Fed released its quarterly Senior Loan Officer Survey. The net share of respondents reporting tighter lending standards for large and medium firms rose slightly to 46.0% vs. 44.8% previously. The quarterly survey was through April and so the full magnitude of the recent banking sector turmoil probably hadn't been felt yet by many of the respondents. Of note, the net share of respondents reporting tighter lending standards for small firms rose slightly to 46.7% vs. 43.7% previously and for credit cards rose to 30.4% vs. 28.3% previously. Of note, lending standards have been tightening since mid-2021, before the Fed started tightening in March 2022. Bottom line: lending standards continue to tighten as one would expect during an aggressive Fed tightening cycle but nothing as disastrous as many doomsayers had feared.

The Fed also released its semiannual Financial Stability Report. It noted that “Notwithstanding the banking stress in March, high levels of capital and moderate interest rate risk exposures mean that a large majority of banks are resilient to potential strains from higher interest rates.” The Fed estimated that in 2020 and 2021, banks added nearly $2.3 trln in securities to their balance sheets and as interest rates rose, banks had mark-to-market losses of $277 billion in their Available for Sale (AFS) portfolios and $341 bln in their Held to Maturity (HTM) portfolios. However, most banks had limited reliance on short-term “runnable” deposits. The report noted that credit quality in the economy “remained strong” even though delinquency rates in some areas such as auto loans and credit card debt have increased. However, the Fed warned that “Structural vulnerabilities remained in short-term funding markets. Prime and tax-exempt money market funds, as well as other cash investment vehicles and stablecoins, remained vulnerable to runs.”

There are no U.S. data reports today. Of note, the Atlanta Fed’s GDPNow model is currently tracking 2.7% SAAR growth for Q2, steady from the previous reading and up from the initial 1.7% reading and 1.1% in Q1. Next model update comes next Tuesday. Bloomberg consensus currently sees Q2 at 0.1% SAAR and Q3 at -0.9% SAAR.

Mexico reports April CPI. Headline is expected at 6.20% y/y vs. 6.85% in March while core is expected at 7.69% y/y vs. 8.09% in March. If so, headline would be the lowest since September 2021 but still well above the 2-4% target range. At the last policy meeting March 30, the bank downshifted to a 25 bp hike and signaled that the cycle is nearing an end as “Since the last monetary policy meeting, annual headline inflation has decreased more than expected. For its upcoming decision, the Board will take into account the inflation outlook, considering the monetary policy stance already attained.” Next meeting is May 18 and markets are evenly split between no hike and a 25 bp hike. March IP will be reported Friday.

EUROPE/MIDDLE EAST/AFRICA

ECB hawks remain vocal. Kazaks warned not to expect the bank’s hikes to end in July and added that expectations for cuts next spring are “significantly premature.” Elsewhere, Kazamir said “The development of core inflation, the continued buildup of wage pressures, and high-profit margins call for vigilance and reconfirm the need to continue on our path.” Yet ECB tightening expectations have fallen a bit. WIRP suggests another 25 bp hike is priced in for June 15. However, the odds of a 25 bp hike July 27 stand near 55% and rise to only 80% for September 14 vs. fully priced in before the ECB meeting. Villeroy and Schnabel speak later today. The split between the hawk and the doves clearly remains in place but it feels like the doves have taken control of the narrative, at least for now.

Minutes from the April Riksbank meeting tilted hawkish. At the April 26 meeting, it hiked rates 50 bp to 3.5% but there were two dissents in favor of a smaller 25 bp move. However, the minutes were decidedly more hawkish as Governor Erik Thedeen said he would be in favor of a higher policy rate than its forward guidance if there are signs of “increased or prolonged inflationary pressures.” Even First Deputy Governor Breman, one of the dissents, said “I will not hesitate to continue gradual increases longer than the path indicates and/or to resume increases in larger steps than 0.25 percentage points. In addition, we can use all our tools, including adjusting the pace of quantitative tightening.” The Deputy Governors tilted hawkish, with Bunge saying further tightening is needed, Floden (the other dissent) pushing for more caution, and Jansson supporting faster and larger hikes if needed. Recall that forward guidance shifted more hawkish at this meeting with the policy rate seen peaking at 3.65% in Q2 2024 vs. 3.33% in Q4 2024 in the February forecasts and staying there through Q2 2025 before falling by Q2 2026. Looking ahead, WIRP suggests 80% odds of a 25 bp hike June 29. Floden speaks today.

ASIA

Japan reported soft March cash earnings and household spending. Nominal earnings came in at 0.8% y/y vs. 1.0% expected and a revised 0.8% (was 1.1%) in February, while real earnings came in at -2.9% y/y vs. -2.4% expected and a revised -2.9% (was -2.6%) in February. Despite some well-publicized wage agreements between the unions and firms, wage growth remains quite restrained. No wonder spending came in -1.9% y/y vs. 0.8% expected and 1.6% in February. Robust wage growth has become a prerequisite to BOJ tightening and so far, there have been no wage pressures to speak of. This supports the cautious stance that the bank is taking under new Governor Ueda, who said “We would like to end yield curve control and then proceed to shrinking a balance sheet once we have an inflation outlook indicating that sustainable and stable 2% inflation will be achieved.”

Bank of Japan tightening expectations are still running high, however. WIRP suggests odds of liftoff near 45% June 16, rising to nearly 55% July 28 and nearly priced in October 31. However, the tightening path is expected to be quite shallow, with 15 bp of tightening over the next 12 months followed by another 20 bp over the subsequent 12 months.

Australia sees solid fiscal numbers in its annual budget forecasts. Treasurer Chalmers is projecting an AUD4.2 bln (0.2% of GDP) surplus for the current FY22-23 ending June 30 before swinging to an -AUD13.9 bln (-0.5% of GDP) deficit in FY23-24, widening to -AUD35.1 bln (-1.3% of GDP) in FY24-25, and peaking at -AUD36.6 bln in FY25-26. These forecasts came in close to earlier press reports and are slightly better than those contained in the latest Bloomberg survey of 17 economists, which see the median estimate for FY23-24 at an -AUD22.25 bln deficit and rising in FY24-25 to -AUD35 bln. Chalmers noted that “In all our decisions, we seek to strike a considered, methodical balance. Between spending restraint to keep the pressure off inflation, while doing what we can to help people struggling to make ends meet.” Still, Australia is in a much stronger fiscal position than nearly all of its DM counterparts.

China reported soft April trade data. Exports came in at 8.5% y/y vs. 8.0% expected and 14.8% in March, while imports came in at -7.9% y/y vs. -0.2% expected and -1.4% in March. The data are disappointing but are consistent with our belief that the impact of China reopening has been overhyped, both for domestic and global activity. Weakness in imports is especially troubling for regional exporters that were counting on a rebound in demand from China. As data continue to weaken, we expect further stimulus measures in the coming months.

China launched a crackdown on local consulting firms after passing new counter-espionage legislation last month. Providers of key financial and economic data were already under pressure to stop providing access to foreign clients. Now, one consulting firm was raided and accused of leaking state secrets for allegedly accepting projects from foreign companies with ties to foreign governments and intelligence agencies. This continues President Xi’s efforts to clamp down on various sectors deemed to have strategic importance. However, the even more limited flow of data and information will most likely drive foreign investors further away. However, that is in keeping with Xi’s more inward-looking stance that really intensified during the pandemic.