Dollar Soft as U.S. Returns From Holiday

May 30, 2023

Win Thin

Party leaders are pushing their members to pass the debt ceiling deal that was struck over the weekend; we believe passage of the deal cements a 25 bp hike at the June 13-14 FOMC meeting; May Conference Board consumer confidence will be the data highlight
Spain reported soft May CPI and April retail sales data; BOE tightening expectations continue to rise after last week’s CPI data
A political scandal in Japan may impact the timing of general elections; Japan reported April labor market data; yuan weakness is likely to continue

The dollar is trading soft as the U.S. returns from holiday. DXY is trading lower near 104 after trading at a new cycle high near 104.534 earlier today. We believe it remains on track to test the mid-March high near 105.103. The euro is trading higher near $1.0730 after making a new low for this move near $1.0675 earlier today. After breaking below the late March low near $1.0715, we now look a test of the mid-March low near $1.0515. Sterling is trading higher near $1.2425 after trading as low as $1.2325 earlier today. After breaking Below the April 21 low near $1.2365, we look for a test of the April 3 low near $1.2275. USD/JPY is trading back near 140 after it was unable to break above 141. The pair remains on track to test the November 21 high near 142.25. Banking sector concerns and dovish market pricing for Fed policy had been major negative headwinds on the dollar in recent months, but those have finally begun to clear. Now, the potential debt ceiling suspension (see below) would remove the final headwind for the dollar and so we see this really continuing.

AMERICAS

Party leaders are pushing their members to pass the debt ceiling deal that was struck over the weekend. The House is expected to vote on the deal tomorrow; if passed, it would quickly be taken up by the Senate. Some details have emerged but we suspect there will still be concessions made by both parties in order to get it passed by Congress ahead of the June 5 x-date. The deal would suspend the ceiling through January 2025, which is positive for President Biden as there wouldn’t be another disruptive showdown ahead of the November 2024 elections. There will be caps on discretionary spending for two years but mandatory programs like Medicare and Social Security will be exempted. The deal also includes a phased-in expansion of work requirements for food stamps and welfare recipients, with some exemptions for veterans and the homeless. $20 bln of IRS funding will be diverted to other non-defense spending. At first blush, the deal seems modest enough to elicit enough support to pass from the moderates in both parties. While there could be some hiccups in the coming days due to posturing from both sides, we expect this deal to eventually pass before June 5.

We believe passage of the deal cements a 25 bp hike at the June 13-14 FOMC meeting. With banking sector stresses fading, a potential default was really the only thing that could have prevented a hike next month. In the two weeks before that meeting, we will get one more jobs report as well as one more each of CPI, PPI, and retail sales data. Those readings will likely be the final determinant for the Fed decision. WIRP suggests odds of a hike then are nearly 60% and is pretty much priced in for the July 25-26 meeting. More importantly, multiple rates cuts by year-end are now priced out, as they should have been long ago. The market now sees the first rate cut at the January 30-31 meeting but even that still seems too soon. Fed repricing has finally gone our way but more needs to be done. Barkin speaks today.

May Conference Board consumer confidence will be the data highlight. Headline is expected at 99.0 vs. 101.3 in April. Of note, the Atlanta Fed’s GDPNow model is currently tracking Q2 growth at 1.9% SAAR, down from 2.9% previously. Next model update comes Thursday. March FHFA and S&P CoreLogic house price indices will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

Spain reported soft May CPI data. Spain was the first to report today and its EU Harmonised CPI inflation came in at 2.9% y/y vs. 3.3% expected and 3.8% in April, the lowest since July 2021. Elsewhere, its core measure came in at 6.1% y/y vs. 6.4% expected and 6.6% in April and was the lowest since July 2022. Germany, France, and Italy report CPI tomorrow and their EU Harmonised CPI y/y readings are expected at 6.7%, 6.4%, and 7.5%, respectively. All would be significant drops from April. Eurozone then reports CPI Thursday, with headline expected at 6.3% y/y vs. 7.0% in April and core expected at 5.5% y/y vs. 5.6% in April. If so, headline would be the lowest since February 2022 and would also be the first deceleration in core since June 2022. Eurozone April M3 today came in a tick lower than expected at 1.9% y/y vs. 2.5% in March and was the slowest since July 2014 and points to slower growth ahead.

ECB tightening expectations remain steady. WIRP suggests a 25 bp hike is priced in June, followed by another 25 bp hike in either July or September. The odds of one last 25 bp hike have fallen to only 15% vs. 40% at the end of last week. ECB speakers are plentiful this week. Simkus , Holzmann, Centeno, and Villeroy speak today. Yesterday, de Cos said “We think that we still have some way to go in tightening monetary policy, although we also think that we are closer to the end.” With inflation continuing to fall, the doves will remain in control of the narrative.

Spain reported April soft retail sales data. Sales slowed to 5.5% y/y vs. a revised 9.9% (was 9.5%) in March. Italy and Spain have been the biggest drivers of eurozone growth in recent months and so further softness in either country would spell trouble for the region as France and Germany struggle to grow. Germany reports April retail sales Thursday and is expected at 1.0% m/m vs. -2.2% in March. April eurozone retail sales won’t be reported until June 6.

Bank of England tightening expectations continue to rise after last week’s CPI data. WIRP suggests a 25 bp hike June 22 is priced in, with around 25% odds of a larger 50 bp move. 25 bp hikes for August 3, September 21, and November 2 are also fully priced in, which would take the bank rate up to 5.5% vs. 4.5% currently. Odds of a 25 bp hike in December have risen to nearly 50% vs. 20% at the end of last week. Yet this repricing has done little for cable, which has been overwhelmed by broad dollar strength. However, the EUR/GBP cross is trading at a new low for this move near .86335 and the more hawkish BOE could see this pair test the December low near .85475.

ASIA

A political scandal in Japan may impact the timing of general elections. Prime Minister Kishida said he would fire his son effective June 1. The younger Kishida, who was his father’s secretary, had been photographed in official areas that are typically reserved for senior cabinet officials. While this may sound fairly innocuous, an Asahi poll showed that around 75% of respondents saw this as a problem. A Nikkei poll showed Kishida’s support falling by five percentage points to 47%. A general election doesn’t have to be called until 2025 but some observers feel that Kishida might take advantage of the strong economy and call an early vote. Kishida had also gotten a bounce in support after hosting the G-7 meeting earlier this month, but faces a leadership vote in the LDP next September.

Japan reported April labor market data. Unemployment was expected to fall a tick but instead fell two to 2.6%, while the job-to-applicant ratio remained steady as expected at 1.32. This was the first drop in unemployment since January but remains above that month’s cycle low of 2.4%. Retail sales, IP, and housing starts will be reported tomorrow. Sales are expected at 0.5% m/m vs. 0.6% in March, while IP is expected at 1.3% m/m vs. 1.1% in March. Bank of Japan tightening expectations remain fairly steady. WIRP suggests liftoff is likely at the December 18-19 meeting. However, the expected rate path remains very modest, with 15 bp of tightening seen over the next 12 months followed by another 15 bp over the subsequent 12 months.

Yuan weakness is likely to continue. USD/CNY traded at the highest level since November 30 just below 7.10. It is testing a key level near 7.0845 and a clean break above would set up a test of the November cycle high near 7.3275. Elsewhere, CNH/USD traded near 7.11 and a clean break above 7.1160 would set up a test of the October cycle high near 7.3750. With the economy clearly softening , we believe the PBOC will ease again in the coming months and this should translate into further yuan weakness. China reports official May PMI readings tomorrow. Manufacturing is expected at 49.5 vs. 49.2 in April and non-manufacturing is expected at 55.0 vs. 56.4 in April. If so, the composite would likely fall over a full point from 54.4 in April to the lowest since January, when reopening first took effect.

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