US
The dollar index (DXY) is consolidating recent gains near resistance at its 200-day moving average. The US macro backdrop (high inflation, stable labor demand) argues for the Fed to stay restrictive for longer which is USD supportive. The swaps curve virtually fully prices a 25bps Fed funds rate hike in the next 12 months.
In parallel, US fiscal credibility is increasingly under strain as 10-year Treasury yields move closer to the roughly 5.3% pace of nominal GDP growth seen over the past decade. That narrows the buffer between growth and borrowing costs, raising concerns about debt sustainability and acting as an important headwind for USD.
Bottom line: we expect DXY to remain anchored within its 96.00-100.00 range that’s held for nearly a year.
The US Senate confirmed Kevin Warsh as the Fed’s 17th chair yesterday. The June 17-18 FOMC meeting will mark Warsh’s first at the helm. That meeting also features an update to the Summary of Economic Projections (SEP), giving markets an early read on how Warsh intends to reshape the communication framework around the monetary policy outlook.
The market narrative is that Fed Chair Warsh will steer the FOMC in a more dovish direction, weighing on USD and steepening the yield curve. That is hardly a groundbreaking take given Warsh’s view on productivity, inflation, and the Fed’s balance sheet.
However, Warsh faces three major constraints that could disappoint markets expecting a more dovish Fed tilt: FOMC is not a one man show, funding stress risk limits Fed’s ability to reduce the balance sheet, and underlying inflation is sticky above the Fed’s 2% target.
Stay tuned for our upcoming special report on what a Warsh-led Fed could mean for markets.
US April retail sales print is due today (1:30pm London, 8:30am New York). Total retail sales are expected at 0.5% m/m vs. 1.7% in March supported by spending at gas stations. The more policy relevant control-group sales - which exclude cars, gas, food services, and building materials – is seen rising by a decent 0.4% m/m vs. 0.7% in March.
US consumer spending has been resilient so far, contributing to half the 2% annualized real GDP growth over Q1. Going forward, the Atlanta Fed GDPNow model estimates annualized real GDP growth of 3.7% in Q2, and real personal consumption expenditure at 1.8% vs. 1.6% in Q1.
CHINA
CNH is outperforming most currencies while USD/CNH edged down to near 6.7820, the lowest since February 2023. The US and China two-day summit in Beijing began today. A key takeaway so far is that Chinese President Xi Jinping told US business leaders his country will further open up its economy. That could enhance the yuan’s appeal as an international currency.
Indeed, the international usage of the yuan is very low compared to China’s shares of world GDP and world trade, implying a lot of potential for an increase in its usage. We have been, and continue to be, long term bulls on CNH reflecting both its internationalization potential and China’s internal rebalancing story.
UK
GBP is trading on the defensive versus USD and EUR. UK economic activity rebounds in Q1. Real GDP was up 0.6% q/q vs. 0.1% in Q4, in line with consensus and a tick above the Bank of England’s (BOE) 0.5% projection. Growth in Q1 was driven by gross capital formation: other and household consumption.
Within gross capital formation: other, the largest contribution was from acquisitions less disposals of valuables. This component is largely made up of non-monetary gold, implying headline GDP exaggerates the strength of the underlying economy.
The swaps curve continues to fully priced-in a 25bps BOE rate hike to 4.00% at the July 30 meeting. For now, UK political uncertainty dominates the price action in GBP and gilts.
Prime Minister Keir Starmer continues to resist mounting pressure to step down stressing “we can’t let a leadership contest plunge us into chaos.” However, the latest headlines suggest Starmer’s main challengers are preparing to make their leadership move:
- Angela Rayner, former deputy prime minister, has been cleared of deliberate wrongdoing by an investigation into her tax affairs.
- Andy Burnham is reportedly close to securing a by-election route back to Parliament. A sitting MP (Afzal Khan) could vacate his seat soon. Also, allies of Burnham believe he’s just one vote short of getting approval from Labour’s National Executive Committee to resign as mayor and run as a by-election candidate.
- Wes Streeting, Health Secretary, is expected to resign today from the UK government.
With or without Starmer, the governing Labour Party faces an uphill battle to restore fiscal credibility which is an ongoing drag to gilts and GBP. UK nominal GDP growth is tracking below 10-year gilt yields, making stopping debt growth very difficult. A tilt further left (Angela Rayner or Andy Burnham) would intensify fiscal concerns, while a more centrist replacement (Wes Streeting) could limit the damage.
JAPAN
USD/JPY is holding near the middle of a more than two-month 155.00-160.00 range. We remain constructive on JPY. But until the energy shock fades, USD/JPY will likely continue to trade within that range.
The Bank of Japan (BOJ) is turning more hawkish. BOJ board member Kazuyuki Masu said “if statistical data do not indicate clear signs of an economic downturn, I believe it is desirable to raise the policy rate at the earliest stage possible.”
Masu’s remarks strengthen the case for a June rate hike, especially after three other BOJ members (Nakagawa Junko, Takata Hajime, and Tamura Naoki) dissented in favor of tightening at the last April meeting. The swaps market continues to price-in about 75% odds of a 25bps BOJ rate hike to 1.00% for the June 16 meeting.
