Elevated risk as possible Fed pause fails to help

USD: Rebound despite ECB rate hike  

The US dollar rebounded versus the euro primarily yesterday but was more mixed versus other currencies but weakened further versus the yen which continues to benefit from the ongoing deterioration in US regional banking sector sentiment again. Fed Chair Powell’s comment that “banking conditions have broadly improved since March” could come back to haunt him based on price action since – the KBW Regional Bank Index fell modestly on Wednesday when the FOMC met but fell a further 3.5% yesterday and is now down 12% this week. PacWest – the latest regional bank in focus is down 69% this week.

But it was short-term yields in core Europe that fell sharply yesterday with the 2yr German bund yield down 16bps, compared to a drop of 2bps in the UST note equivalent. Is this a reflection of a more dovish take by the markets on President Lagarde’s press conference? We published an FX Focus yesterday on the ECB meeting (here) and we would not take the view that the short-term yield drop was a dovish interpretation. The 2yr UST note yield fell sharply on Wednesday in the US with the move predominantly taking place after European markets closed. The 2yr note yield fell 16bps on Wednesday. The German 2yr yield closed 2bps higher on Wednesday and did not respond to the Wednesday US yield move yesterday morning ahead of the ECB meeting. Once that event risk passed with no major surprises from the ECB (like a 50bp hike, which was partially priced) the 2yr yield in core Europe then moved more sharply lower.

There really isn’t much more to it than that and in our view the ECB communications are consistent with potentially two more rate hikes. The APP roll-off pace will be faster than expected from July, averaging EUR 27bn per month while there will be no specific liquidity provision to counter the EUR 477bn of TLTROs maturing in June. Nothing from yesterday felt more dovish than expected.

It remains all eyes on US regional banks and this is turning into a credibility issue for the US authorities given the comments from Powell on Wednesday and the common question now is how will this cycle be broken? Powell on Wednesday in the Q&A described the JPM purchase of First Republic as a one-off and big banks getting even bigger is not ideal. An increase in the deposit protection limit of USD 250k is possible but it could be debated whether that would halt deposit flight. Given First Republic shareholders and bondholders were wiped out, investor selling could well persist in order to reduce risks that have clearly increased.

The yen is the 3^rd best performing G10 currency this week, behind AUD & NZD (strong employment report). EUR is languishing after yesterday’s performance but we would still certainly favour the yen in this market and expect that strong performance to persist if these market conditions are maintained or worsen. Assuming no European bank issue emerges, EUR should play some catch-up while GBP continues to benefit from stronger data and a relatively smaller regional banking sector.

US BANKS SUFFERING MORE THAN IN THE UK OR EUROPE

Source: Bloomberg, Macrobond & MUFG GMR

USD: US jobs report in focus

With building expectations that the US economy is headed for recession, the US jobs data will get increasing focus – the jobs market continues to defy those expectations and the pace of jobs growth is nothing close to signalling a recession. But the NFP gains do indicate a slowing in the pace of jobs growth – that’s especially the case if you assume the Jan-Feb gains were distorted due to the unusually mild weather. The consensus for today is for a gain of 185k – if realised that would be the first increase of less than 200k since the end of 2020 when the jobs market was still volatile during the initial period of covid. The AHE data will be key as well and a 0.3% gain as expected today would be indicative of a slowing pace in wage growth as well, with the 3mth average MoM rate likely around the slowest since early 2021.

But the labour market of course reflects activity from before and is a lagging variable and when conditions turn, the labour market tends to be where you see it last. The impact of both monetary tightening and the more recent tightening of credit conditions has yet to feed through but that could well be imminent. Initial claims have turned higher, the Challenger job cuts data show a rising trend in layoffs, the JOLTS data indicate a weakening labour market while the NFIB small business survey shows hiring plans are trending lower.

It is this last indicator that might prove most telling. Small to medium sized firms rely more on bank loans and hence we should expect the current turmoil in the US regional banking sector to have greatest impact on the outlook for small/medium sized firms in the US. Small businesses alone make up nearly 50% of jobs and including medium-sized the vast bulk of employment. The NFIB Hiring Plans Index is now falling notably and suggests a softening labour market is imminent.

A weaker than expected NFP today would provide compelling reason for a sharper correction lower for the dollar, which would be broad-based across G10.

TIGTHENING CREDIT CONDITIONS WILL SOON IMPACT JOBS MARKET

Source: Macrobond

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
IT	09:00	Italian Retail Sales (MoM)	Mar	0.0%	-0.1%	!
IT	09:00	Italian Retail Sales (YoY)	Mar	4.4%	5.8%	!
EC	09:00	ECB's Elderson Speaks	--	--	--	!!
UK	09:30	Construction PMI	Apr	51.0	50.7	!
SZ	10:00	SNB Chairman Thomas Jordan speaks	--	--	--	!!
EC	10:00	Retail Sales (YoY)	Mar	-3.1%	-3.0%	!
EC	10:00	Retail Sales (MoM)	Mar	-0.1%	-0.8%	!!
US	13:30	Average Hourly Earnings (MoM)	Apr	0.3%	0.3%	!!!!
US	13:30	Average Hourly Earnings (YoY) (YoY)	Apr	4.2%	4.2%	!!!!
US	13:30	Average Weekly Hours	Apr	34.4	34.4	!
US	13:30	Government Payrolls	Apr	-8.0K	47.0K	!
US	13:30	Manufacturing Payrolls	Apr	-5K	-1K	!
US	13:30	Nonfarm Payrolls	Apr	180K	236K	!!!!!
US	13:30	Participation Rate	Apr	62.5%	62.6%	!!
US	13:30	Private Nonfarm Payrolls	Apr	160K	189K	!!
US	13:30	U6 Unemployment Rate	Apr	6.7%	6.7%	!
US	13:30	Unemployment Rate	Apr	3.6%	3.5%	!!!!
CA	13:30	Employment Change	Apr	20.0K	34.7K	!!!!
CA	13:30	Unemployment Rate	Apr	5.1%	5.0%	!!
US	18:00	Fed Governor Cook Speaks	--	--	--	!!
US	20:00	Consumer Credit	Mar	16.50B	15.29B	!

Source: Bloomberg