USD continues to adjust lower encouraged by slowing US growth

USD: Further evidence of slower US growth is dampening USD strength

The US dollar’s downward momentum was reinforced yesterday by the release of the softer ISM manufacturing survey for May. It has resulted in the dollar index breaking below support from the 200-day moving average at around 104.40. The next key support level is located at 104.00 which was tested and held in both April and May. The US dollar has been undermined by a further sharp adjustment lower in US yields. The 10-year US Treasury yield has now fallen by around 25bps since late last week. The main trigger for the further correction lower for US yields and the US dollar yesterday was the latest ISM manufacturing survey for May which revealed that the tentative recovery in the US manufacturing sector has fizzled out. The headline ISM manufacturing index declined by 0.5 point to 48.7 in May. The monthly drop in manufacturing confidence was mainly driven by a larger 3.7 point drop in the new orders sub-component to 45.4 in May. It was the lowest reading for the forward leading new orders sub-component in a year which is indicating that manufacturing confidence is likely to deteriorate further in the near-term. One positive from the report was that the employment sub-component increased for the third consecutive month by 2.5 point to 51.1 in May. It was the highest reading since August 2022. The positive employment signal will help to ease some concerns over a sharper slowdown in employment growth in the coming months, although as we have highlighted recently other leading indicators have still deteriorated recently.

Market attention will now turn to the release later today of the latest JOLTS report to see if it provides further evidence of softening labour demand and wage growth. In the last report for March the JOLTS report revealed job openings fell to the lowest levels since February 2021 and the quits rate remained at the lowest level since April 2019. Overall, the latest developments have provided further evidence that the US economy has lost upward momentum at the start of this year which is beginning to put a dampener on US dollar strength. Investor optimism that US growth would bounce back in Q2 after slowing to an annualized rate of 1.3% in Q1 were dented yesterday as well by the updated GDP estimate for Q2 released by the Atlanta Fed. Their GDPNow estimate for GDP growth in Q2 dropped sharply from 2.7% to 1.8% which suggests below trend growth has continued through the 1H of this year. A development if confirmed by the hard data in the coming months should provide some comfort for the Fed that tight monetary policy is having more of a restrictive impact on the US economy. In our latest monthly FX Outlook report yesterday, we outlined that we still expect the US dollar to weaken modestly this year (click here).         

US GDP ESTIMATES ARE ADJUSTING LOWER

Source: Bloomberg, Macrobond & MUFG GMR

EM FX: Heightened political risks up upends popular EM FX carry trades

Political risk has returned as an important driver of emerging market currency performance over the past week. The results from elections in South Africa, Mexico and India have all created more political uncertainty that has contributed to weaker domestic currencies. The South African rand was hit first at the start of this week after it was revealed that the ruling ANC party lost their majority in parliament after securing just 40.2% of the votes, and are now in the process of trying to form a coalition government. Under the constitution, South Africa’s Assembly must convene within 14 days to elect a speaker and a president after the declaration of the election outcome. The initial rand sell-off briefly lifted USD/ZAR back above the 200-day moving average at around 18.800 although it has since fallen back towards the 18.500-level. The rand staged a strong rebound yesterday after it was revealed that both the ANC and the main pro-business opposition party the Democratic Alliance are open to forming a coalition government. An alliance with the DA would be welcomed by market participants as it could open the door to accelerated economic reforms and privatization initiatives in South Africa. However, the worst-case outcome represented by a coalition between the ANC and the leftist parties can’t be ruled out yet either. An outcome that would pose significant downside risks for the rand. Former president Zuma’s uMkhonto weSizwe party is though demanding that Ramaphosa would need to be replaced as president to join a coalition with the ANC making it a less palatable option.

Heightened political risk in Mexico has triggered an even bigger unwind of popular long peso carry positions. USD/MXN surged higher by around 3% yesterday after the Mexican election results revealed that Claudia Scheinbaum and her coalition government secured a strong mandate to continue with the populist policies of current president Andres Manual Lopez Obrador. The scale of the victory was the main surprise and has heightened investor concerns that the government will have the power to make constitutional changes to consolidate their power. According to Bloomberg, the coalition government will have a supermajority in the lower house of parliament but will likely fall just short in the senate. However even if it falls a few votes short in the senate, the expectation is that it could negotiate the votes needed to achieve a majority for constitutional reform.

Back in February AMLO submitted reforms to Congress including the elimination of autonomous institutions, reducing the number of representatives in the lower house as well as structural changes in the Supreme Court to publicly elect justices. Banxico and the national statistics office were not included in the autonomous institutions to be eliminated. The February proposals also included some social reforms such as pensions for senior citizens and free high quality medical care for all Mexicans. The cost of the potential social reforms will add to concerns over the health of Mexico’s public finances although in her victory speech Claudia Scheinbaum committed to austerity measures and central bank autonomy.

Market participants will be watching closely to see if reforms are pushed through in the coming months ahead of the new Congress starting in September. Overall, the political developments have taken some of the shine off the peso which has been the best performing emerging market currency in recent years boosted by tailwinds including high carry, nearshoring and remittances. It will make investors more reluctant to rebuilt long MXN carry positions in the near-term even though the peso is now trading at more attractive levels. Please see our latest EMEA EM Weekly for more details (click here).      

DOMESTIC POLITICAL RISKS TRIGGER REVERSAL OF EM FX CARRY TRADES

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
GE	08:55	German Unemployment Change	May	7K	10K	!!
US	15:00	Durables Excluding Defense (MoM)	Apr	--	0.0%	!
US	15:00	JOLTs Job Openings	Apr	8.370M	8.488M	!!!
US	15:00	Total Vehicle Sales	--	15.80M	15.74M	!

Source: Bloomberg