USD continues to rebound as x-date moves closer

USD 1: Hawkish repricing of Fed rate hike expectations

The US dollar has continued to strengthen overnight resulting in USD/JPY moving back within touching distance of the 140.00-level for the first time since November of last year. The US dollar is deriving support both from the combination of rising in US yields and more-averse trading conditions in the near-term. The 2-year US government bond yield has now closed higher for nine consecutive days and risen by around 75bps from the low from earlier this month. The hawkish repricing of Fed rate hike expectations has resulted in the US rate market moving to price in around 9bps of hikes at the next meeting in June, and at the same time has scaled back expectations for rate cuts later this year to around 23bps. The hawkish repricing of Fed rate hike expectations was encouraged yesterday by comments from Fed Governor Waller who stated “I do not support stopping rate hikes unless we get clear evidence that inflation is moving down towards our 2% objective. But whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks”. He said he has been disappointed by the recent lack of progress in inflation and will pay special attention to the release of the next US CPI report on 13^th June. The hike or skip comment highlights that even if the Fed does not raise rates in June, he does not view that as the definitive end of the rate hike cycle and could back a hike again as soon as the next meeting in July. The release overnight of the minutes from the last FOMC meeting from 3^rd May revealed on balance that the Fed was still leaning in a more hawkish direction at that time. “Some” Fed officials thought that additional policy  firming would likely be warranted while “several” thought further policy firming may not be necessary. Those who favoured further policy firming referred to “future” meetings and not the next or upcoming meetings leaving open the possibility of the Fed skipping rate hikes at the June and/or July meetings. Those who favoured no further tightening were likely influenced by the economic forecast prepared by the Fed staff for the May FOMC meeting that  continued to assume that “the effects of the expected further tightening in bank credit conditions, amid already tight financial conditions, would lead to a mild recession starting later this year, followed by a moderately paced recovery. Real GDP was projected to decelerate over the next two quarters before declining modestly in both the fourth quarter of this year and the first quarter of next year”. We share the Fed staff’s outlook for a shaper growth slowdown which we believe will bring US yields and the US dollar back down.    

UK GLOBAL GROWTH CONCERNS HELPING TO SUPPORT USD

Source: Bloomberg & Macrobond

USD 2: US debt ceiling & global growth concerns both in focus

The hawkish repricing of Fed rate hike expectations has not been interrupted in recent days by the lack of progress made by US officials over raising the debt ceiling. The lack of progress has had more of a negative impact on equity market performance. The S&P 500 index has closed lower for two consecutive days, and extended its sell-off from the year to date high to around -2.5%. The more risk-averse trading conditions also appear to be offering more support for the US dollar as we move closer to the “x-date” without a deal to raise the debt ceiling.

Recent developments prompted Fitch to place the United States’ AAA credit rating on negative watch yesterday.  Fitch noted that increased political partisanship is hindering reaching a resolution to raise or suspend the debt limit despite the fast approaching x date (when the Treasury exhausts its cash position and capacity for extraordinary measures without incurring new debt). They still expect a resolution before the x-day, but believe the risks have risen that the debit limit will not be raised or suspended before the x-date and consequently that the government could begin to miss payments on some of tis obligations. Failing to make full and timely payments on debt securities is viewed as less likely than reaching the x-date, and he probability of debt default as such as considered very low. At the same time, Fitch noted that US government finances have recently underperformed their expectations on the back of weaker tax receipts and higher interest rates. The general government deficit is forecast to expand to 6.5% of GDP this year and 6.9% of GDP in 2024. We highlighted the worrying long-term path for US government finances in our 10 reasons for USD depreciation released yesterday (click here), although the US debt ceiling developments are clearly the reason for the decision to place the US credit rating on negative watch. The White House reacted to the announcement from Fitch by stating that “tonight’s warning underscores the need for swift bipartisan action …to avoid a manufactured crisis”.

More risk-averse trading conditions have seen commodity prices come under further selling pressure. The price of copper has continued to drop sharply falling back to its lowest level since early November of last year which is reinforcing investor concerns over a sharper slowdown in global growth on the back of weaker data releases recently from China and in Europe. The release of the latest manufacturing PMI surveys for May were at worryingly weak levels in Europe and in the US. Furthermore, yesterday’s disappointing UK CPI report has created more unease over the risk that inflation will prove more persistent in other major economies and require tighter monetary policy for longer. The softening outlook for global growth is helping to support the US dollar

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	ECB's De Guindos Speaks	--	--	--	!!
UK	11:00	CBI Distributive Trades Survey	May	10	5	!
GE	11:30	German Buba President Nagel Speaks	--	--	--	!!
US	13:30	Continuing Jobless Claims	--	1,800K	1,799K	!
US	13:30	Core PCE Prices	Q1	4.90%	4.40%	!
US	13:30	Corporate Profits (QoQ)	Q1	-0.9%	-2.7%	!
US	13:30	GDP (QoQ)	Q1	1.1%	2.6%	!!!
US	13:30	Initial Jobless Claims	--	250K	242K	!!!
US	15:00	Pending Home Sales Index	Apr	--	78.9	!
US	15:30	Fed Collins Speaks	--	--	--	!
UK	17:30	MPC Member Haskel Speaks	--	--	--	!!

Source: Bloomberg