USD on front foot at start of important week

USD: Focus to switch to health of US labour market from US debt ceiling

The US dollar continues to trade close to recent highs at the start of a holiday shortened week. There has been limited reaction in the FX market to news over the weekend that US politicians have agreed a deal to avoid a debt default. The deal will suspend the US debt ceiling until 1^st January 2025 that will likely put off another debt ceiling showdown until the middle of that year after the next election in 2024. As part of the deal, the Democrats have agreed to cap federal spending for the next two years. The White House has been telling lawmakers that the deal would lower spending by about USD1 trillion over a decade, while the GOP has been arguing that the spending cuts would be double that amount. According to the FT, the cut in federal spending in 2024 has been estimated at around 0.2% of GDP which is smaller than the cut to federal spending in the year following the 2011 debt ceiling stand-off which totalled 0.7% of GDP. It would represent a win for the Democrats who have stood up against the Republican demands for bigger spending cuts in exchange for raising the debt ceiling. Moody’s Analytics estimates that the impact of the debt ceiling bill on the US economy would be “manageable” and peak in late 2024. It is expected to shave off 0.15 percent of GDP and to decrease employment by 120k jobs.      

Market attention in the coming days will now turn to the passage of the bill through Congress. The bill will be taken up by the House rules committee today which will determine the framework for considering the legislation. A vote on the bill is then expected in the House on Wednesday which would allow time for the Senate to pass the bill before 5^th June that has been identified as the updated X date when the US government would run out of money to pay the bills. While there is genuine unease about the deal amongst Democrats and Republicans which could make it a close call, we expect the deal to be passed to suspend the debt ceiling in time.  By passing the deal ahead of the X date the US economy will avoid a bigger negative shock.

The US dollar and US rates have already risen in recent weeks in anticipation that a last-minute deal would be reached helping to explain the limited market reaction. Assuming that US politicians don’t surprisingly reject the deal, market attention should switch back to the health of the US labour market in the week ahead including the release of the non-farm payrolls report on Friday. The US rate market has been moving to price in a higher probability of another 25bps hike from the Fed at next month’s FOMC meeting, which is now judged as more likely than not (16bps are currently priced in). Another strong employment report this week would further reinforce those expectations and encourage a stronger US dollar in the near-term. The argument in favour of another Fed rate hike has been strengthened recently by stronger economic data releases from the US including the latest PCE deflator report on Friday. Unlike the CPI report released earlier this month, the PCE deflator report failed to provide reassuring evidence that core services inflation has eased. The PCE core services less housing component increased by 0.42% in April up from 0.27% in March. So far this year it has increased by an annualized rate of 4.9% which is only marginally slower than the equivalent peak back in November of 5.1%. The lack of progress will keep pressure on the Fed to keep hiking rates, although we continue to argue that the Fed has already done enough by raising the policy rate to just over 5.0% especially with credit conditions set to tighten more going forward as well.           

STICKY SERVICES INFLATION LIFTING FED RATE HIKE EXPECTATIONS

Source: Bloomberg, Macrobond & MUFG GMR

TRY: No surprise as President Erdogan remains in power and lira adjusts lower

The other focus over the weekend was the election victory in Turkey for President Erdogan who won the second round face off and secured another five years in power. He won 52.2 percent of the vote against the opposition candidate Kemal Kilicdaroglu in a tight contest. During the campaign President Erdogan had given no indication that he plans to modify the unorthodox economic policies that have undermined confidence amongst international investors in Turkish assets and the lira. However, there have been reports at the start of this week that President Erdogan met Mehmet Simsek who was a more market friendly former finance minister ahead of announcing a new cabinet which is expected as early as Friday. The latest reports of yesterday’s meeting have further encouraged speculation that Mehmet Simsek could return to President Erdogan’s administration to guide it through a potentially turbulent period ahead.  It follows a promise from President Erdogan that his new economic team would have “international credibility”.  

The pace of lira depreciation has been picking up over the past month. The lira has declined by an annualized rate of around -36% against the US dollar so far in May. It marks a step up in the pace of depreciation compared to in the first four months of this year when the lira declined by an annualized pace of around -11%. We expect the faster pace of lira depreciation to continue now that the elections have been completed, and President Erdogan has remained in power. Even if former finance minster Simsek is brought back into the fold, we believe that the lira needs to adjust sharply lower after it was artificially held up ahead of the elections. We will be adjusting our lira forecasts materially lower in our latest monthly FX Outlook report released later this week.   

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	M3 Money Supply (YoY)	Apr	2.1%	2.5%	!
EC	10:00	Business Climate	May	--	0.54	!
CA	13:30	Current Account	Q1	-10.9B	-10.6B	!!
US	14:00	S&P/CS HPI Composite - 20 s.a. (MoM)	Mar	-0.4%	0.1%	!

Source: Bloomberg