Fed Day

Overview

A sharper-than-expected decline in US job openings and weaker factory orders coupled with intensifying bank stress sent ripples through the capital markets. The large US bank index fell 4.5% yesterday, the most in six weeks, while the regional bank index fell nearly 5.5%, its biggest loss since March 13. Both indices took out the March lows. The US 10-year yield unwound Monday's increase and the two-year note yield fell back below 4.0% for the first time since the middle of last week, and yields remain under pressure today. The dollar gave back its earlier gains against most of the G10 currencies. The greenback remains under pressure today. Only the Australian and Canadian dollars are struggling to rise today. Most emerging market currencies are also firm today.

Japanese and mainland Chinese markets were on holiday today and were spared today's regional sell-off led by the 1%+ losses in Hong Kong. After being tagged for 1.25% yesterday, Europe's STOXX 600 is about 0.3% firmer today. Its bank index has steadied after dropping nearly 2.4% yesterday. US equity futures are steady to firmer. European bond yields are 2-4 bp lower, and the US 10-year Treasury is slipping below 3.40%. Lower yields and a weaker dollar lifted gold back above $2000 yesterday, and it is holding a tight range today (~$2012.70-2019.55). Recall that last week's high was slightly above $2009. Oil prices have continued to sell off sharply today. June WTI settled near $76.80 at the end of last week. It dropped to almost $71.40 yesterday, and today, it has slipped below $70 for the first time since March 27. The next area of chart support is around $69 and then $67.

Asia-Pacific

China's markets re-open tomorrow for the first time this week. The Caixin manufacturing PMI will be reported early Thursday. It is seen steady at 50.0, but after "official" PMI fell to 49.2 from 51.9, the risk is to the downside. Caixin service and composite PMI will be published early Friday.

Australia, where the central bank surprised the market with yesterday's rate hike, reported better-than-expected final service and composite PMI earlier today. The services PMI rose to 53.7 from the flash reading of 52.6, and 48.6 in March. The composite PMI stands at 53.0, up from the 52.2 initial estimate and 48.5 in March. Separately, Australia reported that March retail sales rose 0.4%, twice what was expected after a 0.2% gain in February's increase and a 1.8% jump in January. It reports March trade figures tomorrow. In January-February, Australia reported a trade surplus of A$25.2 billion. This compares with a surplus of almost A$20 billion in the first two month of 2022 and A$8.7 billion in the first two months of 2019 (before Covid).

Falling US rates helped push the dollar lower yesterday after it reached almost JPY137.80, slightly shy of the year's high set in March near JPY137.90. It has continued to retreat today and is testing the JPY135.50 area. It has nearly retraced half of the rally from last week's lows (~JPY133). A break of JPY135.40 could signal a test on the JPY134.80-135. The Australian dollar could not sustain the upside momentum given to it by the central bank's surprise hike yesterday. After spiking to nearly $0.6720, it settled slightly below $0.6665. It has largely been confined to a 10-tick range on either side of yesterday's close in lethargic activity. The range can be extended to $0.6640-0.6680 without impacting the technical outlook. The US dollar's heavier tone against the euro and yen signaled a pullback against the Chinese yuan. And sure enough, the greenback is trading near six-day lows below CNH6.92. Ahead of the reopening of the mainland markets tomorrow, look for support around CNH6.90 to hold. Recall that the dollar settled near CNH6.9270 before the extended May Day holiday.

Europe

There is no doubt that the ECB will hike key rates by a quarter-point tomorrow. Indeed, some of the hawkish rhetoric and the firm April CPI reading encouraged the swaps market to price in a small chance of a 50 bp hike. Earlier today, the Eurostat report that the unemployment rate fell to a new historic low of 6.5% for the eurozone. It was at 6.6% in January and February after holding at 6.7% since last April. Ahead of the outcome of the ECB meeting, the final service and composite PMI reading will be announced. Recall that the flash composite PMI rose to 54.4 from 53.7. It has been above the 50 boom/bust level since January, and the preliminary April reading was the best since last May. Perhaps the most interesting development in the eurozone so far this year is what did not happen. A combination of good luck with the warmer winter, preparedness in terms of supplies, and conservation efforts helped avoid a crisis. The eurozone eked out a small expansion in Q1 (0.1%) after contracting slightly (-0.1%) in Q4 '22.

Norway's Norges Bank will also hike its deposit rate by 25 bp to 3.25% tomorrow. It began hiking in September 2021. Headline inflation rose 6.5% year-over-year in March. It was at 5.9% at the end of last year. It recorded the cyclical peak in January at 7.0%. The underlying measure, which excludes energy and adjusts for tax changes, rose to 6.2% in March from 5.9% in February. It peaked in January at 6.4%. Norway was among the first of the G10 countries to begin normalizing monetary policy, but the payoff is not quite what many expected. The Fed and ECB began later and tightened more. The Norwegian krone is easily the weakest of the G10 currencies so far this year, falling more than 9% against the dollar and about 11.5% against the euro. The correlation between changes in Brent crude oil prices and the exchange rate against the dollar and euro are about the lowest over the last 100 sessions (~0.45).

The euro has recovered smartly from a seven-day low set yesterday near $1.0940 to almost $1.1010, and today is approaching $1.1050. The euro slipped below its 20-day moving average Monday and Tuesday but was unable to close below it, and the sharp drop in US rates helped it recover. Recall that last week's high of almost $1.11 was the euro's best level in 12 months. Since the euro bottomed yesterday, pullbacks have been limited to about 15 ticks. For its part, sterling recovered from a four-day low yesterday (~$1.2435), but it was not as impulsive as the euro and settled near $1.2465. It reached almost $1.2535 today in early European turnover but appears to be stalling. Initial support is seen near $1.2480. Lastly, the Czech central bank has kept the two-week repo rate at 7.0% since the middle of last year. It likely will do so again today.

America

There is a consensus like there was in March that the Fed will be done after today. There are some that have argued that the Fed ought to pause now, but if it did, it would come as a big surprise. Chair Powell & Co. are expected to signal a pause after today's hike. However, given investors' reaction function, a suggestion of pause may be seen as validating market expectations of a cut and exciting the market, and would be threatening to undermine some of the Fed's work. Moreover, a pause does little for the bank stress and/or for the Fed's anti-inflation efforts. The Fed funds futures strip implies a year-end effective rate of about 4.37%. It had been as low as 4.30% early last week. We suspect that the Fed will look through what appeared to be softer Q1 growth of 1.1% and instead see underlying strength by looking at final sales to domestic parties (excludes trade, inventories, and government spending), which rose 2.9%. Moreover, recent data, including the GDP deflators and the employment cost index, remain elevated. We have argued a June hike seemed more likely than the market's bias toward nearly 75 bp in cuts over the five remaining meetings this year. The market briefly toyed with the idea of a June hike earlier this week, but the banking stress took it out fully yesterday.

Leaving aside the base effect, where last year's high readings drop out of the 12-month comparison headline, CPI rose at an annualized rate of about 4% in the first quarter. The core rate rose by slightly faster than 5.2% at an annualized pace in the January-March period. There has been some tightening of credit, but as the heavy investment-grade bond issuance this week reminds, in the US, the banks are not the only source of credit and market channels appear to remain robust. Moreover, the senior loan officer survey had shown some tightening in lending began before the bank stress that erupted in March, which is to suggest that the tightening of monetary policy, not the bank stress, may account for most of the restrictions to credit.

Given our understanding of the consensus view, we suspect that anything shy of a confirmation of a pause may be seen as hawkish by the market. In February, the statement mentioned "ongoing increases" would be appropriate. This morphed into "some additional policy firming" may be appropriate in the March statement. It is this one part of the statement that may be key today. We suspect that without much specificity the forward guidance will be "data-dependent." That said, a frequent recent pattern has been for the market to respond one way to the statement and another to Chair Powell's comments. Powell may explain that within that "data dependency", the Fed retains a bias toward tightening.

The Canadian dollar performed poorly yesterday amid falling equities and oil prices. The greenback posted an outside up day by trading on both sides of Monday's range and closing above Monday's high. Although there has not been any follow-through today, the US dollar remains firm, holding above CAD1.3600. Yesterday's high was near CAD1.3640, and the high from the end of last week was a little above CAD1.3665. The next upside target is the CAD1.3700-30 area. The Mexican peso remains remarkably resilient. It is protected by high yields and favorable economic data (stronger-than-expected Q1 GDP, record exports, and robust worker remittances). The dollar traded on both sides of Monday's range yesterday but settled inside that range. So far today, it is holding below MXN18.00. Yesterday's low came within a whisker of the multi-year low set in March near MXN17.8980. Lastly, Brazil's central bank meets late today and is widely expected to keep the Selic rate steady at 13.75% but could sound a bit more dovish.

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