Key Chart Points Hold And The Dollar's Rally Stalls Ahead Of The Weekend

Overview

Hawkish comments from Fed officials and the first decline in continuing unemployment claims below 1.8 million in two months boosted US rates and the odds of a June rate hike rose to about 37%. This represents a near-tripling of the probability in the past week. It has been a trend, with the odds rising in 9 of the past 11 sessions. The two-year note yield has risen for the past five sessions coming into today, for a cumulative gain of about 35 bp. This seems to offer the best explanation of the dollar's rebound. However, despite progress, the debt ceiling debate continues and emergency borrowing from the Federal Reserve is continuing to rise, albeit slowly. The dollar approached or tested key technical levels and is consolidating with a softer bias today.

The large bourses in the Asia-Pacific region rose, with the notable exceptions of Hong Kong and China's CSI 300. Europe's STOXX 600 is up about 0.65% to extend yesterday's recovery, which followed a two-day decline. US index futures are also trading with a firmer bias. The S&P 500 and NASDAQ reached their best levels yesterday since last August. Europe's benchmark 10-year yields are mostly 1-2 bp higher today, while the 10-year US Treasury yield is off slightly more than a basis point to near 3.63%. It reached a two-month high yesterday near 3.65%. Gold held support near $1.950 and is firmer on the back of a softer dollar. Initial resistance is seen near $1975. June WTI is consolidating in a narrow range (~$71.70-72.65). It settled last week near $70.

Asia-Pacific

Japan's April CPI was in line with expectations, helped shaped by Tokyo's estimate a few weeks ago. Headline and core prices rose to 3.5% and 3.4%, respectively, from 3.2% and 3.1%. The decline since January's 4.3% headline rate mostly reflects the government's subsidies. The cleanest read of the underlying pressures may be the measure that excludes fresh food and energy. It accelerated to a new cyclical high of 4.1%. This is why, despite BOJ Governor Ueda's press for patience, many expect an adjustment as early as next month. It does seem to be increasingly hard to justify a negative overnight rate. It is set at minus 0.10%, but the effective rate is about minus 3 bp. Can raising it to zero be that impactful? Still, market talk tends to emphasize the yield curve control policy. Assuming a change, there are three possibilities: abandon it entirely, raise the current band or central rate, or target a different rate. At the same time, the timing of the BOJ's move can influence the political calculations of an early election. Hosting the G7 summit in his hometown of Hiroshima, Prime Minister Kishida is in his glory, and knowing (that everyone else knows) that Japan's economy was the fastest-growing among the G7 in Q1. The rapprochement between Tokyo and Seoul is also a significant achievement. Despite the official denials, a summer election remains a possibility. Still, until the June 16 meeting draws near, US rates may be the most important tell for the exchange rate. The correlation between changes exchange rate and the two-year US yield is near 0.70 and slightly above 0.60 with the 10-year.

The Chinese yuan is a managed currency, but what does that mean? Officials say they monitor it against a basket of currencies. A heuristic would look for a couple of currencies that do the most work. The dollar's movement against the Japanese yen and euro seems to do the trick. We want to see the relationship in a period that allows for distinct phases or disruptions. We want to run the correlations on the change in exchange rates. The correlation between the yuan and euro is typically great and more stable than the correlation between the yuan and yen. The 100-day rolling correlation between the euro and yuan is around 0.61, the upper end of the 6-7 month range. In the second half of 2022, the 100-day correlation was mostly between 0.45 and 0.55. This year, it has been between 0.50 and 0.63. The yuan and yen's rolling 100-day correlation is around 0.48. It was a little closer to 0.50 earlier this month, which is the highest since 2017. In Q3 '23, the correlation hovered around 0.2 and rose sharply as the dollar peaked against the yen, and by mid-November, the correlation rose to around 0.45. It has held above 0.35 since then and jumped toward 0.50 on May 5.

The dollar is snapping a six-day advance against the Japanese yen that carried it from JPY133.75 on May 11 to JPY138.75 yesterday. Softer US rates and what may be a re-acceleration of Japanese inflation helped spur the pullback to slightly below JPY138 in late Asian turnover. Initial support may be near JPY137.70. The bottom end of the Australian's dollar's range (~$0.6600) held yesterday, and the Aussie is consolidating today, reaching almost $0.6660. The intraday momentum indicators are stretched, and nearby support is around $0.6630. The price action reinforces a two-and-a-half month trading range (~$0.6600-$0.6800). The dollar's pullback against the yen and euro is consistent with the heavier tone against the Chinese yuan. The greenback initially rose to a new high (since last November) of CNY7.06. It has come off to around CNY7.02. The dollar has risen in the past three sessions and eight of the past 10. From a somewhat longer perspective, it is the fifth weekly dollar gain in the past six weeks.

Europe

The euro's sell-off is the largest for a two-week period going back to last September. A light economic calendar this week for the eurozone suggests the drivers were elsewhere. We suggest that the key to the euro's 2.3% slide over the couple of weeks reflects an interest rate adjustment in the US while market positioning was extreme. The reception for Germany's 10-year bund sale was strong, 2.3x oversubscribed, the most since August 2020. Yet, this week, Germany’s 10-yield tracked the rise in US rates well (~16 bp vs. 13 bp). The key for the exchange rate may be in developments at the short end. The US premium on two-year money rose for the sixth consecutive session yesterday (and 15 of the past 18 sessions). The premium yesterday settled at 150 bp, the most since late March, and it is up more than 25 bp since late April.

Meanwhile, the net long speculative position in the futures market rose in the five weeks through May 9. At nearly 180k contracts (notional value ~$24.3 billion), it is the largest net long position since early October 2020. Positioning was extreme, and a key part of the fundamental story (rate convergence) changed. Speculators in the futures market have been net long sterling for the four weeks through May 9. It is the longest they have maintained the net bullish position since July 2021. It is not a big position (~$365 million), but just that it is finally net long after sterling rallied 20% from last September's low seems more like a boxer at the end of his punch than the beginning. From the end of March through May 9, the gross longs have soared by 28.3k contracts to 71.6k.(~$5.8 billion notional value). This is the largest gross long sterling position since March 2020. The bears covered in Q4, and the gross short positions fell from almost 110k contracts to 40k by the end of the year. They have been chopped up a bit this year, and the gross shorts have bounced around between 50k and 65k this year. As of last Tuesday, the gross short position was the largest for the year (~67k contracts, or ~$5.4 billion).

The euro made a marginal new low for the move (~$1.0760) earlier today, before stabilizing and recovering to almost $1.08. The euro has fallen for the past three sessions and approached a (61.8%) retracement of the rally since March 15, found near $1.0735. The five-day moving average, which the euro has not closed above since May 5, is slightly above $1.0825. A close above it would help stabilize the technical tone. Yet, the intraday momentum indicators are stretched, and the North American market appears to have led the dollar's recovery. Sterling frayed the support at $1.2400 but continues to hover around it. The session high was set in Asia just shy of $1.2430. Sterling needs to settle above $1.2410 to snap the three-day decline. On the downside, the $1.2345 area corresponds to a (38.2%) retracement of sterling's rally from the March 8 low (~$1.1805). Lastly, note that Greece holds national elections this weekend. Even though the economy is doing relatively well, and may even regain investment-grade status, the cost-of-living squeeze is making for a tight race. Electoral rules have changed, and many observers see a run-off election likely, possibly in July.

America

Despite plenty of recession signals, including the inversion of various parts of the yield curve and the continued plunge in the index of Leading Economic Indicators, it appears the US economy is re-accelerating. This early in the quarterly cycle, the Atlanta Fed's GDP tracker is not particularly accurate, but its 2.9% estimate seems fairer than the median forecast in last month's Bloomberg survey of 0.1% annualized growth here in Q2 (Bloomberg's survey is updated later today). Recall that private sector job growth practically doubled in April (230k vs. 123k in March), and auto sales rose 7.4% from March on a seasonally adjusted basis to their highest level since May 2021. Core retail sales (excluding autos, gasoline station sales, food services, and building materials) rose 0.7% in April. It follows a 0.4% decline in March and a flat February. Manufacturing output jumped 1.0% in April. The median forecast in Bloomberg's survey was for a 0.1% increase. In the week ending May 12, weekly initial jobless claims unwound the 22k rise in the prior week. Continuing claims slipped below 1.8 million for the first time in two months. Among the positive developments, we would add the stabilization of bank shares. This is not to be Pollyannaish. Three headwinds may again challenge business and investors: the commercial real estate market continues to show signs of stress, lifting of the debt ceiling comes at a cost of a fiscal drag, and the resumption of student loan payments absorb savings.

Taking the incoming data on-board, the market has more than doubled the odds of a Fed hike in June this week (from about 13% at the end of last week to around 33% now). In fact, the day after FOMC last met (May 3), the market was still pricing in a risk (albeit de minimis) of a rate cut next month. Since then, the market has moved steadily (nine of the past 11 sessions) toward increasing the likelihood of a hike. Another notable adjustment is gradual scaling back from the aggressive rate cut that had been discounted for this year. There is no meeting in January 2024, so the Jan Fed funds futures contract may offer the cleanest read of year-end 2023 expectations. The implied yield has risen for nine of the past 10 sessions, from 4.11% on May 4 to about 4.66% yesterday. It is a little lower today, where the session highlight is the 11:00 am ET appearance of Fed Chair Powell and Bernanke on the same panel at a Fed-hosted monetary policy research conference in Washington. Earlier this morning in the US, NY Fed President Williams will speak at the same conference, while Governor Bowman speaks at a separate event.

The US dollar is within yesterday's range against the Canadian dollar, which was inside Wednesday's range (~CAD1.3435-1.3535). Bank of Canada Macklem seemed to play down the rise in CPI reported earlier this week and opined that inflation was still in a downtrend. The market did not give strong odds of a rate hike next month, but it has slipped a little, though around 18%, it is still nearly twice as high as a week ago. The market has nearly a 75% chance of a hike by the end of Q3 discounted, up from practically no chance a week ago. Only the dollar bloc currencies have risen against the US dollar this week among the G10 currencies, and the Canadian dollar is in the middle with about a 0.5% gain (the New Zealand dollar is best, up 1.4%, and the Australian dollar has gained almost 0.2%). As most expected, the central bank of Mexico kept its target rate steady at 11.25% and signaled its intention to keep it there for an extended period. The dollar's session high was made prior to the rate announcement. The greenback has largely held below MXN17.75 since the decision. The favorable underlying case for the peso (carry, near-shoring/friend-shoring, rallying stocks) remains in place. The challenge is that market positioning is extended, and the news known. Although the dollar has risen for the past three sessions and five of the past six, the technical tone remains weak. A rise through the 20-day moving average near MXN17.80 would change that assessment.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.