Fitch Puts U.S. On Negative Credit Watch, And The Dollar Extends Its Gains

Overview

Concerns about the political wrangling over servicing US debt prompted Fitch to put the US on negative credit watch. Besides chin-wagging and finger-pointing, it has had little perceptible impact. The dollar is mostly higher, reaching new highs for the year against the Japanese yen, Chinese yuan, and the Antipodean currencies. The euro and sterling met the retracement objectives we have targeted (~$1.0735 and $1.2435, respectively). The greenback is also firmer against nearly all the emerging market currencies but a small handful that includes Russia, Mexico, and Taiwan. Gold reversed lower yesterday from $1985, the upper end of a five-day trading range, and settled slightly below $1957. Follow-through selling today has been limited ($1955), and the intraday momentum is stretched with it near $1965 in the European morning. Benchmark 10-year yields in Europe and the US are up around slightly, but the sell-off in UK Gilts following yesterday's higher-than-expected CPI continues. The 10-year UK yield is up almost 10 bp, bringing the cumulative gain in the seven consecutive increase to almost 50 bp.

Most of the large Asia-Pacific equity markets are weaker, led by a sharp 2.2% sell-off of mainland shares that trade in Hong Kong. The CSI 300 is lower on the year, but both Shanghai and Shenzhen composites are still positive. Japan's Nikkei rose (0.4%) and Taiwan's TAIEX rose by 0.8%. After tumbling 1.8% yesterday, Europe's STOXX 600 has steadied today (~+0.1%). S&P 500 futures are up about 0.6%, which could put the cash market near the upper end of yesterday's range when it gapped lower. NASDAQ futures are around 1.8% higher, and this could translate into a gap higher following yesterday's gap lower. If sustained, a bullish one-day island could be left in its wake. Lastly, July WTI is paring yesterday's surge that had been encouraged by warnings by Saudi Arabia against speculative shorts and the largest drawdown of US stocks (~14.1 million barrels) in more than six years, according to the EIA. July WTI approached $75 yesterday, it highest in more than three weeks. Now it is near yesterday's low (a little above $73).

Asia-Pacific

It was a largely newsless Asia-Pacific session, and the price action itself was the news. Japan's weekly portfolio flow report showed foreign buying of Japanese bonds and stocks continued and Japanese investors continued to buy foreign bonds, though with a weaker yen. The other main development was the Bank of Korea's decision to keep its seven-day repo at 3.5%, where it has been since mid-January. Consumer inflation stood at 3.7% in April, the lows since January 2022, and the base effect allows for additional slowing over the new few months. It has risen at an annualized rate of 2.8% over the last three months. The central bank also shaved this year's GDP forecast to 1.4% from 1.6%. Separately, the central bank of Indonesia also stood pat.

Tomorrow, Japan reports Tokyo's May CPI. While the headline and core rates may slow slightly from the 3.5% year-over-year pace in April, the underlying rate, which excludes fresh food and energy, is seen edging to a new high (3.9%). Tokyo CPI is a good estimate of the national figures, which come with a few weeks' lag. Ahead of the weekend, Australia reports April retail sales. A 0.3% increase is the median forecast in Bloomberg's survey, which is the average of February and March sales.

The dollar broke out of the four-day consolidative pattern against the yen to trade at its best level since last November yesterday and extended the gains to JPY139.70 today. We have been suggesting potential into the JPY139.50-JPY140 area, which corresponds to a (50%) retracement of the dollar's decline since peaking last October near JPY152. The area is also of some chart significance and psychological importance. Options for about $765 million expiring today at JPY139.50 have likely been neutralized. Another set of $920 million options expire tomorrow at JPY140.00. The Australian dollar was dragged to new six-month lows yesterday by the plunging New Zealand dollar. By falling to around $0.6530, the Aussie exceeded the (61.8%) retracement of its rally from the low set last October (~$0.6170). It fell fractionally more today to almost $0.6520. Although the price action is poor, it looks overdone. The Aussie closed below its lower Bollinger Band (two-standard deviations for the 20-day moving average), which is found near $0.6530 today. Other momentum indicators are getting stretched. That said, a break of $0.6500 leaves little chart support ahead of $0.6400. The New Zealand dollar took out March's low (~$0.6085) earlier today and is also below its lower Bollinger Band ($0.6100). Given the yen and euro's weakness, it may not be surprising that the dollar also made new highs for the year against the Chinese yuan (~CNY7.0750). The dollar entered, but did not completely close, the downside gap created by Tuesday's higher opening and then rallied through Tuesday's high. The greenback is climbing the five-day moving average, which is found near CNY7.0460 today. The dollar has entered a band of chart resistance in CNY7.07-7.11.

Europe

Europe also has a light economic calendar today. Germany revised down Q1 GDP to -0.3% from flat, making it the second consecutive quarterly decline, meeting some textbook definitions of a recession. Consumption contracted by 1.2%, after a 1.0% decline in Q4 '22. It was roughly twice the decline that economists projected. Government spending fell by a dramatic 4.9%, which was also considerably worse than expected. The drags were blunted by a recovery in fixed investment (3.0% vs. -2.6% in Q4 '22). Net exports also contributed. Germany reported a nearly 47.5 billion euro trade surplus in Q1. It is the largest since Q3 '21 and is more than 60% larger than that in Q4 '22. Separately, the GfK consumer confidence measure for May was released. The improvement seen since the end of last year seems to be slowing. France reported some business confidence measures that were a little softer than expected and April retail sales. They had fallen by 5.6% year-over-year in March, and in April were 6.8% below year-ago levels. Germany reports April retail sales next week. The UK reports April retail sales tomorrow. A small rise is expected after the 0.9% decline in March.

The euro has been driven to new two-month lows slightly below $1.0715. It has surpassed the (61.8%) retracement of the euro's rally from the March low ($1.0515), found near $1.0735. The momentum indicators are oversold even if they have not turned higher. Additional chart support is seen around $1.07. A close much below $1.07 will likely spur talk of a move back to the March low. Sterling posted a big outside down day yesterday by trading on both sides of Tuesday range and settling below its low. It posted its lowest settlement in more than a month and just inside its lower Bollinger Band (~$1.2355). We have been anticipating a test on the $1.2345 area, a (38.2%) retracement of sterling's rally off the May 8 low near $1.1800, which it met today with a push today to almost $1.2330 before stabilizing. The next retracement (50%) is about a cent lower. The momentum indicators are stretched, and a close above $1.2400 would help the technical tone. Still up, South Africa's central bank is expected to lift its key rate 50 bp to 8.25%, while Turkey may hold the one-week repo rate steady at 8.50%.

America

The FOMC minutes did not seem to tell investors anything they did not already know. The consensus that Chair Powell has forged has been remarkable, but it appears to be fraying as the endpoint is approached. The outlook is not as clear as the "Powell signaled a pause" consensus view would have it. That makes it seem that the bar to another hike is not so high after all. The Fed's staff continued to project a shallow recession later this year and a "moderately paced recovery." We suspect that the economy peaks this quarter around twice the pace of Q1 (1.1%) and then slows markedly in H2. In terms of interest rate expectations, there are two moving pieces. First, the odds of a June hike are around 30%. Recall that they were near 40% before Powell spoke at the end of last week. Second, the market has pared rate cut speculations. The year-end effective rate is seen near 4.83%, the highest in two months. It has risen in 12 of the past 14 sessions coming into today. The yield has risen by 17 bp in the first three sessions this week, after 26 bp last week and seven the week before. We anticipated the markets to converge toward the Fed, and that this would be dollar-positive. However, the lion's share of the interest rate adjustment may be behind us.

Today's US data is unlikely to be impactful, barring a significant surprise. Updated estimates of Q1 GDP will be noted in passing, but the focus is on Q2 and H2. Pending home sales in April may have stabilized, but the year-over-year rate shows the damage. It was 23.3% lower in March year-over-year. The KC Fed manufacturing survey and the Chicago Fed's national activity index do not draw much market attention even in the best of times. The Boston and Richmond Fed presidents (Collins and Barkin) speak today. Both are seen to be middle of the road, though neither votes this year. Tomorrow, the US reports April income, consumption, and deflators, along with trade balance, inventories, durable goods orders, and the final University of Michigan survey. Monday is a holiday, and liquidity will likely dry up after the data and Europe's close tomorrow.

The risk-off mood, captured by the gap-lower opening in the S&P 500 and the rise in US rates, may have pressured the Canadian dollar lower, even if the Australian and New Zealand dollars did not sell off so sharply. The US dollar broke out of the consolidation pattern to poke above CAD1.36 for the first time since May 4. It closed above the downtrend line we have been monitoring (drawn off the March and April highs) that came in yesterday near CAD1.3570. Follow-through dollar buying has been limited to almost CAD1.3615 today. The next important chart area is around CAD1.3650. After trying to sell its branch operations for over a year, Citibank (C) changed course and will now look to offer them in an IPO. Although the fight between the government and Grupo Mexico, which had been the suspected buyer of Citi's branch network in Mexico (~$7 billion), may have been a precipitating factor, the decision has likely been in the works. This (the absence of an outflow) and the lower-than-expected CPI for the first half of May helped the peso recoup the ground lost in the first couple days of the week. It snapped a six-day decline and posted its largest gain in two weeks (slightly more than 0.9%) yesterday. In fact, the dollar gave back (38.2%) of the gains since the May 15 low near MXN17.4205. The greenback is being sold below MXN17.76 in the European morning (the 20-day moving average is around MXN17.7640). The next retracement (50%) is near MXN17.71.

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