US Dollar in defensive mood - armour chest plate

US Dollar in defensive mood after jobs data: Spotlight is on Fed. Photo by Nik Shuliahin 💛💙 on Unsplash

US Dollar in defensive mood after jobs data: Spotlight is on Fed

The US Dollar in defensive mood on Wednesday, with investors expecting a hike in U.S. interest rates later in the day, but unsure how long the Federal Reserve will keep policy tight.

US Dollar in defensive mood - armour chest plate

US Dollar in defensive mood after jobs data: Spotlight is on Fed. Photo by Nik Shuliahin 💛💙 on Unsplash

Reuters: The US Dollar in defensive mood on Wednesday, with investors expecting a hike in U.S. interest rates later in the day, but unsure how long the Federal Reserve will keep policy tight considering the latest gloomy jobs data and U.S. debt ceiling and banking sector risks.

US Dollar in defensive mood

U.S. job openings fell for a third straight month in March and layoffs increased to the highest in more than two years, data showed on Tuesday, offering some hope that the softening in the labour market could aid the Fed’s fight against inflation. The dollar index , which measures the U.S. currency against six rivals, fell 0.128% to 101.710, after sliding 0.245% on Tuesday. The Fed is widely expected to raise interest rates by 25 basis points when it concludes a two-day meeting on Wednesday and investor focus will be on whether the Fed hints at a pause or further tightening.

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Bank of Singapore currency strategist Moh Siong Sim said markets are expecting rate cuts towards the end of the year due to the stress in the U.S. banking system. But, Moh reckoned the Fed might seek to downplay the prospect for lower rates as data is showing that while “the U.S. economy is slowing, it is not slowing fast enough to bring inflation back to the 2% target.” The Fed’s meeting comes as U.S financial markets are reeling from the weekend failure of San Francisco-based First Republic Bank as well as worries that the government could run out of cash after June 1 without a debt ceiling hike. The yield on 10-year Treasury notes slid 13.3 basis points to 3.440% on Tuesday, while the yield on the 30-year Treasury bond dropped 8.5 basis points. With Japan closed for holiday, cash Treasuries were untraded Wednesday.

Blerina Uruci, chief U.S. economist at T. Rowe Price, said the Fed is unlikely to be ready to declare the end of tightening for this cycle and run the risk of the data forcing its hand to make a U-turn. “Banking sector stress is a factor that will come under consideration, but the Fed will likely conclude that a combination of the market measures announced so far and a well-capitalized banking sector will give it the needed room to pursue bringing inflation down to its 2% target.” Meanwhile, the euro firmed 0.23% to $1.1024 after rising 0.2% overnight ahead of the European Central Bank’s regular policy meeting on Thursday. Data on Tuesday showed euro zone inflation accelerated last month but underlying price growth eased unexpectedly, adding to arguments for a smaller interest rate hike from the ECB.

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According to pricing in derivatives markets, traders think there is roughly an 85% chance of a 25 bp ECB hike on Thursday, and a 15% chance of 50 bps. Ryota Abe, an economist in global markets and treasury department at Sumitomo Mitsui Banking Corporation, said markets have priced in more rate hikes in the euro area than in the United States. “If the difference in rates between the two regions become clearer, DXY may fall below the 100 mark.” Elsewhere, the Australian dollar rose 0.11% to $0.667, a day after the Reserve Bank of Australia surprised markets by lifting the cash rate to 3.85% and said further tightening may be required to tame inflation. The kiwi rose 0.40% to $0.623, while sterling was last trading at $1.249, up 0.21% on the day. The Japanese yen strengthened 0.40% to 136.01 per dollar, clawing back some of its losses from last week when the Bank of Japan stuck to its ultra-loose monetary policy.

British Pound

Reuters: The pound fell on Tuesday, ignoring data highlighting a few bright spots in Britain’s economy, as investors focused more closely on the outlook for UK rates relative to others, after the Reserve Bank of Australia delivered a surprise hike. Sterling slipped by 0.3% against the dollar to $1.2457 and by 0.1% versus the euro to 87.91 pence. Against the Australian dollar, it dropped as much as 0.6% after the RBA stunned markets with a quarter-point rate rise overnight and said it may have to raise again as inflation is still far too high. Separate data releases on Tuesday showed British factory output and new orders contracted at the start of the second quarter of 2023, but manufacturers were more optimistic and input costs rose at the weakest rate since May 2020. Meanwhile, the British Retail Consortium said food prices staged their largest annual increase on record in April, but this could mark a peak, while mortgage lender Nationwide said UK house prices rose last month, breaking seven straight months of declines.

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With the Federal Reserve and the European Central Bank meeting this week to discuss policy, activity in sterling could be fairly muted, analysts said. “It looks like sterling will take a back seat to events in the U.S. and euro zone this week. The market has settled on pricing a 25-bp Bank of England hike to 4.50% on 11 May – with which we agree,” ING strategist Chris Turner said. “The market also prices the Bank Rate close to the 4.90% area by November, a view with which we disagree,” he added. The BoE meets next week. Money markets show traders fully expect another quarter-point rise to 4.50% and then again to a peak of close to 4.90% by November, a view that ING’s Turner said the bank did not agree with.

Sterling is vying with the Swiss franc for the title of best-performing major currency against the dollar this year – both show a gain of about 3%. But this has largely been a function of quite how badly the pound was ground down last year. In April, speculators made the biggest addition to their bullish bets on the pound in almost two years, according to data from the Commodity Futures Trading Commission. Investors now hold a long position in sterling worth $453 million, compared with a short position worth $6.3 billion a little over a year ago. Asset managers in particular, have been eroding their bearish position in sterling almost uninterruptedly since September, when sterling hit a record low against the dollar, according to CFTC data.

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South African Rand

Reuters: South Africa’s rand slipped on Tuesday, with market attention this week likely to hinge on a local purchasing managers’ index survey and a U.S. Federal Reserve interest rate meeting. At 1525 GMT, the rand traded at 18.4925 against the dollar, around 0.56% weaker than its previous close. The U.S. currency was last down about 0.12% against a basket of currencies. PMI surveys for the manufacturing sector and whole economy give investors further insight into the health of Africa’s most industrialised economy. South African manufacturing activity contracted again in April but less than in February and March, helped by companies building up inventories, a survey showed on Tuesday.

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Investors will now turn their focus to an S&P Global PMI survey due on Thursday. Meanwhile, the Fed is expected to deliver another 25 basis point rate hike on Wednesday. Investors will focus on whether the U.S. central bank indicates that it expects to pause rate increases after May, or if it keeps alive the possibility of another hike in June or later. Shares on the Johannesburg Stock Exchange fell, with the broader-all share index closing down 0.88% and the blue-chip Top-40 index ending 0.96% lower. South Africa’s benchmark 2030 government bond was slightly weaker, with the yield down 1.5 basis points to 10.195%.

Global Markets

Reuters: Asia’s stock markets fell in thin trade on Wednesday, as investors contended with signs of a softening U.S. economy, and were in full flight from U.S. regional lenders, ahead of an expected U.S. interest rate hike later in the day. Holidays closed markets in China and Japan. Hong Kong’s stock exchange was open and dropping, dragging MSCI’s broadest index of Asia-Pacific shares, ex-Japan, down 1%. Tumbling regional bank stocks weighed on Wall Street, and oil was also left nursing large losses with fears that banks tightening up on lending along with a slowing job market were harbingers of a looming broader slowdown. Bonds and gold held gains. The dollar, slipping, was caught in the crosswinds of falling yields and rising nerves. S&P 500 futures edged up 0.1%; European futures rose 0.5%, but the mood was cautious with banks in the crosshairs.

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On Tuesday, U.S. regionals were hammered, with PacWest Bancorp down 27.8%, Western Alliance Bancorp, down 15.1% and Comerica Inc down 12.4%. “Short sellers, it seems, have gone to town, and as any equity trader will attest, when you know there is a wall of sellers out there, you stand aside,” said Chris Weston, head of research at brokerage Pepperstone in Melbourne. After the failures of Silicon Valley Bank and Signature Bank in March, the collapse of First Republic over the weekend has confidence in smaller lenders flagging and investors more broadly bracing for banks to tighten up lending in response. In Europe, where the crisis of confidence forced Credit Suisse into the arms of larger rival UBS six weeks ago, banks are sharply turning off the credit taps, data on Tuesday showed, perhaps making a case for a smaller rate hike this week.

“This reinforces the idea of 25bps from the ECB this week rather than 50bps,” said NatWest Markets’ rates strategist Jan Nevruzi. “And also plants the seed in our mind that if that is what happened in Europe, it could be much worse here in the U.S.” Markets are all but certain the Federal Reserve will announce a 25 bp hike at 1800 GMT. If that happens, focus will be on whether or how hard Fed Chair Jerome Powell pushes back on investors’ expectations for rate cuts by year’s end. “The hike will be a contemplative one that acknowledges heightened two-way risks and narrower path to a soft-landing,” said Vishnu Varathan, head of economics at Mizuho Bank in Singapore. Currency markets were steady and awaiting direction from the Fed, save for the New Zealand dollar which rose about 0.6% to a three-week high of $0.6242 after strong jobs data fuelled expectations of another rate hike later this month.

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The Australian dollar has given back some of the ground gained on Tuesday, following a surprise rate hike from the central bank, and sat at $0.6664. The euro nudged 0.2% higher to $1.1023, while the yen took a breather as Japan entered its ‘Golden Week’ holiday season, and rose about 0.4% to 136.02 per dollar. Brent crude , which dropped 5% overnight, sat at $75.29 a barrel. Gold hovered above $2,000 an ounce. Cash Treasuries went untraded owing to the holiday in Tokyo, leaving two-year yields down 16 bps overnight to 3.9737% and 10-year yields at 3.4352%. Investors have a wary eye on the looming U.S. debt ceiling, with lawmakers squabbling and Treasury Secretary Janet Yellen warning the government might run out of money as soon as June 1.

Yields on Treasury bills maturing around then have spiked. “Either this game is over within a few weeks or we are going to see a suspension of the debt limit until later this year,” said Rabobank strategist Philip Marey. “In both cases, we are not likely to see any solution until financial markets start to panic.”

Published by the Mercury Team on 3 May 2023

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