CAPITALDIGEST MARKET REVIEW, 22/5/2023

DOLLAR DRIFTS HIGHER AS US DEBT CEILING IN SPOTLIGHT The dollar edged higher on Tuesday in choppy trading, with no clear direction, as investors kept an eye on debt ceiling talks to avert a possible default that could reverberate across asset markets and damage confidence in the world’s largest economy. The dollar index, a measure of the greenback’s value against six major currencies, was up 0.2% on the day at 102.61 =USD. Against the yen, the greenback rose 0.2%-to-136.315-yen JPY=EBS Democratic President Joe Biden and top congressional Republican Kevin McCarthy’s U.S. debt ceiling negotiations ended on Tuesday after less than an hour, as the looming fear of an unprecedented American debt default prompted Biden to cut short an upcoming Asia trip. But the meeting ended on an upbeat and unexpected note as McCarthy, coming out of the meeting with Biden and other congressional leaders, said, “It is possible to get a deal by the end of the week.” Both parties agree on the need for urgent action. “Clearly, to the extent that there is a default risk, it would be chaotic. The question is in a default, can you have Treasuries as collateral in a world that’s highly levered?” said Axel Merk, president and chief investment officer at Merk Investments in Palo Alto, California. Historically speaking, the U.S. dollar tends to rally in times when there is financial stress and in periods of deleveraging as investors scramble to unwind risky bets. “But you don’t want Treasury bills,” Merk said. “So it’s very difficult to suggest that we would have a dollar rally in that deleveraging. I would say it’s very hard to predict what will happen other than volatility might be dramatic.” In afternoon trading, the euro slipped 0.1% versus the dollar to $1.0858 EUR=EBS, while sterling fell 0.4% to $1.2478 GBP=D3. The dollar earlier rose after U.S. retail sales rose less than expected in April, but details showed that the underlying trend remained solid. This suggested that consumer spending likely remained strong early in the second quarter. Retail sales rose 0.4% last month. Data for March was revised slightly lower to show sales dropping 0.7% instead of 0.6% as previously reported. In line with the generally upbeat economic picture, industrial production jumped 1% in April, easily topping expectations for a flat reading and up slightly from the revised 0.8% increase in March. The reports suggested that while the market widely expects the Federal Reserve to pause increasing rates at the next meeting, a hike in borrowing costs was not off the table. STERLING MAINTAINS LOSSES AFTER BAILEY SPEECH The pound slipped against a strengthening dollar on Wednesday and maintained its losses after Bank of England Governor Andrew Bailey reiterated he expected price pressures to ease, as soon as April. Speaking at the British Chambers of Commerce Global Annual Conference, Bailey said that if price pressures were to be more persistent, further tightening of policy may be required, but added there were signs the labour market was loosening a little. On Tuesday, data showed Britain’s jobless rate rose to 3.9%, while the rate of increase in total pay, including bonuses, held steady, prompting some investors to scale back their bets on further interest rate hikes. “We took a dovish view from what the Bank of England was telling us last week and thankfully the (labour market) data has confirmed that,” said Simon Harvey, head of FX analysis at Monex Europe. “While we think that conditions in the UK economy are a bit more constructive towards capital inflows, we don’t think that the improvement is so vast that you’re going to see sterling continue to outperform,” he added. The pound was last down 0.3% at $1.2440, having earlier hit a three-week low of $1.2422. Sterling was little changed at 87.01 pence per euro. The BoE has raised rates by a combined 400 basis points since it began tightening policy in late 2021, but markets are split on the central bank’s next move. Traders price in around a two-in-three chance of a 25 basis point hike at the June meeting, with around a one-in-three chance they remain on hold, according to data from Refinitiv. Much will depend on the strength of future data, with next week’s April inflation print a key input. CitiFX’s economic surprise index for the UK is holding near its highest level in almost two years, suggesting data is more upbeat compared to expectations, supporting the pound in recent weeks. But this also means the bar is higher for potential positive surprises, which analysts said could leave the pound vulnerable if data starts surprising to the downside. DOLLAR FIRMS ON DEBT CEILING OPTIMISM, AUSSIE SLIPS AFTER JOBS DATA The U.S. dollar held near a seven-week peak on Thursday after President Joe Biden and top U.S. congressional Republican Kevin McCarthy worked towards avoiding a damaging debt default, while investors scaled back Federal Reserve easing expectations. Biden and McCarthy on Wednesday underscored their determination to strike a deal soon to raise the government’s $31.4 trillion debt ceiling, having agreed a day earlier to negotiate directly after a months-long standoff. “In the short-term, the debt ceiling is win-win for the dollar,” said Viraj Patel, global macro strategist at Vanda Research. “If it gets worse, you’re going to see a global hard landing and you will want to be owning dollars. If it gets resolved, people shift their expectations for the Fed and we could see another hike,” he added. Traders are pricing in around a 20% chance that the Federal Reserve raises its interest rate at its June meeting. Around a month ago, markets were pricing in around a 20% chance of a cut. The rate traders have priced for the Fed’s December meeting stands at 4.525%, implying around 55 basis points of easing by year-end, down around 5 basis points from the day before. The dollar index firmed 0.2% to 103.08, near Wednesday’s seven-week peak of 103.12. The euro languished near the previous session’s over six-week low of $1.08105 and last bought $1.0817, while sterling fell 0.3% to $1.2450. Action in Asia was partly led by the Aussie dollar, after data on Thursday showed that Australia’s employment unexpectedly dipped in April, following two months of outsized gains. The jobless rate also ticked up in a sign the red-hot labour market might be cooling. The Aussie slipped about 0.4% after the data release and was last 0.35% lower at $0.6637, with expectations for further tightening from the Reserve Bank of Australia dampened. “Today’s employment figures in Australia may complicate any plans to hike again,” said Francesco Pesole, FX strategist at ING. STERLING HEADS FOR SECOND WEEKLY LOSS AS DOLLAR SURGES The pound was heading for its second straight weekly fall against the dollar on Friday, weighed down by a resurgent dollar and weakness in the British economy. Sterling was up 0.15% to $1.243 on Friday. It was set for a weekly loss of 0.17%, however, after falling 1.45% the previous week. The euro was up 0.08% against the pound at 86.87 pence. The dollar has risen around 2.5% since mid-April as economic data has remained strong, raising the possibility that the Federal Reserve will hike interest rates again next month. In recent days, concerns about the U.S. debt ceiling standoff has somewhat counter-intuitively boosted the dollar, which is seen as a safe-haven at times of stress. Data released on Tuesday added to the downward pressure on sterling by making it more likely that the Bank of England will hold interest rates at the current 4.5% level. It showed that British unemployment ticked up to 3.9% in the three months to March and basic pay increased 6.7%, lower than economists’ expectations in a Reuters poll. “GBPUSD has once again broken down through the massive $1.2448 level, in a move initiated by worse than expected unemployment data earlier in the week,” said Joe Tuckey, head of FX analysis at broker Argentex and a former trader. “Next week’s highly anticipated UK inflation data … will determine near term sterling sentiment.” Consumer price inflation data will be released on May 24. Nonetheless, the pound remains well above the record low of $1.0327 touched in September. A better-than-expected economic performance and a slide in the dollar as U.S. inflation has cooled has helped Britain’s currency. Sterling has held up better in recent weeks against the euro, which has also suffered against the dollar. Despite the euro’s rise on Friday it was on track to fall against the pound for the fifth week running. US DOLLAR SKIDS AS FED’S POWELL HINTS AT JUNE PAUSE, DEBT TALKS STALL The dollar fell on Friday after Federal Reserve Chair Jerome Powell struck a moderately dovish stance, contrary to market expectations, saying that given how credit conditions have tightened, the U.S. central bank may not need to raise interest rates as much. A pause in negotiations to raise the federal government’s $31.4 trillion debt ceiling also pressured the dollar. But it was Powell who caught the market by surprise. Tighter credit conditions mean that “our policy rate may not need to rise as much as it would have otherwise to achieve our goals,” Powell said at a central bank conference in Washington. The Fed chief reiterated that the central bank would now make decisions “meeting by meeting,” but also flagged that after a year of aggressive rate increases, officials can afford to make “careful assessments” of the impact of rate hikes on the economic outlook. “Powell was not overtly dovish, but he definitely was not hawkish,” said Erik Bregar, director, FX & precious metals risk management, at Silver Gold Bull in Toronto. “So you’re seeing bond market cover hawkish bets, same thing with FX. This derails upside momentum in the dollar going into the weekend.” Fed officials this week have more or less pushed against rate-pause bets for June given persistently high inflation. Following Powell’s comments, the rate futures market has priced late on Friday a roughly 16% chance that the Fed raises the benchmark rate at its June meeting by 25 basis points. The rate-hike bet was nearly 40% before the Fed chairman spoke. The dollar index fell 0.4% to 103.08, after hitting seven-week peaks the previous session. On the week, the dollar posted a 0.6% gain.