Overview: 

Some creeping optimism about the US debt ceiling, easing of pressure on bank shares, and a continued rise in US rates helped the dollar extend its recent recovery. Over the past two weeks or so, the US 2-year premium has risen 25-30 bp against Germany and nearly 25 bp against the UK.

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The 10-year US Treasury has risen from the lower end of its seven-month range (~3.30%) earlier this month to approach the upper end of the range that has prevailed since the banking stress emerged in March (~3.60%) helping lift the dollar to new highs for the year against the Japanese yen. We note that there has also been a dramatic swing in interest rate expectations for Canada and the central bank's "conditional pause" is seen ending in favor of another hike. The dollar's strength against the G10 currencies has helped lift it against the managed Chinese yuan, against which the greenback is trading a new six-month high today (CNY7.03+).

Global equities are advancing. The weakness of the yen has helped extend the rally in Japanese stocks and Hong Kong and Chinese equities stabilized after yesterday's erosion. The large bourses in region, outside of India rallied. Europe's Stoxx 600 is snapping a two-day decline and its 0.5% gain has nearly recouped those losses. US index futures are enjoying a firmer tone. Benchmark 10year bond yields are higher. European yields are 5-6 bp higher and the 10-year US Treasury yield is a couple of basis points firmer near 3.59%. Higher rates and a stronger dollar weigh on gold. It is approaching the shelf from the second half of April around $1970. A break of this area could signal a move toward $1950. June WTI rallied nearly 2.8% yesterday to about $73.25 and stalled near the 20-day moving average, which it has not closed above in nearly a month. The moving average is found by $73.15 today. US debt ceiling developments blunted the impact of the 5 mln barrel rise in US inventories, the largest in three months.

Asia Pacific

Net exports shave Japan's Q1 GDP by 0.3%, which was a larger drag than forecast. Today, Japan reported a JPY432.5 bln trade deficit in April. The trade balance almost always (17 of past 20 years) deteriorates in April from March but not this year. The March shortfall was JPY755 bln. Japan last recorded a monthly trade surplus in July 2021. Exports rose 2.6% year-over-year in April, the weakest growth since the contraction in the 12 months through February 2021. The improvement in the trade balance is due to the 2.3% fall in imports, the first decline in more than two years. In the first four months of the year, Japan recorded a trade deficit of JPY5.6 trillion (~$ 41.8bln) this year compared with JPY4.25 trillion in Jan-Apr period last year. Separately, the better-than-expected Q1 GDP and the successful G7 summit in Hiroshima may spur speculation of an early election, though Prime Minister Kishida has played down the prospects. 

Australia reported a disappointing set of data today. May consumer inflation expectations rose to 5.2% from 4.6% to snap a three-month decline, while reporting an expected loss of jobs in April. Inflation expectations are back to where they were at the end of last year. Australia's 4.3k job loss understates the weakness of today's report. It lost 27.1k full time positions. In the Q1 23, Australia created an average of nearly 39k jobs a month and they were all full-time (40k). This is slightly off the pace seen in Q1 22 (50.6k average and all full-time posts). The participation rate slipped to 66.7% in April only after March was revised to 66.8%. In April 2022, its was 66.5%. The unemployment rate rose to 3.7%. It set a record low last October at 3.4%.

The rise in US rates helped lift the dollar to new highs for the year against the yen today near JPY137.95. Remember where we are in the bigger picture. The dollar and the US 10-year yield peaked in October 21 last year (~JPY152 and 4.34%). The dollar fell to about JPY127.25 by mid-January. The previous high for the year was about JPY138 (~4.09%) before the banking stress hit. The dollar pulled back to around JPY129.65 (~3.25%) and has been trending higher since late March/early April. The JPY136.70 area was the (38.2%) retracement of the dollar's losses from last year's high. The next retracement area (61.8%) is near JPY139.60, which is reasonably close to the psychologically important, JPY140. In the middle of last week, the Australian dollar was threatening the upper end of its two-cent range around $0.6800 and now is approaching the lower end of the range near $0.6600. It is hovering near yesterday's lows (~$0.6630). It frayed the lower end of the range at the end of April, falling to $0.6575 but has not closed below $0.6600 in two months. Its broad gains helped the dollar rise to its best level against the Chinese yuan since last December. It has pushed above CNY7.03. If it were not as tightly managed, the next technical target would be near CNY7.08. The PBOC set the dollar's reference rate at CNY6.9967, about 35 pips stronger than the median projection in Bloomberg's survey. By setting the fix higher, officials appeared to send a cautionary signal to restrain the pace of the dollar's gains as the greenback is allowed to trade only 2% above the fix. Of course, rarely does it explore the band's extremes. Today, the upper band is near CNY7.1365. 

Europe

None less than Henry Kissinger has suggested that now that China is getting involved talks can begin in earnest to end the war in Ukraine. While this is clearly one scenario, there is another. Just like many in the US and Europe think Russia is overreached and now in embroiled in a new quagmire with the help of military assistance, training, intelligence, and money, Beijing may think that it could be turned into a trap for the US and Europe. Even though Ukraine was part of the Soviet Union for more than a generation, the US and Europe have cast the conflict as a key to the future of democracy and European security. Time may be on Moscow and Beijing's side, arguably, and it is not just about a war of attrition. The US general election is 18 months away. Assistance to Ukraine is likely to be a campaign issue and Trump enjoys a small lead over Biden according to recent YouGov polls. Other surveys show US public support for continued aid to Ukraine is soft (less than 40%).

Meanwhile, Hungary is threatening to block further EU financial aid to Kyiv. A 500 mln euro package is at risk. Foreign Minister Szijjarto cited three incidents that pushed Budapest in this direction: Kyiv's decision to add Hungary's largest bank to a "shame" list of companies doing business with Russia, limited educational rights of ethnic Hungarian citizens in Ukraine, and a Washington Post report that suggested Ukraine President Zelenskiy had considered blowing up a Russian pipeline that went through Ukraine to Hungary. Hungary's Prime Minister Orban's government is perceived to be Moscow's closest ally in the EU. The EU has some leverage in the form of more than 30 bln euros of funds for Hungary that have been suspended on corruption and rule of law issues. The Hungarian forint has not been punished for the government's intransigence. The forint is the second strongest emerging market currency so far this year, with an 8.3% gain. Only the Mexican peso's 10% gain has been better. It is too costly to short, with the policy rate at 13%, where it has been since the 125 bp hike last September. The three-month interbank offered rate is near 16.15%. Hungary's CPI peaked in January at 25.7%. It stood at 24% last month. The central bank meets next week (May 23) and is expected to extend pause. The swaps market has about 200 bp in cuts discounted over the next three months, which seems (too) aggressive. 

The euro made a marginal new low, slipping through $1.0810, where 1.15 bln euros of options expire today. Last month's low was set a little below $1.0790. The $1.0805 are the (50%) retracement of the euro's gains from the mid-March low (~$1.0515). The next retracement (61.8%) is around $1.0735. Watch the five-day moving average (~$1.0845). The euro has not closed above it is May 5. A close above it could be a preliminary sign that the downside pressure is waning. The euro peaked on April 26 a little below $1.11. Sterling recovered yesterday from almost $1.2420 and settled near $1.2485. However, today, it has spent little time above $1.2490 and is approaching yesterday's lows in the European morning. A break of $1.2400 may spur a move toward $1.2345, the (38.2%) retracement of its rally from March 8 (~$1.1805). The low from the second half of April was set near $1.2355.

America

Many observers continue blame the Fed's monetary policy for the banking stress and the fact that two of the largest bank failures happened recently. Leave aside the fact that only a handful of the more than 4100 US banks were unable to manage the adverse conditions. Leave aside the fact that the authorities took specific actions in 2008-2009 to support the large banks to prevent them from failing. The regional and large bank share indices posted their biggest gains since the stress first emerged a couple of months ago. The KBW index for regional banks rallied 7.3% yesterday, the most since early 2020. The KBW index of large banks rallied slightly more than 5% yesterday. Both reached their best levels since May 1. Two-year US Treasury yields rose for the fourth consecutive session and reached nearly 4.16%, its highest rate since April 21. The benchmark 10-year rate approached 3.60%, on the back of a four-day advance, a two-and-a-half week high. At the same time, the Fed fund futures now ascribe a nearly 20% chance to a Fed hike in June. Earlier this month, a small chance of a cut was priced in, and as recently as last Wednesday and Thursday, it was perceived to be virtually no chance of a hike. 

Mexico's central bank meets this afternoon. The governor indicated a pause would be discussed, and many think it will stand pat now. In Bloomberg's survey with 23 respondents, all but five expected it to leave the overnight target at 11.25%. Mexico's inflation has been trending lower. The headline rate peaked in August-September 2022 at 8.70% and was at 6.25% in April, the slowest since October 2021. The decline in the core rate, which Governor Rodriquez noted, has been somewhat less impressive. It peaked last November at 8.51% and stood at 7.67% in April. It is the lowest since last July. The peso has been on fire. It was the second strongest currency in the world last year, rising nearly 5.3% against the US dollar (Brazil's real was up 5.6%). As noted above, it is the strongest this year (~10%). The appeal of the peso is a function of its high interest rates and low volatility, which facilitates carry-strategies. It is also benefitting from the near-shoring, friend-shoring meme, which draws direct investment inflows (which, according to reports includes Chinese companies). In peso terms, the Bolsa is up almost 14% this year (the MSCI Emerging Market Index is up almost 2.5%). In addition, worker remittances easily cover the trade deficit. Last year, the average monthly trade deficit was about $375 mln and worker remittances averaged almost $4.9 bln. The respective numbers through Q1 are $1.6 bln (average trade deficit) and $4.65 bln (remittances). A large US bank is selling its Mexican branches, and although it has been in the works for some time, reports suggest a deal is close. 

There has been a significant re-pricing of Canada's interest rates. The two-year yield has rising today for the fourth straight session. Over this span, the yield has risen from 3.73% to 4.05%. The market is pricing in about a 1-in-3 chance of a hike at the June 7 meeting and a hike is nearly fully discounted by the end of Q3. The broad strength of the greenback has muted the impact on the Canadian dollar. Still, over the past five days, it is the only G10 currency that has not fallen against it. Sterling is the second-best performer, off about 0.6%. The Canadian dollar is trading softer today, with the greenback consolidating over the CAD1.3455 settlement. Yesterday's high was near CAD1.3535. At the start of the week, the US dollar fell to its lowest level against the peso since 2016. It is poised to post its fifth consecutive monthly decline. The upward pressure on the peso have been persistent and the market positioning is extended according to portfolio manager surveys. Speculators (non-commercials) in the futures market have their largest net long position (~70k contracts, MXN500k per for a notional value of almost $2 bln) in three years. Broad US dollar gains and some position adjusting ahead of the outcome of today's central bank meeting is lifting the dollar for the third consecutive session, the longest advance in a little over a month. A technical retracement of just this month's dollar losses would bring the greenback to MXN17.80-90. A technical retracement of the dollar's losses since the squeeze higher in March amid the bank-stress spurred risk of could see MXN18.11-MXN18.30.

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