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FX Update: Difficult terrain for USD ahead on US debt ceiling crunch time.

Forex
Picture of John Hardy
John Hardy

Head of FX Strategy

Summary:  Difficult terrain lies ahead for US dollar traders as the US debt ceiling issue nears crunch time, possibly as soon as early June. Elsewhere, a lower than expected Q1 CPI number knocks NZD lower, while the RBA is set for major structural changes that will bring its structure and meeting frequency in line with global peers.


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Today's Global Market Quick Take: Europe from the Saxo Strategy Team

FX Trading focus: A difficult terrain ahead as debt ceiling crunch time approaches. RBA set for big structural changes.

The House Republicans came up with a complete non-starter of a budget bill that Senate Democrats will never pass, much less the veto-holding Biden administration. The bill looks to raise the debt limit by $1.5 trillion and reduce some $130 billion in spending next year, including axing many of the Biden administration’s hallmark initiatives, like canceling student debt and some of the climate- related programs (although details can be hammered out later). House speaker McCarthy claimed that the bill could save the government $4.5 trillion over the next decade. The House Republicans would have to show extreme discipline to get it passed even in the house as it can’t pass if they lose more than four votes from 222 possible.

What to do with the US dollar then? On the one hand, liquidity headwinds lie ahead and threaten risk sentiment headwinds and possibly USD upside. These come from the Fed continuing its QT while the US Treasury is set to drive a net liquidity drain from here. (Backgrounder: US treasury has been providing extensive liquidity as it drained hundreds of billions of USD from its account at the Fed. That account has now dwindled to about as low as it can go now, stopping that source of liquidity for now. And once the debt limit issue is cleared, the Treasury will set about rebuilding the account by hundreds of billions, driving even tighter liquidity.) But if the Biden administration and Congressional Republicans play a game of brinksmanship, it’s hard to imagine that process as a USD positive and will keep the Fed in a cautious stance. The situation could come to a head as soon as early June because of weaker than expected tax revenues, while otherwise late July has been considered the more likely pinch point at which time the US Treasury runs out of room with its special maneuvers. If sanity prevails and a handful of Republican House members cross the line, the issue can be avoided until possibly 2025, if the “Problem Solvers” caucus discussed in this article can get an alternative passed.

Sterling failed to get much out of yesterday’s hot CPI print, even as 2-year UK swap rates jumped 15 basis points on the news. GBPUSD couldn’t convincingly challenge the 1.2500 resistance again despite the yield spread widening to new extremes for the cycle. At present, the market is pricing BoE rates to be 25 basis points above Fed rates by year end. This is already difficult to swallow, much less any significant extension of the difference. Driving GBPUSD more than a figure or so higher at this point in the cycle would likely require some major US debt-limit related incident requiring eventual Fed liquidity injection. Expecting sterling to ramp higher because the BoE is finally getting more inflation-fighting religion is far less likely. EURGBP is back in the middle of the range it has traded within all year – still a non-story, though upside is likely the side of least resistance. GBPNOK has my contrarian warning lights flashing…

Chart: AUDNZD
While we await for something to give in either direction in the major USD pairs, the relative merits of AUD and NZD are worth consideration here after the kiwi was knocked lower in the wake of a lower than expected inflation number for Q1 at 1.2% QoQ and 6.7% YoY vs. 1.5%/6.9% expected, respectively and vs. 7.2% the prior quarter. This capped NZ yields and lowers the odds of a May rate hike from the RBNZ. From here, if inflation reheats, the RBA will have more work to do than the RBNZ to fight inflation. Meanwhile, an economic slowdown scenario would leave. With China’s economic activity picking up is normally an added potential benefit for the Aussie, although the key commodity prices coincident to that story are not offering much support to that story. See below for more on the RBA, which is set for a changed structure and meeting frequency that brings it into line with global peers. Next steps for firmly shifting focus back to the upside would be clearing the 200-day moving average and 1.1000 area.

20_04_2023_JJH_Update_01
Source: Saxo Group

Big changes ahead for the RBA: Following an independent review of the RBA ordered by the Australian government, sweeping recommendations for change were handed down today. Among these are that the RBA should create a new monetary policy board and meet less frequently (eight meetings per year, down from eleven), in better alignment with international counterparts. These were just some of the recommendations and were “welcomed” by the RBA. The report criticized the RBA’s board composition, which includes one economist and six independent directors who are mainly from business. The recommendations include a dilution of the Governor’s powers as more economist expertise would be brought onto the board. The changes could start from July 2024 and see the RBA governor speaking at a press conference after policy meetings. Current Governor Lowe’s term expires in September.

The Fed Beige Book released late yesterday suggests the US economy is in a holding pattern, with Fed observers claiming that consumer spending was flat to down slightly, while wage growth showed som moderation, while increasing slack in the labor market (evident in the recent rise in jobless claims) was also noted. A moderation of price increases was noted, while “several districts noted that banks tightened lending standards amid increased uncertainty and concerns about liquidity”. The banks reporting thus far show no general patterns of suffering deposit flight, though they may have compete more for retaining deposits than previously, and this will tighten the screws on overall credit growth.

Today’s Philly Fed worth watching: after the stunning April Empire Manufacturing survey, which came in at a stunning +10.8 versus expectations for –18 and –24.6 in March, it is worth watching today’s Philly Fed. More positive surprises in the regional surveys leading up to tomorrow’s preliminary S&P Global Apr. US Manufacturing PMI and the BLM’s ISM Manufacturing survey the week after next might indicate something is afoot in the US manufacturing sector. If so, is it the beginning of a turnaround due to huge announced investments in manufacturing that have been encouraged by the most sweeping US industrial policy initiatives since the second World War, including the Inflation Reduction Act and the CHIPS and Science Act? The setup for today’s April Philadelphia Fed survey is similar to the Empire number, with expectations for a reading of –19.3 after –23.2 in March. If the number comes in as weak as expected, then there is no corroboration of the Empire survey number, but if it swings into positive territory after the deepening negative prints in the last several months, it may point to a major reversal in the outlook for US manufacturing.

Table: FX Board of G10 and CNH trend evolution and strength.
NZD and especially NOK weakness worth noting, but CAD has also lost a lot of altitude here over the last couple of sessions as oil prices corrected lower. On the plus side, the Swiss franc continues its serene strength.

20_04_2023_JJH_Update_02
Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Note that EURCHF is approaching a pivot low near 0.9800, the low area since the zany swings during the March banking turmoil. USDCAD is trying to cement the reversal of the attempt through the 1.3400 area and 200-day moving average. Elsewhere, my contrarian pick for the next three months has to be GBPNOK, which just look so absurdly extended.

20_04_2023_JJH_Update_03
Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights

  • 1230 – US Weekly Initial Jobless Claims
  • 1230 – US Philadelphia Fed Survey
  • 1400 – US Mar. Existing Home Sales
  • 1400 – Eurozone Apr. Flash Consumer Confidence
  • 1530 – Bank of Canada’s Macklem and Rogers to epsak 
  • 1600 – US Fed’s Waller (Voter) to speak
  • 1620 – US Fed’s Mester (Non-voter) to speak
  • 1900 – US Fed’s Bowman and Logan (both voters) in Fed Listens event
  • 2015 – ECB's Schnabel to speak
  • 2301 – UK Mar. GfK Consumer Confidence
  • 2330 – Japan National CPI
  • 2345 – US Fed’s Harker (Voter 2023) to speak on economic outlook

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