Market Brief: US Exceptionalism Fades, Weighing On Greenback

CalendarMay 10, 2024

The “US exceptionalism” trade took another blow yesterday morning when the Bureau of Labor Statistics said the number of Americans filing initial applications for unemployment benefits rose last week to an eight-month high. The jump in jobless claims - up 22,000 to a seasonally-adjusted 231,000 in the week ended May 4 - surprised economists and helped bolster expectations for rate cuts from the Federal Reserve, helping erode the dollar’s yield premium and lift other currencies in relative terms.

Softness in the labour market dovetails with our belief that re-acceleration hopes for the economy have become overblown, and we think that expected growth and rate differentials between the US and other countries could narrow further over the coming months. But seasonal adjustment factors may be playing havoc with the data: as Bloomberg’s Jarrell Dillard observed, more than half of the gain came from New York, where “public schools were on spring recess” allowing school workers to apply for temporary benefits. Next week’s consumer and producer price indices - as well as the critical April retail sales report - should provide far more meaningful insight into how conditions are evolving in the US economy.

Data out this morning showed growth in the British economy accelerating by far more than forecast in the first quarter. Gross domestic product climbed 0.4 percent in March, marking a 0.6-percent expansion in the first three months of the year as retail sales and business investment powered the economy out of last year’s mild downturn. The pound inched higher even as easing expectations for the Bank of England’s next meeting remained undimmed, with markets assigning roughly coin-toss odds to a move. In yesterday’s post-decision press conference, Governor Bailey said a rate cut in June was “neither ruled out, nor a fait accompli” and investors are largely in agreement.

The Mexican peso is holding territory gained after central bankers left policy settings unchanged yesterday, knocking out any remaining bets on a second consecutive rate cut. Officials at the Banxico, as the central bank is known, voted unanimously to hold the benchmark rate at 11 percent, with upgraded inflation forecasts and a steadfastly cautious statement helping to dampen easing expectations in markets. In a radio interview that aired after the decision, Governor Victoria Rodriguez Ceja said “Headline and core inflation are currently at levels visibly lower than what we saw in 2022 and early 2023,” while warning that services inflation had been far more persistent than expected, making it difficult to provide firm forward guidance on upcoming decisions. Odds on a 25 basis-point cut at the June meeting have fallen, but two moves are still priced into the back half of the year, suggesting that markets expect the government’s fiscal spending efforts to slow after the presidential election, helping ease price pressures.

Ahead of this morning’s Canadian jobs report, yield differentials between US and Canadian government bonds suggest that the central bank “divergence” trade may have peaked in mid April. The Bank of Canada is seen cutting rates more sharply over the coming year, with the policy rate declining almost 90 basis points relative to a 75 basis point fall in the Fed Funds rate, but the greenback is expected to maintain a healthy yield premium over the loonie across all time horizons. The gap in two- and five-year yields - typically more important for driving currency market outcomes - has narrowed in recent weeks as US data has softened. To put it more bluntly: a more aggressive easing campaign by the Bank of Canada has been priced in for a while, and is very likely fully incorporated in the current exchange rate. Incoming data - like today’s employment print - will determine whether this gap in expectations remains intact, widens further, or begins to shrink.

China’s renminbi is drifting lower ahead of an expected increase in tariffs from the Biden administration. As soon as next week, President Biden is expected to follow his predecessor in announcing new taxes on Americans buying Chinese-made steel, aluminum, electric vehicles, batteries, and solar cells. As with President Trump’s earlier efforts, we suspect this won’t materially impact Chinese trade surpluses: the country’s exports of industrial metals to the US are extremely small, its electric vehicles are already essentially locked out of American markets by auto tariffs, and other manufacturers are well practised in evading existing trade sanctions by routing products through third countries. An examination of trade imbalances in countries like Vietnam and Mexico shows that trade deficits with China have risen in proportion to trade surpluses with the United States, suggesting that a relatively small share of value-added work is happening domestically. And research from the Bank for International Settlements indicates that supply chains have generally lengthened, but have not diversified in recent years, implying that China remains the ultimate source for a significant share of US imports.

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Karl Schamotta

Karl Schamotta

Chief Market Strategist

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