Market Briefing: Falling Rate Expectations Snap Dollar's Momentum

Equity futures and risk-sensitive currencies rose slightly last night after the US Senate passed compromise legislation designed to raise the debt ceiling. The ironically-named Fiscal Responsibility Act, which moved through the voting process with extraordinary speed, will suspend the statutory limit on federal borrowing until January 2024, averting a possible default without imposing major constraints on government spending. The measure is now headed to the president for signature.

But the real action came earlier in the day, when a series of data releases combined with increasingly-dovish Federal Reserve rhetoric to put Treasury yields and the dollar under pressure. Following Wednesday’s comments from Fed vice chair Philip Peterson, who said “skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming,” the Institute for Supply Management reported its manufacturing purchasing manager index fell to 46.9 in May from 47.1 in April - the seventh consecutive month below the 50-mark that separates expansion from contraction. More worrying signals were evident below the headline, with new orders falling for a ninth straight month and overall order backlogs hitting the lowest levels since 2009. Philadelphia Fed President Patrick Harker later dropped the hammer, saying “It's time to at least hit the stop button for one meeting and see how it goes”.

Market-implied odds on a move at the June meeting tumbled from two-in-three to less than one-in-three, and slid across the front end of the curve. Investors are now positioned for a skip, hike, pause, and pivot by year end, and we’re looking forward to seeing the Toosie Slide added to the expected policy sequence.

This leaves the dollar on the verge of snapping a three-week winning streak going into the May payrolls report. To our knowledge, forecasts for the number of jobs created fall within a range between 100,000 and 250,000, with the median estimate near the 175,000 mark - and most economists think the unemployment rate will tick up to 3.5 percent from April’s 53-year low at 3.4 percent. A stronger-than-anticipated number could anchor rate expectations back upward, but we think Jerome Powell and Jefferson have succeeded in convincing markets of the merits of a pause, and investors will now focus on July as the next likely hike.

In contrast, the Canadian dollar is holding gains achieved during yesterday’s session, with rising monetary tightening odds intersecting with broad-based greenback weakness to push the exchange rate pair through stubborn resistance around the 1.35 mark. Although we still think caution is warranted, investors are increasingly convinced Canadian policymakers will respond to stronger-than-anticipated signs of economic momentum by delivering a final hike at Wednesday’s meeting - and there are certainly good arguments for doing so. Household spending, housing market activity, and inflation have all surprised to the upside in recent months, defying expectations for a debt-driven slowdown.

Also next week, the Institute for Supply Management’s services index is seen rising to 53.0 in May from April’s 51.9 as consumers increased spending on leisure and hospitality. The Reserve Bank of Australia is expected to deliver a hawkish hold, with growing weakness in retail sales and the housing market acting to reduce the monetary tightening impulse. A final revision in estimates for first quarter euro area gross domestic product - which could see the economy edge closer to technical recession after a negative print in fourth quarter 2022 - is likely to leave markets unmoved. But China’s aggregate financing data (timing unknown) could prove more meaningful, illustrating the degree to which government stimulus efforts are needed to prop up private demand.

Upcoming Events

FRIDAY

USD Non-Farm Payrolls, May

USD    Unemployment Rate, May

USD    Labor Force Participation Rate, May

USD    Baker Hughes Weekly Rig Count

SUNDAY

CNY    Caixin China Purchasing Manager Index Services, May

CNY    Caixin China Purchasing Manager Index Composite, May

MONDAY

EUR    S&P Global Eurozone Composite Purchasing Manager Index, May Final

USD    S&P Global US Composite Purchasing Manager Index, May Final

TUESDAY

CNY    Trade Balance, May

AUD    Reserve Bank of Australia Rate Decision

AUD    Gross Domestic Product, Q1

WEDNESDAY

USD    Trade Balance, April

CAD    Bank of Canada Rate Decision

USD    Department of Energy Weekly Inventories

THURSDAY

CNY    Aggregate Financing, May

MXN    Consumer Price Index, May

MXN    Bi-Weekly Consumer Price Index

USD    Weekly Jobless Claims

FRIDAY

CAD    Employment, May

USD    Baker Hughes Weekly Rig Count