Dollar Moves Handcuffed To Fed Talk

Tuesday May 24: Five things the markets are talking about

With “hawkish” Fed rhetoric remaining equities biggest hurdle, coupled with ‘little’ new U.S economic data, the end of the North American earnings season, and significant event risk in the coming month has investor sentiment shifting cautiously in favor of “wait and see.”

This approach continues to have a profound effect on forex trading ranges. Again this morning, the “big” dollar seems confined against most of its major pairs as we head to the open stateside, with the notable exception of the yen (¥109.53) and the pound (£1.4605).

Due to a lack of decisive trading cues, investors are shifting attention to U.S. May jobs data due June 3 and Fed chairwoman Janet Yellen’s speech on June 6.

1. Japan’s Aso repeats intervention pledge

Last weekend’s G7 finance leaders’ meeting did not yield any surprises ahead of this week’s upcoming leader summit. Naturally, finance officials discussed some of the most pressing issues in the financial system – reliance on negative interest rates, need for FX stability, and risks related to Brexit.

Friction between Japan and U.S on FX was particularly notable – Japan’s Finance Minister Aso described the recent spike in yen as a “disorderly” move that leaves the door open to government intervention, while U.S Treasury Secretary Lew suggested the “volatility was normal and not disorderly.”

Overnight, Aso tried to deflect the criticism on FX from U.S Treasury’s Lew, noting different countries will have various views on the FX market, but reiterated that Japan has “no” intention to further lower FX. He also said he should generally tone down his remarks on FX going forward. The yen has since appreciated on his comments.

2. Fed rhetoric heats up

U.S Fed officials continue to ‘jawbone’ the market to be prepared for more rate hikes, perhaps as early as next month.

On the weekend, Boston Fed’s Rosengren (voter) said that most of the conditions for more rate hikes that were laid out in the FOMC minutes seem to be on the verge of broadly being met.

Yesterday, San Francisco Fed’s Williams said it would be a good idea to raise rates with inflation below target, due to the lag in policy impact, and warned that the Fed sets policy based on the direction inflation is headed, not where it is now.

And overnight, Philly Fed President Harker (hawkish non-voter) called for two to three rate hikes by the FOMC this year in response to expected acceleration in wage growth and inflation along with improvement in U.S Q2 GDP.

Bond prices are little changed, but short rates continue to edge higher once again and flatten the U.S yield curve.

3. Brexit odds change

Sterling (£1.4585) has extended its Euro session gains after another opinion poll gives further evidence of declining risk of a vote to exit the E.U in a U.K. referendum on June 23.

The latest Brexit ORB/Daily Telegraph poll has opened up a double-digit lead for the ‘stay’ campaign: +55% in favor of remaining in the E.U, while +42% is in favor of leaving.

The pound has traded up +0.8% to hit an intraday high of $1.4602, while EUR/GBP fell -1% to €0.7667. Rate differentials continue to put pressure on the EUR.

Sterling does not seem to be directly impacted by BoE policy maker’s testimony before U.K. lawmakers this morning, who warn a Brexit would have a material negative impact on “growth and inflation.”

4. U.S yield curve flattens further

The yield on the benchmark U.S 10-year has backed up to +1.842% ahead of the U.S open, while 2-year yield rallies +8bps to +0.91%.

Dealers expect short-term Treasury yields to continue to rise as investors reposition their portfolios for the Fed’s recent hawkish tone.

Longer U.S dated maturities (10-years and beyond) are expected to remain better bid, as the global “disinflationary” environment remains favourable for long-term maturities.

In this scenario, in demand debt (10’s and 30-years) will lead to longer-term yields to remain subdued, which would lead the yield curve to flatten further (2/10’s – 93bps).

5. Crude dips on stronger dollar

Ahead of the U.S open, WTI delivery in July trades at $47.90, down -$0.18, while July Brent crude fell -$0.30 to $48.63 a barrel.

Expect investors to take their cue from today’s data from the American Petroleum Institute (API). Estimates expect Cushing oil stocks to have dropped by almost -1m barrels w/w.

On the flip side, outside of the U.S., the supply picture is stronger, with Canada’s oil sands production expected to resume shortly after wildfires shut down several sites. However, there is an ongoing strike by French oil workers, which could dent global supply.

For the crude ‘bear,’ their sights are firmly set on OPEC and its production quotas. The June 2 OPEC summit in Vienna is expected to leave the status quo in place. With Iran still ramping production higher and the Saudi’s determined to continue competing for market share the world will remain awash with the “black stuff.”

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