Twixt ceilings for debt and the Fed
The market has widened the spread
Of rates here at home
Despite what Jerome
Last weekend ostensibly said
Thus, dollars remain to the fore
As traders want so many more
The megacaps rise
But in a surprise
There’s less and less talk of the war
The debt ceiling negotiations remain at the top of the market’s list of concerns as the ostensible X-date of June 1stapproaches. Certainly, the positive aspect is that both sides are talking as opposed to merely grandstanding, but as is always the case in a political standoff with a non-political impact, it is clear no deal will be reached until the Nth hour. The other thing to remember is that the June 1st date is not a hard deadline, it is the current estimate by Secretary Yellen and subject to change. In the end, nothing has changed my view that a deal will be reached as both sides desperately want one, but also, no deal will be reached until both sides can explain to their supporters that they did everything possible to achieve their agendas.
However, this process is clearly having an impact on the markets, especially in the interest rate space as we have seen 10-year Treasury yields, which are higher today by 3.3bps, rise 36 basis points in the past two weeks. In addition, the yield curve inversion, which at one point had fallen to as low as -41bps, is back to a -64bp difference. Not only that, but the 4-week T-bill, the nearest expiry past the X-date, is now yielding 5.47%, far above Fed funds and the highest spot on the yield curve. That is clearly a direct response to fears over a possible default. My sense is this process will go on right through Memorial Day and US interest rates may well have further to rise between now and then.
But this begs the question, are US rates dragging up rates around the world? I would argue the answer is yes. Looking at European sovereigns, which have all seen yields rise by around 3bps-4bps today (Gilts are actually +8bps), they have all risen in concert with Treasury yields. During the same time frame that Treasuries rose 36bps, Bunds are +28bps, OATS +25bps and Gilts +43bps. Yet during that period, the dollar has gained more than 1% vs. both the euro and the pound (and all the other G10 currencies as well).
Perhaps what we are seeing is a new safe haven asset being born, the US megacap tech stock. The likes of Apple, Microsoft and Alphabet have seen steady strength, helping to drive the NASDAQ 100 Index up nearly 5% during this same two-week period. In fact, a quick look at YTD performance in US equity markets shows that the Dow Jones Industrials are +0.4% YTD while the NASDAQ is up 21.5%. In the past, there was a concept during bouts of USD strength that investors were buying dollars to buy Treasuries. I think right now investors are buying dollars to buy Apple! In fairness, one can see the premise as regardless of the debt ceiling outcome or timing, the belief that Apple (or Microsoft or Alphabet) shares will react to that news rather than their own positive stories generates no concerns.
Of course, those names are the exceptions to the rule as the bulk of the rest of the market has been under pressure recently on the back of all the catastrophic predictions if the debt ceiling isn’t raised and the US defaults on its debt. This can be seen in the fact that the other major indices have seen almost no movement, just sideways trading, during the recent period in question.
Turning to the Fed, it appears that we are reaching an inflection point in the tightening process, or at least in the rate hiking cycle. While prior to the last FOMC meeting, virtually every speaker was on the same message, we are starting to see some differences. Most importantly, Powell, last weekend, hinted that there was some concern that the continued rate hikes were starting to impact financial stability (seriously, after 4 major bank failures it is now a concern?). But the implication is that while inflation remains job number one, there are other issues on the agenda. That seems to be the dovishness that was attributed to Powell over the weekend.
Meanwhile, yesterday we heard from two regional Fed presidents. James Bullard from St Louis, who said that he saw at least two more rate hikes (50bps total) as necessary to be certain they have slain the inflation dragon. As per Bloomberg news, “I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner,” Bullard said at an event in Florida on Monday. “I’m thinking two more moves this year — exactly where those would be this year I don’t know — but I’ve often advocated sooner rather than later.”
However, we also heard from Minneapolis President Neel Kashkari with a different message, “I think right now it’s a close call, either way, versus raising another time in June or skipping. What’s important to me is not signaling that we’re done.” I guess the Eccles Building will be rocking in June when they next meet.
As it stands currently, at least according to the Fed funds futures market, the market is pricing in a 23% probability of a 25bp rate hike on June 14th. Remember, though, between now and then we see a lot of critical data including this week’s Core PCE release, next week’s NFP data and finally the May CPI data, scheduled to be released the day before the FOMC announcement. In the meantime, all eyes seem to be on the debt ceiling negotiations, and reasonably so, given the fallout could begin before the big data comes.
Looking at today, the big movers overnight were the bond markets with equity markets mildly in the red in both Asia and Europe. US futures are also edging lower, but barely -0.1% at this hour (7:45). As to commodities, oil (+0.5%) is edging higher on word that the Saudis are going to push for another production cut, while gold (-0.5%) is sliding on the back of the strong dollar and the base metals are falling again, clearly anticipating a recession.
As to the dollar, it remains king of the hill, continuing to rally vs. virtually all its G10 counterparts with only the yen (+0.1%) managing to hold its own. In the emerging market space, the story is similar with HUF (-1.0%) the laggard on expectations of a rate cut today and the bulk of the bloc lower. The one outlier seems to be KRW (+0.4%) which saw substantial equity inflows as the driver. I would be remiss if I didn’t mention that CNY has rallied substantially in my absence and is now well above 7.0500 as there is a growing belief the PBOC will continue to ease policy to support the Chinese economy.
On the data front today, we see preliminary PMI data (exp 50.0 Mfg, 52.5 Services) and New Home Sales (665K). The European flash PMI data was slightly soft, but pretty close to expectations. Meanwhile, only Dallas Fed President Lorie Logan is on the docket today, but don’t be surprised to hear from others on CNBC or BBG as they basically cannot shut up.
In the wake of the Silicon Valley Bank failure, I was convinced the Fed was going to be finished and accordingly, changed my views on the dollar. I had been bullish until a clear pivot was seen and I thought that was the case. However, it increasingly appears that no pivot is coming and that higher for longer is the future. In that case, I have to revert to my original stance and look for continued dollar strength until we get that signal.