USD: Debt ceiling fears are ticking higher
In what has been a quieter week for US data and Fed-speak (the Fed goes into a blackout period this weekend ahead of the 3 May rate meeting), increasing focus has fallen on progress on the US debt ceiling. Here the one-year US credit default swap has risen to a new cycle high of 106bp as investors price increasing acrimony in Congress. The Democrats and Republicans seem far apart and investors suspect we will need to see a lot more market stress before adults enter the room. For reference, the weaker tax receipts this year have some analysts bringing forward the 'X' date - when the US government could start to see shutdowns - to end June from a prior expectation of mid-July to mid-August.
This comes at a time when US banks are happy to hang onto their emergency funding from the Federal Reserve. Here, the latest weekly data from the Fed showed a slight increase in borrowings from its Bank Term Funding Programme. At the same time, the view of a Fed pause and subsequent easing cycle is not unlocking the kind of healthy investment flows into emerging markets. Normally, one might expect the Chinese renminbi to be leading the recovery in emerging currencies. Instead, USD/CNH is edging higher and bracing for some new US investment curbs on China - potentially announced at the G7 summit in mid-May.
What does this all mean for FX? The challenging investment environment makes it hard to market a 'sell dollar, buy everything' thesis. Even though we think US data will slow and that the Fed will ease, that story of a benign dollar decline may not emerge until the second half. Instead, we think investors will increasingly favour defensive positions in the Japanese yen and Swiss franc - at least on the crosses if not against the dollar. So far example a cross rate like AUD/JPY could be heading back to the 86/87 lows over the coming months.
For the DXY itself, we think USD/JPY could drag it lower and feel it is far too early to buy the dollar on any kind of flight-to-quality trade. A dollar rally might only be the final chapter in a debt ceiling crisis should US money markets seize up. Before that, we see downside pressure building on USD/JPY again and favour it moving towards the lower end of its new 130-135 range. Look out for April PMI data in the US today. DXY looks biased to 101.50.
Chris Turner
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