After a stand-off lasting several months, it was reported over the weekend that House Speaker Kevin McCarthy and President Biden have reached an agreement in principle to increase the debt ceiling past the 2024 election and reduce the next two years of government spending. The agreement needs be voted through both chambers of Parliament before June 5, when the US Treasury Yellen has warned the government will run out of money to pay its bills. While an 11th hour agreement was anticipated, the deal removes a source and uncertainty and potential tail risk for markets.
US equities ended the week strongly, with the S&P again testing the 4200 region which has formed multiple highs through 2023. Technology stocks continue to outperform, boosted by the rally in AI-related stocks, with the Nasdaq recording five consecutive weekly gains. Meanwhile the KBW Regional Banking index is showing signs of stabilisation having made two consecutive weeks of gains and is currently 11% above the lows from earlier in the month.
US personal consumption data beat expectations rising by 0.8% in April picking up from the soft readings in February and March. However, the rebound in spending may not be sustained given it was driven by a surge in vehicles sales, which are noisy and are expected to retrace in May. Meanwhile the Federal Reserve’s preferred measure of inflation, core PCE, came in higher-than-expected printing 0.4% against the 0.3% survey median. Within the report, the core services ex-rent component rose 0.4%, the highest in three months. Longer term inflation expectations from the final print of the University of Michigan survey retreated from the preliminary release but remain close to the highs from June last year.
The resilience in activity and inflation data have contributed to a reassessment of the prospects of a rate hike at the Fed’s June meeting. Futures markets are now pricing a 70% chance of a 25bps rate hike up from closer to 20% a week ago. However, it is the expectations for the Fed funds rate at the end of 2023 which have adjusted the most, as the market reduced expectations for rate cuts in the second half of 2023. Stronger data and fading tail risks from the banking sector stress have underpinned the change in Fed outlook.
US Treasuries were mixed overnight Friday. Both 2y and 10y bonds were drifting lower in yield before the economic data which contributed to a sharp move higher in yields. US 2-year yields jumped more than 10bps from 4.48% to 4.60%. The move higher was exacerbated by comments from Federal Reserve Bank of Cleveland President Loretta Mester that signalled openness to an interest-rate hike in June amid stubbornly high inflation. This saw 2-yields peak at close to 4.64% before retracing lower into the close. Moves in 10-year yields were less pronounced and ended Friday modestly lower in yield contributing to a flatter yield curve.
The US Dollar made broad based gains following the move higher in front-end yields. Indeed, the Dollar and 2-year yields bottomed simultaneously in early May and have been moving higher in tandem since. The continued fall in EUR/USD may test speculative long positioning, which although reduced, still appears stretched according to the latest CFTC data covering futures trading positions. The stronger US Dollar weighed on the NZD/USD which made fresh lows for 2023 near 0.6050 in the process. NZD/AUD remained under pressure into the weekly close with the pairing closing near 0.9280 marking a sharp fall from 0.9450 levels from before the RBNZ’s Monetary Policy Statement last Wednesday.
There were signs of discomfort from Asian policy makers in response to the rising USD Dollar following the move through key psychological levels of 140 in USD/JPY and 7.00 in USD/CNH. Japanese Finance Minister remarked that ‘FX should reflect fundamentals’ while China’s state banks were reported to be selling US Dollars in onshore FX markets to support the Yuan on Friday.
Australian 3 and 10-year bond futures were little changed on Friday night suggesting limited directional bias for local rates on the open. In the week ahead the main domestic focus will be ANZ business survey on Wednesday while US labour market data, global business surveys and preliminary estimates of European CPI are notable international releases. It is a quiet start to the week from a data perspective with a clear events calendar and holidays in both the UK and US.
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