Unwinding in US rate space amid debt ceiling deal

The debt ceiling deal announced over the weekend provided a less dramatic finale than many had anticipated. With legislation expected to pass through Congress in the coming days, a sharp unwind in the US rates space unfolded overnight.

After rising for 12 straight sessions, the yield on US 2-year notes fell 16bp.

In spite of a notable sell-off in yields, the US dollar index stands firm, poised to wrap up the month of May, preserving all of its 2.60% gains.

A contributing factor is the decrease in the cash balance of the Treasury’s General Account (TGA), deployed for daily transactions, which has dwindled to below US$50 billion.

This is traced back to the impact of hitting the debt ceiling limit earlier in the year, specifically in January.

This means that Treasury will likely issue over US$1 trillion of bills over the next two months to replenish the TGA. Combined with QT and the June repayments for the TLRO repayments that will reduce ECB reserves by almost 12%, liquidity is expected to fall by up to 5% over the next two months, driving demand for the US dollar.

Supportive tailwinds remain for the US dollar

Providing further support for the US dollar heading into the June FOMC meeting, resilient growth data, sticky inflation, and hawkish Fed Speak have the market pricing in a 66% chance of a 25bp rate hike for the upcoming June FOMC meeting.

Finally, the DXY includes a 57% weighting of the euro.

Earlier this month, the first cracks in the Euro Area growth story emerged as Euro Area industrial production fell by 4.1% m/m, the steepest drop since March 2020.

Since then, flash PMIs have disappointed, and the German economy has fallen into a technical recession, weighing on demand for the EUR/USD.

In summary, several supportive tailwinds remain for the US dollar as we approach the business end of the week in the shape of ISM manufacturing and labour market data outlined below.

ISM expectations

• ISM Manufacturing for May, to be released Friday, June 2 at 12.00 am AEST
• It is expected to tick down to 47 from 47.1 in April. This will mean a seventh consecutive month in contractionary territory (below 50) as higher rates and tight credit slow the economy
• Within the key sub-indexes, Prices Paid are expected to fall to 52.3 from 53.2, and Employment is expected to fall to 49.8 from 50.2.

JOLTS, ADP and NFP expectations

JOLTS job openings

• JOLTS job openings are released on Thursday, June 1 at 12.00 am AEST
• The market is looking for JOLTS job openings to fall to 9,400k from 9,590k. This would be the lowest number of Job openings since April 2021

ADP employment report

• The ADP employment report is scheduled for released on Thursday, June 1, at 10.15 pm AEST
• The ADP report isn’t an exceptionally reliable guide to Non-Farm Payrolls
• Nevertheless, the market expects a 170k rise in May, falling from 296k in April.

NFP

• Non-Farm Payrolls is scheduled for release on Friday night, June 2, at 10.30 pm AEST
• The market is looking for payrolls to rise by 190k in May, slowing from 253k in April
• The unemployment rate is expected to rise to 3.5% in May from 3.4% in April
• The participation rate is expected to remain unchanged at 62.6%
• Average hourly earnings are expected to rise by 0.3% in May, keeping the annual rate steady at 4.4%.

DXY technical analysis

In 2023, the US dollar index, the DXY, tested and held support at 101.00/80 on three separate occasions, providing evidence of a base. After a strong rally in May, the DXY has broken above the downtrend resistance at 104.00, coming from the September 114.78 high.

Given the macro backdrop outlined above and the sustained break above 104.00, we expect the DXY to extend its rally towards significant resistance at 105.65/105.88 (from the March 105.88 high and the 200-day moving average) in the sessions ahead.

DXY daily chart