Dollar Consolidates, While Market Shrugs Off China Downgrade

After staging a modest recovery in North America yesterday afternoon, the
greenback is consolidating in narrow ranges.
  Momentum traders, who
appeared to dominate activity recently, paused.  To be sure, the
greenbacks upticks have been modest, and little technical damage has been inflicting on the major foreign currencies.  

The main development today was Moody’s decision to cut China’s credit
rating to A1 from Aa3.
  It cited the risk of a material rise in
economy-wide debt levels as the economy slows.  The outlook was shifted to stable from negative.  It is Moody’s first downgrade of China since
1989.  S&P, which has China on a negative outlook, rates it AA-, while Fitch sees it as A+.  

The impact was marginal.  In part, this is due to the
exaggeration of the internationalization of  China.  Specifically,
China’s external debt is low at around 12% of GDP.  The PBOC estimates
that foreign investors own about CNY830 bln (~$121 bln) of mainland bonds at
the end of March, compared with CNY853
bln at the end of 2016.  That is equivalent to about 1.5% of the CNY63.7
trillion outstanding.  

Chinese shares initially weakened
but recovered and closed fractionally
higher.
  The price of industrial metals fell, but it
is difficult to say the downgrade was the spur. 
Iron ore fell 4%, for example, after falling 3% yesterday.  Nickel fell 1.7%, while copper slipped
1%.  Among the currencies, the Australian
dollar and the Malaysian ringgit seemed to be the most sensitive, but both
recovered fully. 

There
are three events in North America that are noteworthy:  the Bank of Canada meeting, the  Congressional Budget Office scoring the
health care reform that already passed the House of Representatives, and the
FOMC minutes.  

The
Bank of Canada will leave rates on hold. 
The economy has generally
evolved as it has expected. 
However,  there is little reason
to abandon its cautious posture.   The risks from trade are significant.  NAFTA negotiations begin in a few
months.  Although the White House has
balked at the border adjustment tax, the vacuous of the Administration’s budget
gives breathing space to the ongoing efforts in Congress to keep it alive.    The Canadian economy has accelerated faster
than the US, but the output gap is only slowly closing, and a rate hike seems
unlikely over the next few quarters, at least.  

The
Canadian dollar staged a key reversal on May 5, after the US dollar almost
reached CAD1.38.
  The US dollar has fallen about 2.5% against
the Canadian dollar to hit almost CAD1.3455 yesterday.   The speculative market is leaning the other
way, as non-commercial accounts have a record gross short CAD position in the
futures market as of a week ago.  With US
dollar resistance seen around CAD1.3550, there is potential toward CAD1.3440,
which corresponds to a 61.8% retracement of the greenback’s rally that began in
mid-April. 

The
CBO scoring of the health care reform bill that passed the House of
Representative is important
.  It is the official arbiter of such
issues.  If the deficit is not reduced by
two billion dollars over the next decade, 
it is possible that the bill is modified again and a new vote is
needed.  This is problematic because the
bill passed narrowly (217-213) before and was a delicate and fragile
balance.  A new provision that had been
added allows states to waive some regulations that could lead to more people
becoming eligible for tax credits, which has deficit implications.  Recall that the savings from health care were
going to be used to fund tax reform.  

Although
many will look at the FOMC minutes; it is difficult to imagine the minutes will
be much more revealing that the meeting itself, which was as much of a non-event
as an FOMC meeting can be.
  The FOMC statement looked through the recent
softness of the US economy and said nothing to dissuade ideas that the Fed is
poised to hike rates in June.   Given
that the minute’s pick-up sentiment from non-voters as much as voters,  the risk seems asymmetrical for more hawkish
rather than dovish minutes.   It still seems early to expect many
revelations about the balance sheet strategy.  

Note
that tomorrow New Zealand’s milk coop will set initial prices for the new fiscal
year, and separately the government may announce that the economy’s performance
is generating greater revenue.
  It is likely to announce modest tax cuts
ahead of the Septemeber election.  This
may allow the New Zealand dollar to extend its recovery.   It had fallen to a one-year low on May 11
near $0.6820.  It pushed above $0.7000
yesterday.  Offers were seen in front of
$0.7050, but near-term potential extends toward $0.7100. 

The
euro is trading with a slight downside bias.
  A break of $1.1150-$1.1160 could
squeeze more momentum players and spur losses toward the $1.1080-$1.1100.  Option expires today include $1.1140-$1.1150
(~1.5 bln euros).   The dollar is in
narrow ranges against the yen (~JPY111.75-JPY112.05).  There is a large (~$2.55 bln) JPY112.0 strike
that expires today.  The intraday technicals
warn that it will likely be a fight there today.   Sterling is wrestling with the New Zealand
dollar for the top position today, but it has so far been unable to resurface
above $1.30.  Although the low in
sterling is debatable, 38.2% retracement of the sell-off since last year’s
referendum, according to Bloomberg, is found near $1.3055.  Thus far this has capped the resurgent
pound.  

Disclaimer

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