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Hawkish Fed Pauses Rates, rebound in USD not ruled out while CNY continues to struggle

Contributed by Jeff Cheah, Strategic Sales Manager

USD/SGD Skews Towards Downside | skip to CNY/SGD

Last week, we saw USD traded with bearish momentum after the U.S. released its CPI data on Tuesday (13/06/2023). U.S. CPI inflation slowed in May, which may have supported the Fed's desire to pause rate hikes this week and assess the state of the economy. Data from the U.S. Bureau of Labor Statistics showed that the U.S. CPI in May rose by 4% y/y for the 11th consecutive decline, which is the smallest y/y increase since April 2021. The core CPI, which excludes food and energy prices, rose 5.3%, lower than the expected 5.2%, indicating the slowing increase y/y in core CPI.

On June 14th, at local time, the U.S. Federal Reserve Board concluded its two-day monetary policy meeting and announced that it would pause rate hikes and maintain the current target range for the federal funds rate of 5%-5.25%, in line with market expectations.

This is the first time the Federal Reserve has paused its current rate hike cycle. Since the Federal Reserve started the current round of interest rate hike cycle in March 2022, it has raised interest rates 10 times, and the cumulative rate of interest rate hikes has reached 500 basis points.

Regarding the understanding of the "pause" of interest rate hikes, Powell said that he was unwilling to describe the decision to keep interest rates unchanged as a "skip". But what the outside world wonders is, if it is necessary to continue raising interest rates, why doesn't the Fed do it in one step? At the news conference, Nick Timiraos, a reporter who is regarded as the "mouthpiece of the Fed", first raised the issue.

Powell made a magical metaphor for this. He replied: "It's like driving a car, speed and ultimate purpose are two different issues. Last year, speed was very important, but as we get closer and closer to the destination, it is common sense to slow down." On rate cuts, Powell said they would only come after inflation has fallen significantly, which could take several years. “It would be appropriate to cut rates at a time when inflation has come down really significantly. Again, we’re talking about a few years out. As anyone can see, not a single person on the committee has indicated a rate cut this year, and I don’t think that’s appropriate at all.”

However, we would like to note that the market is weighing the prospect of other major central banks' coordinated efforts to curb inflation, especially after the Bank of Canada unexpectedly raised interest rates last week following the Reserve Bank of Australia’s decision. The possibility of the Fed raising interest rates again in July is high because core inflation is still stubborn. At this juncture, we would like to flag the risks that rate hikes are back on the cards, which may lead to upside risks for the USD in or near July if the jobs report and various indicators continue to favor a narrative that the economy is still hot.

The Fed has emphasized in recent months that its policy decisions will depend on the direction of economic data. So, while the price increases that have plagued consumers over the past two years have indeed slowed markedly, the deceleration has hardly convinced Fed officials that they can stop raising interest rates. The Fed's preferred measure of inflation - the annual rate of core PCE - is also well above its 2 percent target.

We would like to reiterate our view that the upside bias for USD is likely to be limited, given that the Fed is near the end of its tightening cycle, and the Fed and markets are looking for rate cuts into 2024 and 2025. We have expressed our view earlier last week that the risk for USD is skewed to the downside. We retain our preference for a bearish view, favoring USD/SGD trade south of 1.34 after 13-14 June, which we have previously opined. However, we would also flag risks of sporadic and intermittent uptick of USD behavior, should economic data releases and future Fedspeaks (through interest rate policy languages) favor the opposite directional bias in price action.

CNY/SGD Fatigued Sentiments Not Helping CNY Recovery

Moving on to China, we continue to see softness in CPI prints, with May’s CPI rising 0.2% y/y, an increase of 0.1 percentage points over the previous month. Considering the overall drop in international bulk commodity prices, the overall weak demand for industrial products at home and abroad, as well as the relatively high comparison base in the same period last year, the PPI fell by 4.6% y/y, an increase of 1.0 percentage points from the previous month, and a m/m decrease of 0.9%, and a decrease of 0.4 percentage points over the previous month. Presently, China’s economic recovery remains weak, and insufficient domestic demand will continue to further restrict China's price trend. CPI and PPI are expected to continue to remain soft.

According to data released by the National Bureau of Statistics of China, in April 2023, the national surveyed urban unemployment rate was 5.2%, a decrease of 0.1 percentage points from the previous month. However, the 16 to 24-year-olds unemployment figure reached 20.4%. This is the first time the youth unemployment rate has broken 20%, a record high since the data was regularly published in 2018. Furthermore, graduation season is approaching. According to statistics from the Ministry of Education, the number of college graduates in 2023 is expected to be 11.58 million, a y/y increase of 820,000. It is not ruled out that the pressure on total employment will further increase.

Although the youth unemployment rate is a sensitive indicator, it can reflect that macroeconomic growth has not met expectations on one side, but the value of this indicator should not be exaggerated, and the reasons cannot be simplified. Factors affecting employment are complex. The impact of the three-year epidemic, external unfavorable factors, and the time-lag effect of contractionary policies, among others, as well as short-term factors and medium- and long-term factors are intertwined. The high youth unemployment rate is not unique to today, nor is it a unique phenomenon in China. How the Chinese government deals with the employment problem and avoids more complicated situations that may potentially arise from it will very much put the wisdom of governance to the test.

The meeting of the Political Bureau of the Central Committee of the Communist Party of China held on April 28 pointed out that China’s economy is mainly in the process of recovering, with the endogenous driving force still weak and demand insufficient. Economic transition and upgrading are facing new headwinds, and hardships and challenges still need to be overcome to promote high-quality development.

As the main body of the market, the private sector accounts for more than 80% of urban employment, and the contribution rate of new employment exceeds 90%. At this current juncture, enterprises, especially private enterprises, have insufficient expectations for the future. Not only are they hesitant to provide jobs, but they may also trigger salary cuts and layoffs. In the long run, the main way to solve youth employment difficulties is to boost the confidence of enterprises, especially private enterprises, and stabilize their expectations.

After experiencing the impact of the aforementioned unfavorable conditions, enterprises need to “recuperate”, as well as go through a process of adaptation and adjustment. In recent years, through supply-side structural reforms, the short-term structural contradictions in economic operations have been alleviated and positive results have been achieved.

The market-oriented reform of factors is something that urgently needs to be taken. In fact, factor market reform is a fundamental and institutional reform, as it promotes the development of productivity through the adjustment of relations of production. In other words, it is to create a benign environment for the development of enterprises. Only when enterprises have benign long-term behaviors can they continuously provide jobs.

Sunrise industries will undoubtedly provide more jobs. Today, the most discussed areas of focus are new energy vehicles, artificial intelligence, bio-medicine, and electronic integration. The view that promoting the development of high-tech industries leads to increased unemployment is ignoring or underestimating the industrial chains, supply chains, and cluster effects generated by the development of these industries, as well as their role in creating new jobs, optimizing the employment structure, and attracting foreign investment.

Development is still the fundamental solution to all problems. Only by mobilizing the overall sustainable development potential and the vitality of market players can the economy enter a virtuous circle - the improvement of the outlook of enterprises, and enhancement of people's confidence.

Meanwhile, on June 13, the People’s Bank of China (PBoC) reported that in order to maintain reasonable and sufficient liquidity in the banking system, PBoC carried out a CNY 2 billion 7-day reverse repurchase operation, cutting its rate by 10bp from 2% to 1.9%. This is the first adjustment of the 7-day reverse repurchase operation interest rate since August 2022. It is worth noting that the current 7-day reverse repurchase rate is already the lowest in history.

The significance of this move is this has led many overseas investment institutions to quickly reassess the valuation of the RMB exchange rate after PBoC cut the 7-day reverse repurchase rate. Affected by this, the yield of China's 10-year government bond once fell by 3 basis points to 2.64%, the lowest value since September last year. As a result, the inversion of the China-U.S. interest rate spread (the difference between the 10-year China-U.S. bond yield) has expanded to 105 basis points.

Many overseas investment institutions that originally expected the Federal Reserve to suspend interest rate hikes, which would narrow the inversion of the interest rate spread between China and the United States, had to reassess the valuation of the RMB exchange rate. The reality of the widening inversion of the interest rate differential between China and the United States led many of them “buying down technically” RMB exchange rate, and then judged the new equilibrium valuation of the RMB exchange rate based on market fluctuations.

Now, we see the support of SGD/CNY at 5.3063. We do not see any catalyst that favors the strengthening of CNY. The lack of green shoots in China’s macroeconomic data, and fatigued market sentiments (towards China’s reopening story) are not helping CNY recovery.

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