2023 May

Worries over the debt ceiling have had the stock market on edge, yet the Saturday night deal to avoid a default may not trigger a big relief rally. That’s because aggressive Fed tightening and the end of the last Covid-era fiscal giveaways appear likely to help push the U.S. economy into recession later this year.

The rocket fuel of easy money and excessive government spending that propelled GDP, inflation and, for a long while, the stock market is nearly spent. A fiscal hangover is just beginning.

While the debt-ceiling deal reached by President Biden and House Speaker Kevin McCarthy includes pretty mild spending curbs, one detail could pack a punch. News reports indicate that the deal will codify into law the Biden administration’s planned end of the student loan payment freeze that has helped fuel spending over the past three years.

That will likely deepen a spending slowdown at a time that growth already has slowed almost to a stall. Yet the Federal Reserve, after five percentage points of rate hikes, may step even harder on the brakes. After last Friday’s hotter-than-expected PCE inflation report, Wall Street now thinks another rate hike is likely in June or July.

Meanwhile, any debt-ceiling relief for investors will be fleeting because the stock market is about to lose its own fiscal support.

The Treasury’s inability to issue debt in recent months has more than offset Fed efforts to tighten financial conditions by unloading assets purchased during the Covid-19 pandemic. But Treasury issuance is about to surge following a deal to raise the debt ceiling. That means we’re about to get Fed quantitative tightening on steroids.

Debt-Ceiling Deal
Facing a possible June 5 debt-ceiling breach, Biden and McCarthy reached a deal with much more modest spending curbs than House Republicans proposed. Instead of cutting discretionary spending back to 2022 levels, the cuts would hold nondefense spending at roughly 2023 levels, while exempting military and veterans’ health spending. For fiscal 2025, the discretionary budget allowance increase would be limited to 1%, below the rate of inflation.

The deal tightens work requirements for adults without children to receive food aid, while exempting the homeless and veterans. It also trims $10 billion from the extra $80 billion in IRS funding that Democrats passed to boost tax enforcement.

The White House has been resigned to at least modest discretionary spending cuts as part of a debt-ceiling deal. Even if President Biden had attempted an end run — such as by declaring that the debt limit is itself unconstitutional — he would have still needed the GOP-controlled House to sign off on the 2024 budget before the new fiscal year begins Oct. 1.

Failing that, the government might have shut down until the parties reached a spending deal. The last partial shutdown under former President Donald Trump eventually grounded air traffic while delaying paychecks for 800,000 federal workers, as well as contractors. A repeat scenario would surely amplify U.S. recession risks.

McCarthy may have had limited leverage, since any deal would need Democratic votes to pass. If he pushed too hard, Biden also may have resorted to a controversial plan to get around the debt ceiling.

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Student-Loan Payments
credit delinquency chartWhile the debt-ceiling deal averts the potential for harsh economic fallout that might have come from a breach, another fiscal time bomb is lurking.

Biden’s $400 billion student-loan forgiveness program faces a Supreme Court ruling in late June. If the justices find that GOP-run states have standing to sue, there’s a strong chance Biden won’t like the verdict. Recent rulings by the conservative-dominated court show little patience for government agencies adopting consequential policies without the explicit consent of Congress.

A ruling against Biden’s program to forgive up to $20,000 in federal college loans per person could hit borrowers by September. Biden has set an end-of-August deadline for lifting a three-and-a-half-year moratorium on student-loan payments.

The halt of student loan payments for about 40 million borrowers has cost the government more than $5 billion per month, including forgone interest, according to the Committee for a Responsible Federal Budget.

Yet that understates the extent to which the payment pause for $1.3 trillion in student loans with a median balance of $18,773 has helped consumer finances.

The average student loan payment was $393 per month for borrowers before the pandemic, Jefferies economist Thomas Simons notes.

“Consumer balance sheets are already kind of exhausted at this point,” Simons told IBD.

With the added pressure from an end to the student-loan holiday, “We’re setting up for a pretty significant rollover” for consumer spending in the second half of the year, he said.

Other Fiscal Drags To U.S. Economy
After dodging recession fears in 2022, the U.S. economy appeared to rev back up to start 2023. The Fed responded by turning even more hawkish. Now that burst of growth, which was helped by a mild winter and an 8.7% cost-of-living boost to Social Security benefits, is looking like the last gasp of pandemic-era fiscal fuel.

Two of the last remaining Covid-era supports for household finances have now hit their end date. Emergency SNAP (Supplemental Nutrition Assistance Program) benefits recently expired. That amounted to a hit of $95 per month for eligible households, or nearly $50 billion per year. Medicaid income limits, suspended at the start of the Covid pandemic, are now returning. That could knock up to 17 million people out of the program over the next year, leaving them to find more costly insurance coverage, a Kaiser Family Foundation analysis finds.

Covid-19 Pandemic-Era Giveaways
It’s hard to overstate how pandemic-era fiscal giveaways and ultralow interest rates transformed household finances. Three rounds of stimulus checks, unemployment benefits that were more generous than many paychecks, and expanded child tax credits helped Americans amass $2.3 trillion in excess savings by late summer 2021, a Federal Reserve study found.

An epic mortgage refinance boom cut average monthly payments by $220 for about 9 million families, the New York Fed says. Another 5 million capitalized on lower interest rates and higher home values to take $430 billion worth of cash-out refis.

Another New York Fed study estimates that student loan borrowers saw $195 billion worth of payments waived in the first two years of the moratorium, implying that sum has now grown to around $300 billion.

Fiscal Fuel For Inflation Spike
All of this helps explain why the U.S. economy has held up through 500 basis points of Fed rate hikes — twice the level of tightening that proved untenable in the last cycle. Yet it also explains why the economy has suddenly become much more vulnerable to recession.

That massive boost to savings — even as consumers splurged and paid down debt — mixed with pandemic supply-chain disruptions to set off an inflationary chain reaction. Because consumers had so much spending power, businesses held the pricing power to afford hefty wage hikes and still reap unusually wide profit margins.

Hiring remained strong because wage hikes helped to sustain robust demand. Plus, households gradually began to spend down their extra savings, piling up credit card debt amid high inflation and fast-rising interest rates.

Finally, to start 2023, the biggest inflation outbreak in four decades produced the biggest Social Security cost-of-living increase since 1981. At the same time, employers coughed up one more round of outsized pay hikes as the labor market remained tight.

U.S. Economy Sees Consumers Pull Back
credit card balances chartYet that cycle has now likely run its course. The consumer already pivoted in the fourth quarter of 2022. The urge to splurge drove the savings rate down to 3% of disposable income by September 2022 from close to 9% before the pandemic, boosting consumption by about $1 trillion at an annual rate. But caution then started to creep in, raising the savings rate to 4.1% of disposable income by April.

Even so, William Blair economist Richard de Chazal figures that consumers already have spent more than 75% of their excess savings haul during the pandemic.

Retail sales, after a COLA-flavored income bounce to start the year, have trended lower over the past three months, slipping about 1% in April vs. January’s level. Walmart (WMT) and Home Depot (HD), which both announced big minimum-wage hikes early in the year, have seen consumers take a step back. Walmart CFO John Rainey cited the end of emergency SNAP benefits and smaller tax refunds as contributing factors.

Businesses Change Spending Plans
Businesses have pivoted too. Corporations announced 337,000 planned layoffs in the first four months of 2023, according to the Challenger, Gray outplacement firm. That’s up more than 300% from the same period a year earlier. Labor Department data shows that the number of job openings sank by 1.6 million in Q1. That’s the biggest fall in data back to 2001, excluding the April 2020 hit during the Covid-19 pandemic lockdown.

The National Federation of Independent Business’ small business optimism index is at the lowest level in more than a decade. Nearly one-third of small firms say they’re dependent on bank credit at a time when short-maturity loans come with an average 8.5% interest rate, up 5 percentage points from March 2022.

As demand slackens and pricing power ebbs, high borrowing costs likely will push small businesses to cut their biggest expense: labor.

Businesses “are responding to a 500 (basis point) increase in interest rates over the past 14 months, which alone usually would be enough to push the economy into recession, but they now face a credit crunch too,” wrote Ian Shepherdson, chief economist at Pantheon Macroeconomics.

Shepherdson takes issue with Fed hawks eyeing further rate hikes because inflation isn’t coming down fast enough. Not only has the Fed done enough, he says, but a failure to cut rates very soon “will amount to overkill.”

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Can U.S. Economy Avoid A Hard Landing?
Treasury securities held by the Federal Reserve chartA case can still be made that the U.S. economy is headed for a soft landing. While pandemic-era government supports may be on their last legs, infrastructure spending and business investment are enjoying a growth spurt. Three big spending packages approved under President Biden could plow $1 trillion into earthmoving projects over a decade.

However, Jefferies’ Simons doubts that the ramp in spending on infrastructure, chip plants and green energy projects will come fast enough before consumption fades and layoffs pick up.

Yet others argue that consumer finances look plenty strong to keep the U.S. economy on track.

Despite hand-wringing over a rise in credit card debt, “Households are having no trouble servicing their debt,” wrote Doug Peta, chief U.S. investment strategist at BCA Research.

“We do not see any credit obstacles preventing households from sustaining their consumption growth” by taking on more debt, Peta said.

Yet the end of the student-loan moratorium could be a game-changer for consumers, while deepening problems for banks. Even without student-loan obligations, credit card and auto-loan delinquency rates have climbed back to pre-pandemic levels, New York Fed data shows.

Delinquencies are highest for younger borrowers, who are more likely to hold student loans in forbearance. Once those payments resume, delinquencies may spike.

Student-Loan Wildcard
The unknown fate of student-loan relief complicates the outlook for the U.S. economy and the stock market.

Even if the Supreme Court strikes down student-loan forgiveness, the White House has a backup plan. The Congressional Budget Office estimated that Biden’s Plan B, limiting repayment based on income, would cost the government $230 billion.

Under the plan, student loan borrowers would have to pay no more than 5% of income above about $33,000 per year, down from 10% under current law. That would surely minimize the economic hit once the moratorium ends. However, this relief plan also could get tangled in a legal fight if the Supreme Court rules against Biden’s loan forgiveness.

Stock Market Rally Faces ‘Liquidity Storm’
With hopes for a debt-ceiling deal and blockbuster earnings from artificial-intelligence play Nvidia (NVDA) lifting the stock market, the S&P 500 ended last week at its highest close since August.

Yet investors should be on guard for a stock market pullback, if history is a guide. The S&P 500 rallied a few weeks ahead of the 2011 debt-limit deadline. But the stock market turned down ahead of the deal, and the sell-off continued as the ink dried. The S&P 500 dived more than 10% in two weeks surrounding the Aug. 2 debt ceiling deal.

A replay of that stock market sell-off is far from certain, since debt-ceiling negotiators didn’t need a push from financial market stress to reach a compromise. The rally in artificial intelligence stocks also might have legs.

Still, investors have reason to worry that the immediate aftermath of a debt-ceiling deal might not be pretty, as the dam on Treasury issuance bursts.

For regional banks competing with high bond yields as they try to minimize deposit flight, the coming increase in Treasury issuance “is likely to make things worse,” Simons wrote. That risks a further tightening of lending standards.

Barry Knapp of Ironsides Macroeconomics told clients in an audio note that he sees the S&P 500 falling as low as 3,850 as the reprieve from Fed quantitative tightening abruptly ends.

“We’re on the verge of what we would describe as a liquidity storm,” he said.
From JED GRAHAM

The Australian dollar had a rough session on Wednesday as we continue to see a lot of trouble out there and are waiting to see whether we will have more of a “risk off” type of market. This could be about to kick off a major leg lower, and if the market does close to a fresh, new swing low, then the Australian dollar could very well drop down to the 0.64 level. All things being equal, this is a market that I do think will continue to see plenty of sellers if we are going to continue to see a lot of trouble.

On the other hand, if the market were to see a turnaround, then we could reenter the previous consolidation area. It’s probably worth noting that the market has recently broken through the 0.66 level a couple of times, so unless we can hang on to significant bearishness, we could very well see this market turn right back around. However, I do think that it is probably only a matter of time before we see the breakdown, mainly due to the fact that we have so much in the way of concern around the world. Furthermore, the market has to pay close attention to the commodity markets because there will be a great influence on the Aussie as it is Australia’s biggest export.

Pay particular attention to China, as Chinese demand is always a major input into the Aussie economy. Even if we do rally from here, it’s very likely that there will be a lot of resistance just above, especially near the 50-Day EMA, which is currently at the 0.67 level. In general, this is a situation where we will continue to see a lot of volatility, which can offer a lot of opportunities. At this point, I do favor shorting the Australian dollar rather than buying it, but that does not necessarily mean that we are going to shoot straight up in the air. At this point, it is probably only a matter of time before we see exhaustion enter the market on any short-term rally. All things being equal, this is a market that is going to struggle to see a lot of upward momentum.

For a look at all of today’s economic events, check out our economic calendar.

This article was originally posted on FX Empire

AUD/USD ANALYSIS & TALKING POINTS
US debt ceiling discussions will lead the way this week.
China’s LPR remains steady as growth potential comes into question.
Fed speakers in focus for today.
AUD/USD consolidates as external factors dictate terms.
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AUSTRALIAN DOLLAR FUNDAMENTAL BACKDROP
The Australian dollar looks to be facing another challenging week after US factors weighed on the pro-growth AUD. Beginning late on Friday, Treasury Secretary Janet Yellen addressed bank CEO’s and stated there may be a need for additional mergers due to the slew of bank failures seen over the last few months. This dampened risk sentiment leaving the AUD on the backfoot against the US dollar. Market caution gained traction over the weekend as optimism around the US debt ceiling was quickly dispelled when President Joe Biden mentioned that the demands from Republicans were ‘unacceptable’. President Biden and House of Representatives Speaker Kevin McCarthy will hash it out once more later today as time runs out.

That being said, Fed Chair Jerome Powell relayed a rather dovish statement last week which was largely lost in the debt ceiling shadow, hinting that the Fed may pause their hiking cycle. In summary, the week should be dominated by debt ceiling negotiations but Fed monetary policy should be a close second.

Earlier this morning China kept its 1 and 5-year Loan Prime Rates (LPR) unchanged. The increasing interest rate differential between the US and China has weighed on the Yuan and the PBoC’s desire to cut rates (as a stimulus measure) to meet their 5% GDP growth target. Commodity prices (Australian specific exports) have weakened thus exacerbating downside for the Aussie dollar.

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The day ahead will be led by Fed speakers (see economic calendar below) and it will be interesting to see how the scheduled officials react to Fed Chair Powell’s recent comments.

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Daily AUD/USD price action reveals recent uncertainty in global markets as the pair fluctuates between the 0.6600 and 0.6800 psychological levels. The Relative Strength Index (RSI) further reiterates investor skepticism due to fundamental ambiguity. This week may be a ‘wait and see’ mindset from traders awaiting external cues.

Key resistance levels:

200-day MA (blue)
0.6700
50-day MA (yellow)
Key support levels:

0.6620
0.6565
0.6500
IG CLIENT SENTIMENT DATA: BULLISH
IGCS shows retail traders are currently LONG on AUD/USD, with 73% of traders currently holding long positions. At DailyFX we typically take a contrarian view to crowd sentiment resulting but due to recent changes in long and short positioning, we arrive at a short-term upside disposition.

From Warren Venketas
Analyst

US DOLLAR FORECAST:
U.S. dollar begins the week on the back foot, undermined by concerns over the U.S. debt limit impasse and disappointing economic data
The U.S. retail sales and industrial production reports from April should be watched on Tuesday
In terms of technical analysis, the DXY reverses lower off Fibonacci resistance, failing to follow-through on the topside after a bullish breakout late last week

From Diego Colman
Contributing Strategist

AUSTRALIAN DOLLAR OUTLOOK:
AUD/USD has lacked directional conviction in recent months, with the pair stuck in a consolidation phase
While ranging markets can be predictable, traders should exercise caution ahead of a high-impact event looming on the calendar: the U.S. inflation report
This article looks at potential technical scenarios for Aussie

FROM Diego Colman
Contributing Strategist

US DOLLAR AND NASDAQ 100 OUTLOOK:
The U.S. dollar, as measured by the DXY index, loses ground on Monday, despite the rally in U.S. yields
Meanwhile, the Nasdaq 100 posts moderate losses after failing to clear technical resistance AT 13,370
The U.S. debt ceiling drama and the April inflation report will take the spotlight this week
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Most Read: EUR/USD Price Forecast – Euro Bulls Fight Exhaustion Below the 1.1100 Level

The U.S. dollar, as measured by the DXY, index was a tad weaker on Monday despite the advance in U.S. Treasury yields seen across the curve following better-than-expected nonfarm payrolls data last Friday and higher oil prices over the past two trading sessions.

Meanwhile, the Nasdaq 100 was also subdued, sliding about 0.3% to 13,280, pressured by the rally in bond rates, with upward momentum fading and bulls failing to push the tech index above technical resistance at 13,370 ahead of a loaded economic docket.

Two key events are likely to grab the spotlight this week: 1) a White House meeting between the President and several lawmakers to discuss the U.S. borrowing cap and 2) the April U.S. inflation report.

Focusing on the first item, President Biden will host House Speaker Kevin McCarthy, House Minority Leader Hakeem Jeffries and senior Senate figures representing both ends of the political spectrum on Tuesday to address the impasse over raising the debt ceiling.

With the Treasury Department expected to run out of cash to pay its bills as early as June 1, President Biden needs to negotiate a deal soon to prevent the U.S. from heading toward default, a situation that could prove catastrophic for the global economy and financial system.

Turning our attention to the second item, the U.S. Bureau of Labor Statistics is due to release consumer price index data from the previous month on Wednesday morning. In terms of expectations, headline CPI is seen rising 0.4% m-o-m, keeping the annual rate steady at 5.0%.

For the Fed’s monetary policy outlook to stay dovish, as priced in by Fed futures, inflation must remain on a downward path. Should CPI numbers surprise to the upside, rate cut expectations for the second half of 2023 could fade, boosting yields and the U.S. dollar. This would be bearish for the Nasdaq 100.

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US DOLLAR TECHNICAL OUTLOOK
After the recent pullback, the U.S. dollar, as measured by the DXY index, is steadily approaching technical support at 100.75, near the 2023 lows. If the bears manage to drive the greenback index below this floor, we could see a move toward 99.50 in short order.

On the flip side, if prices get repelled from current levels and turn higher, initial resistance appears at 102.30. A successful climb above this barrier could embolden buyers to launch an attack on the 50-day moving average, followed by 103.50.

US DOLLAR (DXY) TECHNICAL CHART
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US 500
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DAILY 15% 5% 9%
WEEKLY 13% -6% 0%
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NASDAQ 100 TECHNICAL CHART
The Nasdaq 100 rallied aggressively last Friday, but fell short of clearing technical resistance at 13,370, near the 2023 peak. Failure to follow through on the topside appears to be attracting sellers on Monday, with the tech index retreating from its recent highs – a sign bullish impetus may be waning.

If the pullback accelerates in the coming days, the first key support to keep an eye on rests at 13,000-12,950. If bulls fail to defend this floor, we could see a drop toward 12,635 soon. Conversely, if the index resumes its ascent and breaches 13,370, prices could be on their way to test 13,735 imminently.

NASDAQ 100 TECHNICAL CHART
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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

From Diego Colman
Contributing Strategist

US NFP AND JOBS REPORT KEY POINTS:
The US Added 253,000 Jobs in April, Surpassing the Average Forecast of 180,000 New Payrolls.
The Unemployment Rate Dropped to 3.4%, Matching the January Print Which was a 50-year low.
The Positive Data Continued as Average Hourly Earnings Increased More Than Expected as Well, Likely to Add to Inflationary concerns.
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Hiring in the US accelerated through April as the economy added 253K jobs in April 2023, beating forecasts of 180K and following a downwardly revised 165K in March. According to the U.S. Bureau of Labor Statistics employment continued to trend up in professional and business services, health care, leisure and hospitality, and social assistance. It is also important to note the overall change in total nonfarm payroll employment for February and March was revised down by 78k and 71k respectively, leaving employment for the two months 149k lower than previously reported.

The unemployment rate, at 3.4 percent, and the number of unemployed persons, at 5.7 million, changed little in April. The unemployment rate has matched a 50-year low which was seen in January and has ranged from 3.4 percent to 3.7 percent since March 2022. The labor force participation rate, at 62.6 percent, and the employment-population ratio, at 60.4 percent, were unchanged in April. These measures remain below their pre-pandemic February 2020 levels (63.3 percent and 61.1 percent, respectively).

Looking more closely at the employment survey, average hourly earnings which remains a powerful inflation gauge for the Fed, increased by 0.5% MoM up from 0.3% in March, bringing the annual rate back to 4.4% from 4.3% previously. This print in particular doesn’t bode well for the Fed in the fight against inflation with two inflation reports ahead of next month’s FOMC meeting.

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FEDERAL RESERVE AND THE WAY FORWARD
The FOMC meeting didn’t disappoint this week while continuing stress among US Regional Banks weighs on sentiment and stokes recessionary fears. Fed Chair Powell for one said he doesn’t see a recession but rather miniscule growth for the US in 2023 even though some of his peers on the FOMC fear a recession is inevitable. The Fed Chairs confidence stemming from the strength of the labor market and low unemployment rate. However, given the increasing jitters around regional banks since the FOMC meeting recessionary fears have risen and the probability of rate cuts in 2023 have increased (By market participants at least).

The Fed did not rule out further hikes completely but given the banking sector stress of late it would seem the peak is in. As we move forward though jobs data will be of particular interest. If the US can keep the unemployment rate from rising too fast, they may be able to achieve Powells vision of marginal growth rather than a recession in 2023. Tighter credit conditions usually leads to higher unemployment which was is why this is a key metric moving forward. The Feds dream scenario would ideally be that tighter credit conditions lead to a slowdown in the economy to put in a dent in inflation while at the same time seeing only a marginal uptick in the unemployment rate.

The Dollar itself remains vulnerable as we hover near YTD lows. The ECB are expected to continue hiking with fellow central banks like the RBA striking a hawkish tone of late and markets unconvinced about the banking sector, the greenback could be in for a tough summer.

Initial reaction on the EURUSD saw the dollar strengthen and gain approximately 30 pips to trade back below the 1.1000 level.

Looking at the bigger picture EURUSD fell from YTD highs yesterday despite a hawkish tone from the ECB. The weekly timeframe was in overbought territory earlier in the week with the H4 timeframe printing a lower high yesterday. Looking at the daily chart above you can see we have closed below the ascending channel for the second time. A push lower could be in store for EURUSD but the 1.0900 handle may prove too strong a hurdle to overcome.

Key Levels Worth Watching:

Support Areas

1.0950
1.0900
1.0845
Resistance Areas

1.1000
1.1075
1.1135
— Written by Zain Vawda for DailyFX.com