Markets Tread Water ahead of US CPI, Gold and Yields Dip

As U.S. lawmakers push for the urgent regulation of stablecoins, the Financial Stability Oversight Council (FSOC) and the Federal Reserve Board warn about the risks of stablecoin runs that threaten the country's financial stability. Treasury Secretary Janet Yellen brought up the terrausd (UST) fiasco as an example of why a comprehensive regulatory framework is urgently needed.

Stablecoins have become a hot topic in Washington. Following Monday's terrausd (UST) fiasco, U.S. lawmakers are calling for the urgent regulation of stablecoins.

On Tuesday, U.S. Treasury Secretary Janet Yellen brought up UST as an example of a "stablecoin run" during her testimony before the Senate Committee on Banking, Housing, and Urban Affairs on the Financial Stability Oversight Council (FSOC) Annual Report.

Senator Pat Toomey (R-Pa.) asked Yellen to confirm her view on the need to regulate stablecoins. "I would like to ask if you can confirm for the record here that it is still your view that it is important, I would argue even urgent, for Congress to pass legislation governing the regulations of the payment stablecoins," he said.

Yellen replied:" Yes, I'm happy to confirm that, Senator Toomey."

She continued: "The president's working group issued a report concluding that the current statutory and regulatory frameworks don't provide consistent and comprehensive standards for the risks of stablecoins as a new type of payment products, and urges Congress to enact legislation to ensure that stablecoins and such arrangements have a federal prudential framework."

The treasury secretary elaborated: "I would urge a bipartisan action to create such a framework. We would look forward to working with you." She added:" There was a report this morning in the Wall Street Journal that a stablecoin known as terrausd [UST] experienced a run and had declined in value."

"I think that simply illustrates that this is a rapidly growing product and there are risks to financial stability and we need a framework that's appropriate," Yellen stressed.

Toomey quickly responded: "It's important to note that the stablecoin to which you refer, I believe, is an algorithmic stablecoin. So that means by definition it is not backed by cash or securities as the — if you can call them — 'more conventional stablecoins.'"

The stablecoin terrausd (UST) lost its parity with the U.S. dollar and dropped to an all-time low of $0.66 per unit on Monday.

The FSOC annual report also states that stablecoins may be vulnerable to run risks. Noting that "the potential for the increased use of stablecoins as a means of payment raises a range of prudential concerns," the report states:" If stablecoin issuers do not honor a request to redeem a stablecoin, or if users lose confidence in a stablecoin issuer's ability to honor such a request, runs on the arrangement could occur that may result in harm to users and the broader financial system."

The FSOC's view on stablecoins is shared by the Federal Reserve. The Board of Governors of the Federal Reserve System published its semi-annual Financial Stability Report Monday similarly warning about the run risks of stablecoins.

Among the risks discussed in the report is "funding risks," which "expose the financial system to the possibility that investors will 'run' by withdrawing their funds from a particular institution or sector," the report details, elaborating:" Some types of money market funds (MMFs) and stablecoins remain prone to runs."

In addition, "The stablecoin sector continued to grow rapidly and remains exposed to liquidity risks," the report notes.

The relentless selling of the yen looks to have come to an end and some green shoots of positive commentary are beginning to appear.

Goldman Sachs Group Inc. touted the currency as an ideal recession hedge and remarked on its 'significant value' in a note Tuesday. Scotiabank analysts made the case for a modest yen rebound in a report the same day.

The yen has been in freefall this year as the dovish Bank of Japan keeps local yields anchored to the floor while their Treasury equivalents surge on expectations for aggressive Federal Reserve rate hikes. It has fallen 12% against the dollar — the worst performance among Group-of-10 peers — with Japan's position as a commodity importer at a time of surging prices also weighing.

But the currency is now 20%-25% undervalued against the dollar and screens as the cheapest safe haven asset at a time when global recession risk is on the rise, according to Goldman strategist Karen Reichgott Fishman. Furthermore, dollar-yen has climbed to levels that imply greater odds of official intervention, she added.

A recession scenario could lead to a 15%-20% drop in the currency pair, she suggested.

"Over the short-term, amidst highly volatile global markets, the yen will likely be influenced by changes in Treasury yields and commodity prices," Fishman wrote. "At the same time, we expect the combination of cheap valuation, non-trivial risk of intervention, and, most importantly, rising odds of recession to open up paths to dollar-yen downside."

Fishman's more upbeat analysis on the prospects for the yen contrast with comments she made last month that government intervention would be unlikely to drive a 'sustained appreciation' in the currency.

The yen traded around the ¥130.40 level against the dollar Wednesday, not far off a 20-year low of ¥131.35 reached Monday. But the currency is little changed in May compared to recent months — it slumped over 6% in April and more than 5% in March.

While longer-term headwinds for the currency remain intact, the "bear trend" may be slowing, opening up the door for a modest reversal, wrote Scotiabank analysts Shaun Osborne and Juan Manuel Herrera.

"Basically, the yen is heavily oversold," they said.

Views the yuan will drop further are gaining ground as signs emerge that China's central bank is preparing interest rates cuts to prop up a faltering economy.

The yuan has sharply weakened in recent weeks as China's economy slowed due to its zero-COVID lockdowns and as interest rates start rising in the U.S. The currency slid 5% since mid-April, touching 6.74 yuan per dollar in the Shanghai market on Tuesday, an 18-month low.

Furthermore, the country's central bank, the People's Bank of China, has set the yuan's reference rate in the weaker direction for three consecutive sessions through Tuesday, demonstrating it will tolerate the currency depreciating by a certain amount.

But the yuan may weaken even more. The PBOC appears to be laying groundwork for a rate cut now that it is urging commercial banks to cut deposit rates.

Last month, the Industrial and Commercial Bank of China, a major state-owned lender, cut two- and three-year deposit rates by 10 basis points to 2.6% and 3.25% for large accounts.

The weighted average rate for all new deposits nationwide stood at 2.37% for the period between April 25 and May 1, according to a report released Monday by the central bank, marking a 0.1-point drop from the previous week.

These cuts were triggered by the PBOC, which has urged commercial banks to lower deposit rates. Although nonbinding, a central bank's report issued on Monday offered incentives to lower deposit rates. Banks that fall in line will score points in macro prudential assessments, which evaluate lender health to maintain stability in the financial system.

The Chinese economy, which has slowed down largely due to Shanghai's COVID lockdown that began at the end of March, needs a shot in the arm. The restrictions disrupted logistics, and domestic demand has slumped.

The central bank aims to prop up the economy by boosting bank financing. By first lowering deposit rates, commercial banks lower their costs, creating a better environment for lending.

On April 25, the PBOC lowered the reserve requirement ratio for commercial banks by 0.25 to 0.5 percentage points, a move that also lowers costs for banks. It was the first time the reserve ratio has been cut since December, and the average rate for all banks fell to 8.1%, a low not seen since July 2006.

In addition, the central bank has returned 800 billion yuan ($119 billion) in profit to the central government this year, money that will be directed to companies and other entities, meaning the same amount of money is being supplied to the market. This would be equivalent to lowering the reserve ratio by 0.4 point, according to the PBOC.

After noting these cost-cutting measures for banks, many in the market believe that the PBOC is setting the stage to cut the loan prime rate, which functions as China's de facto policy rate.

"A rate cut will occur in May or June," said Lu Ting, chief China economist for Japanese brokerage Nomura Holdings.

One lingering concern is the risk that a sharply weaker yuan will trigger capital flight. If China goes in the reverse direction of the rate hikes taking place in the U.S. and Europe, it may create pressure on international investors to sell off Chinese government bonds and other assets. It is believed that the PBOC is monitoring the yuan's movement closely in the run-up to its monetary decision.

The turbulence in global markets is throwing a lot of mixed signals, but there's one that everyone is agreeing on: this is a very bullish time for the U.S. dollar.

Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp. and Societe Generale SA are all telling clients that as long as fear runs through markets, the U.S. currency will keep charging higher.

"There's no other alternative," said Kit Juckes, chief FX strategist at Societe Generale. "If we get one big single bad event in the world, or a big big fall in equities, or a geopolitical event, the dollar will spike higher, so certainly nobody wants to be short of it."

The clamor for the safest of safe havens, the Federal Reserve's aggressive rate hikes and global shocks from the war in Ukraine and China lockdowns are all driving more cash into the dollar.

It's a market force that will raise the buying power of Americans facing inflation, but also make exports less attractive. The stronger dollar will tighten financial conditions at a time when many economists are warning about the prospect for a recession.

The Bloomberg Dollar Spot Index has surged 5.4% since the start of April and near the strongest levels on record. The currency is at US$1.05 against the euro and more analysts have started raising the possibility that the two could soon trade at parity.

More money is being concentrated in dollars as a result of the selloff in stocks and bonds, said Kamakshya Trivedi, the co-head of global FX and interest rates at Goldman Sachs. The bank estimates that investors have sold US$65 billion in stock and bond funds over the past month, the first major outflows since the pandemic chaos of early 2020. On top of that, flow data show that demand for major currencies is contracting.

Some strategists are starting to add caution that the dollar is looking overvalued. The currency is the most expensive in the G-10 based on real effective exchange rates, according to the Bank of International Settlements.

"Positioning is increasingly tilting towards the long USD trade," said Jeremy Gatto, a portfolio manager on Unigestion's cross asset solution's team. "Momentum is bound to slow."

The dollar hovered near a two-decade high against major peers on Wednesday, ahead of a key reading on inflation that should provide clues on how aggressive the Federal Reserve will be in tightening monetary policy.

The dollar index, which measures the currency versus six rivals, was around flat at 103.92, not far from the high of 104.49 reached at the start of the week for the first time since December 2002.

The euro languished at 1.05305, continuing to trade mostly sideways since plumbing a more than five-year low at 1.04695 at the end of last month.

The yen continued to get some respite from a pause in the recent relentless rise in benchmark U.S. Treasury yields, trading little changed at 130.40 per dollar, after dipping to a more than two-decade low of 131.35 on Monday.

Investors will be closely watching the April U.S. consumer price index reading later on Wednesday for any signs inflation may be starting to cool, with expectations calling for a 8.1% annual increase compared with an 8.5% rise recorded in March.

After the Fed raised its benchmark overnight interest rate by 50 basis points last week, the largest hike in 22 years, investors have been attempting to assess how aggressive the central bank will be.

Markets are priced for another hike of at least 50 basis points at the central bank's June meeting, according to CME's FedWatch Tool.

The greenback has climbed nearly 9% this year amid an increasingly hawkish Fed, as inflation burned hotter than policymakers had expected.

Commonwealth Bank of Australia sees the risk tilted to further gains from here.

"The USD's reaction to the CPI will be asymmetrical in our view," CBA currency strategist Joseph Capurso wrote in a client note.

"A positive surprise will encourage markets to increase pricing for a 75 (basis point) increase in the Funds rate later in the year and support the USD, while a negative surprise will keep pricing for 50bp increases in June and July intact and leave the USD steady."

The euro "remains heavy" above $1.05, he wrote, and a strong CPI print could push the Australian dollar below $0.69.

The Aussie ticked up 0.17% to $0.6951 on Wednesday, but not bouncing much from the 22-month trough of $0.6911 touched on Monday.

Sterling also struggled near a 22-month low at $1.2262 from the start of the week, last trading flat at $1.2323.

Bitcoin nursed its wounds after dropping to the cusp of $30,000 this week for the first time since July of last year, changing hands at $30,758.92.

1. Xi Jinping speaks with Macron: Vigilance against bloc confrontation, which poses a bigger and more persistent threat.

2. China's Foreign Ministry: The U.S. revision of the "fact sheet of U.S.-Taiwan relations" will surely invite trouble.

3. Yoon Suk-yeol takes office as South Korea's new president, and his internal and external policies may be totally different from Moon Jae-in's five-year legacy.

4. Google is again hit by an antitrust lawsuit: dating-app giant suing Google over "in-app payment".

Chinese President Xi Jinping spoke by phone with French President Emmanuel Macron on the afternoon of May 10.

Over the past five years, Mr. President and I have maintained close contact, leading China-France relations to keep a positive development momentum, promoting bilateral cooperation to achieve fruitful results, and showing a sense of responsibility as major countries in addressing climate change and protecting biodiversity, and other issues, Xi said, according to Xinhua News Agency. In the face of the world's unprecedented changes in a century, China and France, as permanent members of the UN Security Council and independent powers, should adhere to the original intention of establishing diplomatic relations of "independence, mutual understanding, far-sightedness, mutual benefit, and win-win situation", adhere to the positioning of a close and lasting comprehensive strategic partnership, respect each other's core interests and major concerns, and coordinate and cooperate closely at bilateral, Sino-European, and global levels. China is willing to continue to work closely with the French side at all levels to promote the healthy development of Sino-French relations and maintain world peace and stability.

In response to a recent revision of the "fact sheet of U.S.-Taiwan relations" by the U.S. Department of State, Chinese Foreign Ministry spokesman Zhao Lijian said on May 10 that such Political manoeuvres on the Taiwan issue and attempts to change the status quo in the Taiwan Strait will surely invite trouble.

The inauguration ceremony of South Korea's new president was held in front of South Korea's National Assembly building in Yeouido, Seoul on the morning of May 10. Yoon Suk-yeol, aged 61, the conservative candidate who won the election in March this year, was sworn in as the 20th president of South Korea. The new South Korean president, a former Prosecutor General who was elected by the conservative party, faces the challenges of governing with the growing tensions on the peninsula, the ongoing stalemate and potential escalation of the Russia-Ukraine conflict, the risks of global supply chains, and inflation, as well as the highly torn ideological confrontation within South Korean.

The dating-app Tinder under the U.S. dating-app giant Match Group is known as the world's most popular dating app.

09:30 China CPI YoY (Apr)

09:30 China PPI YoY (Apr)

14:00 Germany CPI Final YoY (Apr)

16:00 China Social Financing Scale (Apr)

--China M2 Money Supply YoY (Apr)

20:30 U.S. CPI YoY (Not SA) (Apr)

--U.S. Core CPI YoY (Not SA) (Apr)

22:30 U.S. EIA Crude Stocks Changes for the Week Ended May 6

--U.S. EIA Gasoline Stocks changes for the Week Ended May 6

--U.S. EIA Refined Oil Stocks Changes for the Week Ended May 6

22:30 U.S. EIA Weekly Crude Oil Imports for the Week Ended May 6