Dollar Firm as FOMC Minutes Signal Aggressive QT

April 07, 2022
  • FOMC minutes tilted hawkish, as expected; the 2- to 10-year curve is no longer inverted; Mexico reports March CPI; Peru is expected to hike rates 50 bp to 4.5%
  • ECB minutes will be a major highlight; ECB tightening expectations remain heightened; eurozone data continue to come in weak; Poland delivered a hawkish surprise with a 100 bp hike to 4.5% vs. 50 bp expected
  • Japanese firms are starting to complain about the weak yen; China is signaling more stimulus measures will be seen soon

The dollar remains firm in the wake of hawkish FOMC minutes. DXY is up for the sixth straight day and made a new cycle high near 99.821 before easing to around 99.65. After the psychological 100 level, the March 2020 high near 103 is the next big target. The euro remains heavy after breaking below last week's low near $1.0945 and traded at a new cycle low today near $1.0865 before bouncing back to near $1.09. A test of the March 7 low near $1.0805 is still in the cards. The relentless rise in USD/JPY has paused today but the recent break above 123.65 sets up a test of last week’s high near 125.10. Sterling remains heavy just below $1.31 after having an outside down day earlier this week. We still look for an eventual test of last month’s cycle low near $1.30. After that is the November 2020 low near $1.2855 and then the September 2020 low near $1.2675. Between the likely return of risk-off impulses and the even more hawkish Fed outlook for tightening, we believe the dollar uptrend remains intact.


The FOMC minutes tilted hawkish, as one would expected. Many officials said one or more 50 bp hikes may be warranted, with many also saying they would have sought a 50 bp hike in March if not for Ukraine. The minutes also set out a likely scenario for balance sheet runoff, with a $95 bln monthly cap likely appropriate. This cap would be split $60 bln for USTs and $35 bln for MBS. Furthermore, the appropriate phase-in period for this cap was seen at three months or “modestly longer if market conditions warrant.” While the details may be tweaked,, the pace of QT is much faster this time around. Back in 2017, the phase-in period was 12 months and the final monthly caps were $30 bln for UST and $20 bln for MBS. So just as the Fed advertised, QT this time is likely to be much quicker and larger. Lastly, “the Committee was well placed to begin the process of reducing the size of the balance sheet as early as after the conclusion of its upcoming meeting in May.” If the Fed stays true to form, then a plan close to the one outlined here will be announced May 4 and implemented on May 15. Bullard, Bostic, and Evans speak today, while weekly jobless claims and February consumer credit ($18.1 bln expected) will be reported.

It’s worth noting that the 2- to 10-year curve is no longer inverted. That is because the 10-year is underperforming and that is not surprising in light of the Fed’s very aggressive plan for balance sheet runoff. QE has artificially depressed long yields and so QT should see a reversal of this. Furthermore, the 3- and 5- to 10-year curves are also steepening and both are the least inverted since the last week of March. This is a welcome development. While all of these curves may continue to flirt with inversion, it's more important to look at the 3-month to 10-year curve. That stands at a whopping 193 bp and is nowhere near inverting. As such, we continue to downplay recession risks here.

Mexico reports March CPI. Headline is expected at 7.38% y/y vs. 7.28% in February, while core is expected at 6.71% y/y vs. 6.59% in February. If so, this would be the highest headline reading since December and further above the 2-4% target range. Banco de Mexico minutes will also be released. At that March 24 meeting, the bank delivered the expected 50 bp hike to 6.5%. Swaps market is pricing in a peak policy rate of 9.0% over the next 12 months. Next policy meeting is May 12 and another 50 bp hike to 7.0% seems likely.

Peru central bank is expected to hike rates 50 bp to 4.5%. CPI rose 6.82% y/y in March, the highest since August 1998 and further above the 1-3% target range. The bank started the tightening cycle with a 25 bp hike to 0.5% back in August but has since hiked 50 bp at every meeting. We expect this pace to be maintained. Bloomberg consensus sees the policy rate peaking near 5.25% by year-end but we see upside risks. Meanwhile, Finance Minister Graham announced targeted tax cuts in response to more protests by farmers and truckers. The government announced a fuel tax cut and will propose a bill to exempt basic food items like chicken, eggs, flour, and noodles from sales taxes. This may provide some limited relief to CPI readings but it will be of a one-off nature.


European Central Bank minutes will be a major highlight. The March 10 decision was a hawkish hold as the ECB announced an end to PEPP that month. APP was increased to EUR40 bln per month in April from EUR20 bln but will fall to EUR30 bln in May vs. Q3 previously and will fall again to EUR20 bln in June vs. Q4 previously. The ECB also dropped the wording that rates could be lower than current levels. On the other hand, the bank dropped its pledge to end APP “shortly” before rates rise. This was meant to suggest that the early end to QE does not necessarily translate into an earlier start to rate hikes. Indeed, some officials have been playing that aspect up.

That said, ECB tightening expectations remain heightened. WIRP suggests liftoff July 21 is fully priced in. Swaps market is pricing in over 100 bp of tightening over the next 12 months, with another 70 bp of tightening is priced in over the following 12 months. This seems way too aggressive to us, especially in light of recent weakness in the real sector data. Since the last meeting, inflation data have missed to the upside while real sector data have missed to the downside. Next ECB decision is April 14 and the forward guidance then will be key after Bundesbank President Nagel said the ECB will decide on its next monetary policy steps at the June meeting and hinted at an imminent rate hike. Specifically, he said “We’ll take new decisions on the basis of numbers that we’ll see in June. What we’re seeing at the moment suggests that savers could potentially enjoy higher rates soon.”

Eurozone data continue to come in weak. February retail sales rose 0.3% m/ vs. 0.5% expected and 0.2% in January. Elsewhere, German IP rose the expected 0.2% m/m vs. a revised 1.4% (was 2.7%) in January. However, the near-term outlook is poor after Germany reported factory orders at -2.2% m/m yesterday.

National Bank of Poland delivered a hawkish surprise with a 100 bp hike to 4.5% vs. 50 bp expected. The bank said that it remains in a rate-hiking cycle but added that it’s hard to determine how high rates may go. It added that it may meet twice a month on rates and favors strong, decisive action. Next policy meeting is May 5 and another 100 bp hike to 5.5% seems likely. Minutes to yesterday’s meeting will be released May 6. Swaps market now sees the policy rate peaking near 6.0% over the next 12 months vs. 5.0% at the start of this week. After going slow at first, most of the CEE central banks have accelerated their tightening cycles. Latam remains the most hawkish but CEE is catching up. Asia is the notable laggard and is likely to remain that way in light of the massive China slowdown.


Japanese firms are starting to complain about the weak yen. Chamber of Commerce and Industry Chairman Akio Mimura warned that a weak yen has a bigger negative impact on the economy than positive. This follows recent comments from chairman of the Japan Iron and Steel Federation Eiji Hashimoto, who said that the risks from the weaker yen are “unprecedented.” Yet as we have pointed out numerous times, the weak yen is a natural by-product of the Bank of Japan’s ultra-dovish stance. If policymakers want to change the fundamental reason behind yen weakness, then they will have to shift their policy stance and we do not think they are ready to do this yet. With the recovery still evolving, we believe policymakers are concerned that a hawkish tilt from the BOJ would lead to excessive yen strength that derails this recovery. Stay tuned.

China is signaling more stimulus measures will be seen soon. The State Council pledged to use monetary policy tools at an “appropriate time” to boost the economy, citing worsening downside risks that have “intensified” and “exceeded expectations.” PBOC sets its 1-year MLF rate sometime next week and is expected to cut it 5 bp to 2.80%. Given the growing sense of urgency, we see risks of a dovish surprise. US-China interest differentials have narrowed sharply in recent months given the start monetary policy divergence seen between the PBOC and the Fed. This argues for a weaker yuan, which in turn will weight on returns to foreign investment.  

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