Dollar Steady Ahead of FOMC Decision

November 03, 2021

The FOMC is expected to announced tapering when its two-day meeting ends this afternoon; ADP private sector jobs will be the data highlight; ISM services PMI for October will also be reported
ECB President Lagarde is pushing back harder against market tightening expectations; U.K. reported firm final services and composite PMI readings; Poland is expected to hike rates 25 bp to 0.75%; Turkey October CPI came in slightly below expectations
New Zealand reported stronger than expected jobs data; China’s leadership has confirmed that more support measures are in the pipeline; Malaysia kept rates steady at 1.75%, as expected; oil prices are down nearly 2% overnight as the risk of higher supply from OPEC grows

The dollar is holding steady ahead of the FOMC decision this afternoon. DXY is trading flat just above 94.0. The euro continues to trade heavy just below $1.16 as the post-ECB euphoria wears off, while sterling is still trading close to the weakest level since October 13 near $1.3620 ahead of the BOE decision tomorrow. USD/JPY is trading just below 114, while NZD is the best performing major after New Zealand reported very strong jobs data (see below). So much has been priced in for the Fed that there is some risk of some profit-taking after the decision. Yet when all is said and done, we expect U.S. yields and the dollar to continue rising.

AMERICAS

The FOMC is expected to announce tapering when its two-day meeting ends this afternoon. At this point, the Fed has managed expectations perfectly in terms of preparing the markets for what is likely to be speed tapering. Most Fed officials seems to agree that it’s better to get tapering over as quickly as possible in order to leave the Fed maximum flexibility to hike rates when needed. The most likely path for tapering has already been flagged by the Fed, which would reduce asset purchases by $15 bln per month ($10 bln UST and $5 bln MBS) starting this month so that QE effectively ends mid-2022.

The market has taken the process a step further and is pricing in nearly 50% odds for liftoff in Q2. Q3 liftoff is already fully priced in, as is another hike in Q4. This is much more aggressive than what the Fed itself anticipates, at least in the Dot Plots. The Fed has tried to say that tapering has no impact on the tightening timetable but so far, this hasn’t worked. We suspect Chair Powell and the Fed will try to push back a bit against such aggressive tightening expectations, but we are not sure that the market will listen. Next updated forecasts and Dot Plots will come at the December meeting.

ADP private sector jobs will be the data highlight. A gain of 400k is expected vs. 568k in September. Weekly jobless claims continue to fall to pandemic lows, supporting the outlook for solid October ADP and NFP numbers. For NFP, consensus sees 450k jobs added vs. 194k, with the unemployment rate expected to fall a tick to 4.7%. Average hourly earnings are expected to accelerate to 4.9% y/y from 4.6% in September, adding to inflation concerns.

ISM services PMI for October will also be reported. Services PMI is expected at 62.0 vs. 61.9 in September. Keep an eye on the employment component, which stood at 53.0 in September. Earlier this week, October ISM manufacturing PMI came in at 60.8 vs. 60.5 expected and 61.1 in September, with employment coming in at 52.0 vs. 50.2 in September. In addition, the Fed regional manufacturing surveys were mostly stronger in October, while the Chicago PMI came in at a whopping 68.4 last week, the highest since July. As such, we see upside risks to today’s PMI reading. September factory orders (0.1 m/m expected) will also be reported.

EUROPE/MIDDLE EAST/AFRICA

ECB President Lagarde is pushing back harder against market tightening expectations. She noted that “In our forward guidance on interest rates, we have clearly articulated the three conditions that need to be satisfied before rates will start to rise. Despite the current inflation surge, the outlook for inflation over the medium term remains subdued, and thus these three conditions are very unlikely to be satisfied next year.” Madame Lagarde appears to be doing some damage control after her comments on market expectations right after the ECB decision were seen as lackluster. Of note, the swaps market is pricing in 7 bp of tightening over the next twelve months, down from 11 bp yesterday and over 20 bp right after Thursday’s decision. As such, Lagarde’s efforts seem to be working.

U.K. reported firm final services and composite PMI readings. Services PMI rose to 59.1 vs. 58.0 preliminary, while the composite PMI rose to 57.8 from 56.8 preliminary. Construction PMI will be reported tomorrow. For the most part, recent U.K. data have disappointed and so today’s data are welcome news. That said, liftoff expectations have calmed somewhat this past week. The Bank of England decision is due out tomorrow and markets remain split. Bloomberg consensus sees steady rates but the 45 analysts polled are split 23-22. Elsewhere, WIRP suggests a little less than a two thirds chance of a hike tomorrow, but rising to 100% at the next meeting December 16. Sterling remains heavy, suggesting most of the good news and prospects for higher rates is largely priced in.

National Bank of Poland is expected to hike rates 25 bp to 0.75%. However, nearly half of the analysts polled by Bloomberg look for a larger 50 bp hike to 1.0%. October CPI inflation came in last week at 6.8% y/y, the highest since May 2001 and further above the 1.5-3.5% target range. As such, we see risks of a hawkish surprise today. The bank is already behind the curve and an aggressive move is needed this week to ease market concerns. Of note, the swaps market is pricing in over 200 bp of tightening over the next twelve months.

Turkey October CPI came in slightly below expectations, but there’s not much to cheer about. CPI rose 19.89% y/y and 2.39% m/m, while core inflation eased slightly to 16.82 y/y. Food prices eased somewhat, but higher energy costs and a weaker lira continue to drive inflation higher. Fundamentally, the problem here is a weak policy framework and the (in our view) misguided easing cycle the central bank has embarked on. Next policy meeting is November 18 and another 100-200 bp cut is likely. The lira continues on its downwards journey with USD/TRY now at 9.68.

ASIA

New Zealand reported stronger than expected Q3 jobs data. Employment jumped 2.0% q/q vs. 0.4% expected and a revised 1.1% (was 1.0%) in Q2. This drove the unemployment rate down to 3.4^ from 4.0% in Q2, and comes even as the participation rate rose to 71.2% from 70.5% in Q2. RBNZ tightening expectations remain high, with WIRP suggesting a 5 bp hike is fully priced in for November 24, with nearly 30% odds of a 50 bp move. Looking ahead, a similar outcome has been priced in for the February 23 meeting while the swaps market sees 175 bp of tightening over the next twelve months. NZD is outperforming today on the data, bouncing higher off support at the 200-day moving average near .71 today.

China’s leadership has confirmed that more support measures are in the pipeline. Premier Li sees downward pressure on the economy and said that the government is considering new ways to help SMEs and to get financial institutions to support the economy. Policymakers are also considering supply side measures to ensure electricity and coal supply. On the monetary policy side, the PBOC reduced the amount of liquidity drain overnight. The background here is a combination of supply shocks (food, electricity, chips), negative sentiment from Evergrande, and a worsening Covid outlook. On the positive side, China’s Caixin service PMI held up well in October at 53.8, up slightly from the previous month. The yuan has been roughly steady over the last several sessions, but still trading at the stronger end of the year’s range.

Bank Negara Malaysia kept rates steady at 1.75%, as expected. CPI rose 2.2% y/y in September, well below the 4.7% peak from April. While the bank does not have an explicit inflation target, falling price pressures should allow it to maintain current rate through much of next year. The bank noted that headline inflation will average 2-3% this year and will remain “moderate” next year, while core inflation will average less than 1% this year vs. 0.5-1.5% previously edge higher next year but “remain benign.” Bloomberg consensus sees steady rates to mid-2022, with the first hike seen by end-2022.

COMMODITIES

Oil prices are down nearly 2% as the risk of higher supply from OPEC grows. The latest headlines suggest President Biden is applying pressure on the cartel, and specifically the UAE to increase output. The base case is still for an increase of only 400K barrels a day at the next meeting. This could trigger the U.S. to use its strategic reserves, but it’s far from certain they will. Japan has also voiced concern about OPEC’s decision and may also tap its strategic reserves.

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