Dollar Firm as U.S. Rates Continue to Move Higher

April 11, 2022

Win Thin

U.S. rates continue to move higher; Fed officials are likely to remain hawkish
France held its presidential election Sunday; U.K. began its monthly data dump on a soft note; BOE tightening expectations remain steady; Norway reported March CPI; Israel is expected to hike rates 15 bp to 0.25%
BOJ lowered its economic assessment for eight of the nine regions; the yen continues to weaken; China reported strong new loan and money supply data

The dollar remains firm as U.S. rates continue to adjust. DXY is flat on the day after seven straight up days and is trading just below 100. After the psychological 100 level, the March 2020 high near 103 is our next big target. The euro bounced after the French election (see below) but remains heavy near $1.09. A test of the March 7 low near $1.0805 is still in the cards. The relentless rise in USD/JPY continues as it is up for the seventh straight day and trading at a new cycle high near 125.55. Until the BOJ changes its ultra-dovish stance, the yen is likely to continue weakening. Sterling is enjoying a slight bounce but remains heavy and is trading just above $1.30. We still look for a test of the November 2020 low near $1.2855 and then possibly 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.

AMERICAS

U.S. rates continue to move higher. The 10-year yield traded at a new cycle high near 2.78% and is on track to test the October 2018 high near 3.26%. With inflation expectations remaining fairly steady, the real 10-year yield has risen to -0.13%, the highest since March 2020 and poised to move into positive territory for the first time since before the pandemic. The 2-year yield is trading near 2.60% and is on track to test the November 2018 high near 2.97%. As a result, the 2-year differentials continue to widen in the dollar’s favor.

Fed officials are likely to remain hawkish. Bostic, Bowman, Waller, and Evans speak today and are likely to confirm market expectations for a 50 bp hike next month. Indeed, WIRP suggests nearly 90% odds of back-to-back 50 bp hikes at the May 3-4 and June 14-15 FOMC meetings. Looking ahead, swaps market is pricing in nearly 275 bp of tightening over the next 12 months that would see the policy rate peak between 3.0-3.25%. We see room for the expected terminal rate to move even higher if inflation proves to be even more stubborn than expected.

EUROPE/MIDDLE EAST/AFRICA

France held its presidential election Sunday. No candidate won an outright majority and so a runoff well be held April 27 between Macron and Le Pen. Macron got 28% of the vote vs. 24% for Le Pen in the first round, with leftist Melenchon coming in third with 20%. One early poll shows Macron winning 54-46% in the second round, while another one is a lot closer at 51-49%. We warn of the so-called Bradley effect, which suggests that the polls will likely understate Le Pen’s support. If polls tighten up ahead of the runoff, we expect markets to become more jittery. The euro bounced on the headline results but remains heavy ahead of the ECB decision Thursday. A break above $1.1050 is needed to signal a deeper correction towards the March 31 high near $1.1185.

U.K. began its monthly data dump on a soft note. February GDP came in at 0.1% m/m vs. 0.2% expected and 0.8% in January, IP came in at -0.6% m/m vs. 0.3% expected and 0.7% in January, construction output came in at -0.1% m/m vs. 0.5% expected and a revised 1.6% (was 1.1%) in January, and services index came in as expected at 0.2% m/m vs. 0.8% m/m. Lastly, the trade deficit came in at -GBP9.26 bln vs. -GBP7.15 bln expected and a revised -GBP12.84 bln (was -GBP16.16 bln) in January. It appears that the U.K. economy is already slowing ahead of the upcoming hikes in the payroll tax and the cap on household energy costs. Labor market data will be reported tomorrow and CPI data will be reported Wednesday.

Bank of England tightening expectations remain steady. WIRP suggests another 25 bp hike to 1.0% is fully priced in for the next meeting May 5. Swaps market is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 2.5%. There are no BOE speakers scheduled for this week. Sterling is seeing a little bounce today off of Friday’s new cycle low near $1.2985. We look for an eventual test of the November 2020 low near $1.2855 followed by the September 2020 low near $1.2675.

Norway reported March CPI. Headline inflation came in at 4.5% y/y vs. 5.0% expected and 3.7% in February, while underlying came in at 2.1% y/y vs. 2.4% expected and 2.1% in February. Despite the lower than expected reading, headline accelerated for the second straight month to the highest since the cycle peak of 5.3% in December and further above the 2% target. At the last policy meeting March 24, Norges Bank hiked rates 25 bp to 0.75%, as expected. The updated rate path suggested a longer, greater tightening cycle ahead as the bank now sees the policy rate peaking near 2.5% in 2024 vs. 1.75% previously. The bank said the rate will mostly likely be hiked again at the June 23 meeting, adding “The committee was concerned with the prospect that the war in Ukraine could result in weaker-than-expected global growth amid rising inflation. If there are prospects of persistently high inflation, the policy rate may be raised more quickly.” Next policy meeting is May 5 and rates are likely to remain steady as the CPI data should allow the bank to stick to its forward guidance.

Bank of Israel is expected to hike rates 15 bp to 0.25%. However, some analysts look for a bigger 25 bp move. At the last policy meeting February 21, the central bank made a hawkish pivot and said it would being tightening over the next few months. March trade data will be reported Wednesday. March CPI will be reported Friday. Headline inflation is expected at 3.7% y/y vs. 3.5% in February, If so, it would be the highest since June 2011 and further above the 1-3% target range. Swaps market sees the policy rate peaking near 2% over the next 24 months.

ASIA

The Bank of Japan lowered its economic assessment for eight of the nine regions. The so-called Sakura Report was prepared for the upcoming policy meeting April 27-28 and is equivalent to the Fed’s Beige Book report. The downgrades reflect the impact of the omicron wave as well as supply-chain issues, according to the report. The weakness is likely to be reflected in the bank’s updated macro forecasts for that April meeting. Governor Kuroda stressed that "We will watch the impact of the novel coronavirus for the time being and take additional easing action without hesitation if necessary." Q2 data have been generally weak and Bloomberg consensus sees GDP coming in at -0.1% SAAR but then rebounding to 4.8% in Q2. That rebound is open to question and so the government is preparing another fiscal package to help boost growth.

The yen continues to weaken. USD/JPY traded at a new cycle high near 125.45. The June 2016 high near 125.85 is drawing near. After that, there are no significant chart points until the February 2002 high near 135.15. In terms of potential FX intervention, it seems highly unlikely given the BOJ’s ultra-dovish stance. It seems to us that until the BOJ shifts this stance, the fundamentals suggest that the yen is likely to continue weakening. Expect more verbal intervention, of course, but the central bank divergence couldn’t be more stark here.

China reported strong new loan and money supply data. New loans came in CNY3.13 trln vs. CNY2.74 trln expected and CNY1.23 trln in February, while aggregate financing came in at CNY4.65 trln vs. CNY3.55 trln expected and CNY1.19 trln in February. The news is certainly welcome but more needs to be done. PBOC sets its 1-year MLF rate sometime this week and is expected to cut it 10 bp to 2.75%. March CPI and PPI were also reported. CPI came in at 1.5% y/y vs. 1.4% expected and 0.9% in February, while PPI came in at 8.3% y/y vs. 8.1% expected and 8.8% in February. While inflation is creeping higher, the sole focus of policymakers is to boost growth.

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