Dollar Flat as Markets Await Fresh Drivers

October 26, 2021

Democrats may be nearing a compromise that could unlock trillions in fiscal stimulus; regional Fed manufacturing surveys for October will continue to roll out; Brazil reports mid-October IPCA inflation
U.K. Chancellor Sunak will reportedly unfreeze public sector salaries next April; BOE tightening expectations are getting trimmed; Erdogan dropped his demand for ten Western ambassadors to be expelled from Turkey
Latest Asahi poll suggests the LDP will win a majority in this weekend’s general election; RBNZ Governor Orr warned of a period of elevated global inflation that may require policy responses; next RBNZ meeting is November 24 and it is expected to hike rates again; borrowing rates in China fell after the PBOC injected a net CNY190 bln into the system; Korea reported softer Q3 GDP

The dollar is flat as markets await fresh drivers. DXY is trading around 93.75, right in the middle of the 93.50-94.00 range that has largely held in recent days. USD/JPY is poking above 114 for the first time this week but feels somewhat heavy. Elsewhere, the euro is trading slightly higher after testing support near $1.16, while sterling is trading back above $1.38 for the first time this week. With U.S. data remaining firm, the Fed is ready to taper and markets are fully pricing in Q3 22 Fed liftoff. As such, we believe the move higher in U.S. rates and the dollar will eventually pick up steam again.

AMERICAS

The Democrats may be nearing a compromise that could unlock trillions in fiscal stimulus. Senator Manchin said members of his party should be able to reach a deal this week on the framework for President Biden’s “human infrastructure” plan. Manchin said that he hadn’t deviated from his $1.5 trln limit on the package, but we would be surprised if the final total isn’t closer to $2 trln. His comments come after a weekend meeting with Biden and Senate Majority Leader Schumer. Stay tuned.

Regional Fed manufacturing surveys for October will continue to roll out. Richmond Fed is expected at 5 vs. -3 in September. Kansas City reports Thursday and is expected at 19 vs. 22 in September. Yesterday, Dallas Fed came in at 14.6 vs. 4.6 in September. This follows the Empire survey (19.8 vs. 34.3 in September) and the Philly Fed survey (23.8 vs. 30.7 in September). Most of these readings have been at or near historically high levels and so some moderation is to be expected. August S&P CoreLogic home prices, September new home sales (2.5% m/m expected), and October Conference Board consumer confidence (108.3 expected) will also be reported. There are no Fed speakers due to the media blackout.

Brazil reports mid-October IPCA inflation. Inflation is expected at 10.11% y/y vs. 10.05% in mid-September. If so, it would be a slight drop from 10.25% y/y posted in September and still well above the 2.25-5.25% target range. COPOM meets Wednesday and is expected to hike rates 125 bp to 7.5%. However, the market is split as nearly a third of the analysts polled by Bloomberg see a 100 bp hike and nearly another third see a 150 bp hike. After Bolsonaro announced further fiscal loosening, we see risks of a hawkish surprise. The swaps market is pricing in nearly 575 bp of tightening over the next twelve months, which we think is probably too much given COPOM’s already aggressive tightening.

EUROPE/MIDDLE EAST/AFRICA

U.K. Chancellor Sunak will reportedly unfreeze public sector salaries next April. The pay freeze was announced last November and has been in effect since April. However, government officials would not commit to raising public sector wages enough to offset the higher cost of living. The Treasury noted that any pay increases would be announced next year in response to recommendations made by government agencies and pay review boards. Reports suggest Sunak will also announce an increase in the national minimum wage to GBP9.50 per hour. He makes his budget speech tomorrow.

Bank of England tightening expectations are getting trimmed. WIRP suggests only 50% odds of liftoff November 4, down from being fully priced in at the start of last week. However, a hike at the next meeting December 16 remains fully priced in. Yesterday, MPC member Tenreyro said the bank should hold off on tightening as current price pressures are likely to be temporary. She stressed that hiking too soon could even have a disinflationary impact on the economy. She has always been one of the most dovish members of the MPC and so her comments are not that surprising.

President Erdogan dropped his demand for ten Western ambassadors to be expelled from Turkey. The ten embassies involved all issued identical statements confirming their compliance with the Vienna Convention on Diplomatic Relations. The moves were welcomed by Erdogan, who said the envoys had issued statements to undo the “slander” caused by their earlier joint statement asking Turkey to release a businessman and government critic who’s been jailed for four years. Erdogan said that “Our intention is never to cause a crisis. It’s about protecting our country’s sovereign rights.” This has helped the lira off of its record low but the currency is still saddled with awful fundamentals.

ASIA

The latest Asahi poll suggests the LDP will win a majority in this weekend’s general election. This is more favorable than the recent FNN poll, which suggested that the LDP would win less than 233 of the 465 seats in the lower house vs. 276 seats held before the Diet was dissolved. The Asahi poll also suggests that main opposition party CDP will win 109 seats, the same number it held before the Diet was dissolved. The conflicting polls support the view that it will be a very close race. Frankly, we are surprised that Prime Minister Kishida didn’t announce a fiscal package ahead of the vote in order to shore up support.

RBNZ Governor Orr warned of a period of elevated global inflation that may require policy responses. He noted that “Some of the price pressures we will see will lead to quite sustained, higher generalized prices. We’re already seeing that in food prices globally and energy prices, transport, at present.” Orr added that “We will have to look through some very obvious price shocks but to the extent that they are persistent and truly changing the price of the basket of goods and services we consume, then there will be monetary policy reactions.” Lastly Orr noted that the current inflationary episode caused by supply chain disruptions have proven to be more persistent than expected.

Next RBNZ meeting is November 24 and it is expected to hike rates again. According to WIRP, a 25 bp move is fully priced in, while a 50 bp move is about 25% priced in. Same goes for the February 23 meeting. After that, 25 bp hikes are priced in for the April 13, May 25, July 13, and August 17 meetings. Overall, the swaps market is pricing in 150-175 bp of tightening over the next twelve months. This is by far the most tightening expected for the major central banks, with the U.K. and Canada next with nearly 100 bp priced in over the next twelve months.

Borrowing rates in China fell after the PBOC injected a net CNY190 bln into the system. The overnight repo rate fell to 1.54% as a result, the lowest since late September. Liquidity is expected to remain tight as local governments are set to boost debt issuance at the urging of the central government in order to boost spending and growth. With growth likely to slow further, we continue to expect an outright RRR cut from the PBOC in order to give liquidity a more long-lasting boost.

Korea reported softer Q3 GDP. Growth was expected at 0.6% q/q but instead came in at half that at 0.3% vs. 0.8% in Q2. The y/y rate slowed to 4.0% from 6.0% in Q2, which is particularly disappointing given the low base effects from 2020. IP will be reported Thursday and is expected to fall -0.3% m/m vs. -0.7% in August. The central bank started its tightening cycle August 26 with a 25 bp hike to 0.75%. However, it stood pat in October, which supports our view that the tightening cycle will be fairly mild. Next policy meeting is November 25 and a 25 bp hike to 1.0% seems likely. However, there is a chance of a dovish surprise then if the data continue to weaken.

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