- The Fed continues to tilt more hawkish; U.S. rates market continues to adjust to the new Fed messaging; the week starts off quietly ahead of key inflation and retail sales data later this week
- Brexit tensions are back; calls for U.K. tax relief are growing; Norway CPI data were higher than expected
- Reports suggest China’s policymakers are encouraging greater consolidation in the property sector
The dollar is trading a bit firmer to start the week. After trading as low as 95.712 Friday, DXY is up modestly today and trading just below 96. The euro remains heavy after being unable to build on Friday’s gain and is trading back near $1.13 again. GBP continues to outperform but is still having trouble breaking above $1.36. Lastly, USD/JPY continues to struggle and is down for the fourth straight day and still recording a series of lower highs. Despite today’s drop back below 116, we continue to target the December 2016 high near 118.65. We expect dollar gains to resume but are certainly disappointed that the more hawkish Fed and higher U.S. yields (see below) have translated yet into larger dollar gains.
The Fed continues to tilt more hawkish. Barkin is the latest, saying that a March hike is “conceivable.” He joins Bullard, who has also said the same thing. Barkin noted that "If you've got an economy that continues the levels of unemployment that we're living through now, which of course is very healthy, with price pressures elevated, I think according to our mandate and framework, we need to move toward normalization." Barkin is not a voter this year but Bullard is. That said, we believe their view is becoming increasingly shared within the wider FOMC. WIRP now suggests nearly 90% odds for March 16 liftoff, and a fourth hike this year is getting priced in more and more. As a corollary of the accelerated timetable, we now believe balance sheet runoff is likely to come towards the beginning of H2 rather than toward s year-end, as previously thought.
The U.S. rates market continues to adjust to the new Fed messaging. The U.S. 2-year yield is trading at a new cycle high near 0.90%, while the U.S. 10-year yield is trading at a new cycle high near 1.81%. With breakeven inflation rates stable, the real 10-year yield continues to climb to -75 bp, the highest since mid-June. All of these moves are likely to continue and should underpin our strong dollar call for 2022. Lastly, the US curve steepening continues in force, with the 3-month to 10-year curve at a new cycle high of 168 bp, just short of the May 2021 high near 169 bp and the March 2021 high near 173 bp. This steepening is welcome and may help allay fears that the Fed tightening cycle will lead to a flat or even inverted yield curve.
The week starts off quietly ahead of key inflation and retail sales data later this week. Today, only November wholesale trade sales and inventories will be reported. There are no Fed speakers.
Brexit tensions are back. Foreign Minister Truss, who recently took over Brexit negotiations from Frost, said she’s prepared to unilaterally override parts of the deal if needed. She said she will put forward some “constructive” proposals this week when meeting her EU counterpart Sefcovic but remains willing to trigger Article 16 as “This safeguard clause was explicitly designed -- and agreed to by all sides -- to ease acute problems because of the sensitivity of the issues at play.” Frost also said he was willing to use Article 16 and so it appears that Truss will maintain the hard party line.
Elsewhere, calls for U.K. tax relief are growing. Cabinet minister Gove joined colleague Rees-Mogg in calling for Prime Minster Johnson to scrap the planned payroll tax hike to help fund that National Health Service. Between this and the expected surge in energy costs this spring, U.K. households face a fiscal cliff that is quite daunting, especially on top of the expected monetary tightening from the Bank of England. While the rate outlook has helped sterling outperform so far in 2022, we believe the fundamental outlook is shaky and will get even shakier as the headwinds mount.
Norway CPI data were higher than expected. Headline inflation came in at 5.3% y/y vs. 5.1% exp3cte and actual in November, while underlying inflation came in at 1.8% y/y vs. 1.4% expected and 1.3% in November. Next Norges Bank meeting is January 20 and rates are likely to remain steady at 0.50% after it hiked rates 25 bp at the last meeting December 16, as expected. Governor Olsen said then that “There is considerable uncertainty about the evolution of the pandemic. But if economic developments evolve broadly in line with the projections, the policy rate will most likely be raised in March.” New macro forecasts and an updated rate path were released last month and will be updated in March. While the growth and inflation forecasts were raised substantially, the expected rate path was surprisingly little changed. Swaps market is pricing in a terminal rate of 1.50% for the policy rate by end-2023, close to the tightening path that the bank has set out in its projections.
Reports suggest China’s policymakers are encouraging greater consolidation in the property sector. State-owned developers are reportedly being urged to take on troubled rivals through M&A activity. Officials in Guangdong province are reportedly facilitating meetings between struggling firms and their state-owned counterparts. While this may alleviate some concerns, it opens up another can of worms as the state basically becomes responsible for any of the contingent liabilities. That said, it is another muddle-through approach that may kick the can down the road again. This is a problem that isn’t going away anytime soon. In related news, shares of troubled developer Shimao jumped on reports that it’s in talks with bigger rivals on asset disposals.