Dollar Climbs as Risk Off Impulses Build

May 12, 2022

Win Thin

U.S. yields are lower as risk off sentiment takes hold; April U.S. PPI data now takes center stage; Fed officials remain hawkish; Dallas Fed named Lorie Logan as its next president; the heavy slate of UST issuance concludes; both Mexico and Peru are expected to hike rates 50 bp
More ECB officials are on board with July liftoff; yet ECB tightening expectations remain subdued; U.K. monthly data dump was weaker than expected; BOE tightening expectations have cooled; Sweden reported higher than expected April CPI
The summary of opinions from the April BOJ meeting came across as universally dovish; Japan reported March current account data; HKMA intervened to defend the HKD trading band, as expected

The dollar is firm as risk off sentiment takes hold. DXY is trading at a new cycle high near 104.539 and we continue to target the 2002 high near 107. The euro is trading at a new cycle low near $1.0420 despite hawkish ECB comments (see below) and we continue to target the January 2017 near $1.0340. After that, we have to start talking about parity. USD/JPY is trading below 129 due to risk off impulses but once this episode passes, we believe the pair will resume weakening. BOJ is showing no signs of concern (see below) and so we continue to target the January 2002 high near 135.15. Sterling has an outside down day yesterday and has seen follow-through losses today on weaker than expected data (see below). Cable is trading at a new cycle low near $1.2165 and we look for a test of the May 2020 low near $1.2075. After that, we have to start talking about the March 2020 low near $1.1410. With U.S. yields likely to rise again, the dollar should continue to benefit from the so-called dollar smile.

AMERICAS

U.S. yields are lower as risk off sentiment takes hold. The 10-year yield is trading near 2.83%, down from the cycle high near 3.20% from Monday. The 10-year breakeven inflation rate fell as low as 2.63% yesterday but has since recovered to 2.73%. Similarly, the 2-year UST yield is trading near 2.58% from a peak near 2.85% last week. Market expectations for Fed tightening picked up a bit after the CPI data but have since fallen back. The swaps market saw a terminal Fed Funds rate of around 3.25% yesterday but it is back to 3.0% now, where it started the week. The dollar is gaining today despite falling yields, which illustrates the so-called dollar smile whereby it gains during periods of risk off as well as in periods of strong U.S. data and rising yields. Either way, the dollar’s climb is likely to continue for the time being.

April U.S. PPI data now takes center stage. Headline is expected at 10.7% y/y vs. 11.2% in March, while core is expected at 8.9% y/y vs. 9.2% in March. Keep an eye on the m/m gains to slow from 1.4% and 1.0% in March, respectively. Yesterday, CPI offered a mixed bag but the underlying message was that inflation is not going away anytime soon. Headline came in at 8.3% y/y vs. 8.1% expected and 8.5% in March, while core came in at 6.2% y/y vs. 6.0% expected 6.5% in March. The m/m gain for headline slowed to 0.3% vs. 1.2% in March, but for core rose to 0.6% vs. 0.3% in March. While any sort of improvement in the inflation numbers is welcome, we are a long ways off from the 2% target for core PCE and so we believe the data will do nothing to deter the Fed from hiking rates aggressively at the coming meetings. Weekly jobless claims will also be reported.

Fed officials remain hawkish. Yesterday, Bostic said he would favor moving rates above neutral if inflation stays too high. Bostic added that he supports Powell’s intent to hike rates by 50 bp in both June and July but didn’t rule out a 75 bp move in the future. As we’ve noted before, we feel that Powell erred by taking 75 bp off the table and that other Fed officials are working hard to get it back on the table. That said, WIRP suggests market pricing remains centered around 50 bp hikes in June, July, and September, followed by 25 bp hikes in December and February that would take the Fed Funds rate up to 3.0%. This pricing will of course be subject to change and we expect a higher terminal rate. Daly speaks today.

The Dallas Fed named Lorie Logan as its next president. She goes to Dallas from the New York Fed, where she currently oversees implementation of Fed policy as the manager of its $9 trln securities portfolio (SOMA). She is also the head of Market Operations, Monitoring, and Analysis (MOMA) and so brings a wealth of knowledge about markets as well as the world’s financial plumbing. Logan succeeds Robert Kaplan, who stepped down last year following unflattering revelations about personal trading activity during the Fed’s pandemic policy response. Her appointment is effective August 22. The Dallas Fed is not a voter this year but will become one in 2023. In related news, Jefferson was confirmed to the Fed’s Board of Governors by the full Senate yesterday. Reports suggest a full Senate vote will be held today on Powell, who will easily pass. Barr’s committee hearing will reportedly be held May 19. Should he be confirmed, the Board of Governors will have no vacancies for the first time since the Trump administration.

The heavy slate of UST issuance concludes. $22 bln of 30-year bonds will be sold today. At the last auction, indirect bidders took up 65.2%, the bid/cover ratio was 2.30, and the high yield was 2.815%. So far this week, demand has been strong. Yesterday, the $36 bln of 10-year notes saw strong demand. Indirect bidders took 70.3% vs. 64.3% at the previous auction, the bid/cover ratio was 2.49 vs. 2.43, and the high yield was 2.943% vs. 2.720%. Similarly, Tuesday’s $45 bln sale of 3-year notes saw indirect bidders take up 62.0% vs. 53.4% at the previous auction, the bid/cover ratio was 2.59 vs. 2.48, and the high yield was 2.809% vs. 2.738%.

Banco de Mexico is expected to hike rates 50 bp to 7.0%. Earlier this week, April headline inflation came in at 7.68% y/y vs. 7.45% in March, while core came in at 7.22% y/y vs. 6.78% in March. Minutes from the March meeting suggest policymakers mostly favored continuing the recent pace of 50 bp hikes. One noted that market expectations for tightening were too high, while another said raising rates too fast could hit growth. The swaps market is pricing in 275-300 bp of further tightening over the next 12 months that would see the policy rate peak between 9.25-9.50%. March IP will also be reported and is expected at 2.1% y/y vs. 2.5% in February.

Peru central bank is expected to hike rates 50 bp to 5.0%. CPI rose 7.96% y/y in April, the highest since May 1998 and further above the 1-3% target range. As such, we see risks of a hawkish surprise this week. At the last meeting April 7, the bank forecast inflation to slow starting in July and return to target around Q2 or Q3 2023. This seems too optimistic and so markets should be prepared for a longer tightening cycle. Bloomberg consensus sees the policy rate peaking near 5.25% in Q4 but that is clearly unrealistic.

EUROPE/MIDDLE EAST/AFRICA

More ECB officials are on board with July liftoff. Kazamir tweeted from the EBRD meeting in Marrakesh that “Ready to hike in July -- and not just the beautiful Atlas Mountains here in #Morocco.” Of course, this is a bit anti-climactic after President Lagarde pretty much sealed the deal earlier this week. More importantly, there seems to be a growing consensus that the deposit rate will move into positive territory by year-end, which would require three hikes to accomplish. De Cos and Makhlouf speak today.

Yet ECB tightening expectations remain subdued. While liftoff July 21 remains fully priced in, the swaps market is only pricing in 125 bp of tightening over the next 12 months followed by another 50 bp of tightening priced in over the following 12 months that would see the deposit rate peak near 1.25% vs. 1.75% at the start of this week.

U.K. monthly data dump was weaker than expected. With the Bank of England warning of recession risks, the data have taken on more importance. March GDP came in at -0.1% m/m vs. 0.0% expected and a revised 0.0% (was 0.1%) in February. As a result, Q1 GDP came in at 0.8% q/q vs. 1.0% expected and 1.3% in Q4. Private consumption, government spending, and net exports were drags on growth and somewhat stronger investment could not fully offset. Elsewhere, IP came in at -0.2% m/m vs. 0.0% expected and a revised -0.3% (was -0.6%) in February, construction output came in at 1.7% m/m vs. 0.2% expected and a revised 0.2% (was -0.1%) in February, index of services came in at -0.2% m/m vs. 0.1% expected and a revised 0.0% (was 0.2%) in February, and the trade balance came in at -GBP11.55 bln vs. -GBP7.8 bln expected and a revised -GBP9.2 bln (was -GBP9.26 bln) in February. The data confirm that the U.K. economy ended Q1 on a weak note and the loss of momentum is like to carry over into Q2, as payroll tax and household energy caps were hiked in April.

Bank of England tightening expectations have cooled. WIRP suggests another 25 bp hike is priced in for the next meeting June 16. Looking ahead, the swaps market is pricing in 125 bp of total tightening over the next 12 months that would see the policy rate peak near 2.25% vs. 2.5% at the start of this week. Deputy Governor Ramsden warned that “Certainly on the basis of my current assessment of prospects, we’re not there yet in terms of how far monetary policy has to tighten. I‘m still very, very supportive of the forward guidance that there may well need to be further tightening in the coming months.” He said that the June 16 meeting “will be a chance to take stock -- in this extraordinary period we really are learning things every day. I don’t think we’ve gone far enough yet on bank rate, but I do think that what we’ve already done is having an impact.”

Sweden reported higher than expected April CPI. Headline came in at 6.4% y/y vs. 6.2% expected and 6.0% in March, while CPIF came in at 6.4% y/y vs. 6.2% expected and 6.1% in March. CPIF was the highest since and December 1991 and further above the 2% target. No wonder the Riksbank delivered a hawkish surprise last month and started liftoff. Next policy meeting is June 30 and another 25 bp hike then seems likely. The bank said at the April meeting that it expects another two or three more hikes this year and also announced a slower pace of asset purchases in H2. The bank adjusted its expected rate path upward and saw the policy rates “somewhat below 2%” in three years’ time. Contrast this rather modest path with the swaps market, which is pricing in 200 bp of tightening over the next 12 months followed by another 50 bp over the subsequent 12 months that would see the policy rate peak near 2.75%, up from 2.5% right after the April hike.

ASIA

The summary of opinions from the April 27-28 Bank of Japan meeting came across as universally dovish. One policymaker said the bank shouldn’t hesitate to add easing if needed, while one said it’s vital to support the economy with easing. One said the challenge is still to escape from low inflation, while one said it’s still hard to achieve the stable inflation target. One said that yen deprecation works positively for the economy now, while one said any policy targeting the exchange rate is inappropriate. One said its appropriate to keep forward guidance unchanged, while one said clarifying the bank’s stance helps maintain the appropriate yield curve. Bottom line: the BOJ remains largely unconcerned about rising inflation and the weak yen. Next policy meeting is June 16-17 and all signs point to continued dovishness from the BOJ.

Japan reported March current account data. An adjusted surplus of JPY1.56 trln was reported vs. JPY628 expected and a revised JPY523 bln (was JPY517) bln in January. However, the investment flows will be of most interest. March data showed that Japan investors were net sellers of U.S. bonds for the fifth straight month and the -JPY2.9 trln sold nearly matched the -JPY3.1 trln sold in February, which was the most since April 2020. Japan investors were net buyers (JPY149 bln) of Australian bonds for the second straight month but were net sellers of Canadian bonds (-JPY188 bln) for the second straight month. They were net sellers of Italian bonds (-JPY92bln) after two months of net buying. Of note, this was the last month of FY21 and so there were likely some year-end distortions.

HKMA intervened to defend the HKD trading band, as expected. HKMA bought HKD for USD several times as USD/HKD tested the weak end of the trading band at 7.85 for the first time since early 2019. The total amount was not particularly large ($520 mln) but the commitment is there. This is quite the change from much of 2020, when inflows into Hong Kong and mainland China led to HKD strength that required the HKMA to sell HKD for USD at 7.75, the strong end of the band. We are writing an in-depth piece on the HKD peg but long story short, the peg will hold. Period.

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