Dollar Steady as Markets Await Fresh Drivers

January 11, 2023

Win Thin

Markets should take heed of recent signs that global inflation may not have peaked yet; indeed, we continue to believe markets are underestimating the Fed; there are no Fed speakers nor U.S. data today
Eurozone countries reported mixed data; ECB officials remain hawkish
BOJ survey showed a deteriorating outlook for households; BOJ tightening expectations remain elevated; Australia November CPI ran hot; Australia also reported firm November retail sales

The dollar is steady as markets await fresh drivers. DXY is trading flat near 103.271 after trading at a new cycle low Monday near 102.944. Next target is the May low near 101.297. The euro is trading flat near $1.0740 after trading at a new cycle high Monday near $1.0760. Next target is the May low near $1.0785 and after that is the late April high near $1.0935. Sterling is trading a little lower near $1.2120 and a break above $1.2215 is needed to set up a test of the December high near $1.2445. USD/JPY remains stuck in the middle of recent trading ranges near 132.60. While we believe that the current dollar weakness is overdone, we have to respect the price action. Until a more hawkish Fed narrative emerges, the dollar is likely to remain under pressure.

AMERICAS

Markets should take heed of recent signs that global inflation may not have peaked yet. With markets bulled up on expectations of further easing in price pressures in tomorrow’s U.S. CPI data, we believe developments Down Under are worth discussing. Overnight, Australia reported higher than expected CPI data that belies the narrative that the inflation battle has been won quickly and relatively painlessly (see below). And it’s not just Australia. Yesterday, Norway reported higher than expected underlying inflation and on Friday, Sweden is expected to report accelerating inflation at both the headline and underlying level. At the ECB, the hawks are focusing on the continued rise in core inflation (see below). As a result, markets will likely have to reprice tightening expectations for several major central banks.

Indeed, we continue to believe markets are underestimating the Fed. WIRP suggests a 25 bp hike February 1 is fully priced in, with nearly 30% odds of a larger 50 bp move. Another 25 bp hike March 22 is fully priced in, while one last 25 bp hike in Q2 is nearly 50% priced in that would take the Fed Funds rate ceiling up to 5.25%. However, the swaps market continues to price in an easing cycle by year-end and we just don’t see that happening. Similarly the swaps market is pricing in high odds of H2 easing cycles for Canada, New Zealand, and Sweden, as well as low odds for the ECB and BOE. In our view, none of these central banks are easing in 2023.

There are no Fed speakers nor U.S. data today. As a result, markets are likely to drift in the direction of recent trends driven by the Fed pivot narrative. That is, higher equities, lower bonds yields, and weaker dollar. While we continue to disagree with this narrative, we have to respect the price action until markets see evidence that this favorable outlook is much too optimistic. Of note, Fed Chair Powell offered no insights on Fed policy in yesterday’s appearance.

EUROPE/MIDDLE EAST/AFRICA

Eurozone countries reported mixed data. Spain reported November IP at -0.7% m/m vs. -0.4% expected and a revised -0.6% (was -0.4%) in October. The y/y rate fell to -1.1%, the worst since February 2021. Elsewhere, Italy reported November retail sales at 0.8% m/m vs. -0.3% expected. Italy reports IP Friday that is expected at 0.4% m/m vs. -1.0% in October. Eurozone-wide IP and trade data will also be reported Friday and is expected at 0.5% m/m vs. -2.0% in October.

ECB officials remain hawkish. Holzmann said “As long as core inflation isn’t peaking, the change in headline inflation won’t make a change in our determination.” He added that while there’s hope that headline inflation has peaked, that’s not the case for the core reading, which must be watched closely. ECB tightening expectations remain steady. WIRP suggests a 50 bp hike February 2 is almost fully priced in, followed by 75% odds of another 50 bp hike March 16. A 25 bp hike May 4 is nearly priced in, while a last 25 bp hike in Q3 is nearly priced in that would see the deposit rate peak near 3.5% vs. 3.75% last week. If inflation continues to slow, the expected peak rate is likely to move closer to 3.25% and perhaps even to 3.0%, which is where it stood back in mid-December. Vujcic, Villeroy, and de Cos also speak today.

ASIA

Bank of Japan survey showed a deteriorating outlook for households. 53% of households said their economic livelihood has worsened from a year ago, the highest reading in nearly 13 years, while only 4% said it has improved and 42% said it’s hard to judge. A record 68% of respondents cited inflation as a very important factor that will be taken into account for the upcoming year’s spending plans. Lastly, households’ inflation forecast for the next 12 months doubled to a record 10%. We believe this is a major reason why the BOJ unexpectedly tweaked YCC last month; that is, Prime Minister Kishida is concerned that high inflation is eroding his popular support and pressured the BOJ to take action. With inflation still rising, we think the bank will come under pressure to take further steps towards tightening.

BOJ tightening expectations remain elevated. Nothing is expected at next week’s meeting January 17-18, though another tweak to YCC is possible. WIRP suggests nearly 40% odds of liftoff at the March 9-10 meeting and 95% at the April 27-28 meeting. Given the recent dynamics, we believe liftoff is likely to come earlier than we previously anticipated, with significant risks of a move in Q2 vs. H2 seen previously. Given Kuroda’s penchant for surprises, we cannot rule anything out right now and even Q1 is possible.

Australia November CPI ran hot. Headline inflation came in a tick higher than expected at 7.3% y/y vs. 6.9% in October, while trimmed mean came in a tick higher than expected at 5.6% y/y vs. a revised 5.4% (was 5.3%) in October. Headline matched the cycle high from September and moved further above the 2-3% target range. At the last policy meeting December 6, the Reserve Bank of Australia hiked rates 25 bp to 3.10% while Governor Lowe said “The board expects to increase interest rates further over the period ahead, but it is not on a pre-set course. The size and timing of future interest rate increases will continue to be determined by the incoming data.” Next policy meeting is February 7. WIRP suggests nearly 65% odds of a 25 bp hike, while the swaps market is pricing in a peak policy rate near 3.85%. Updated forecasts will come at that meeting.

Australia also reported firm November retail sales. Sales came in at 1.4% m/m vs. 0.6% expected and a revised 0.4% (was -0.2%) in October. The y/y rate slowed due to high base effects but is likely to be boosted in December by low base effects. Bottom line: the economy remains robust and the RBA still has work to do in order to slow it. We also note that it’s not just Australia; Canada and New Zealand are still experiencing robust growth and persistent price pressures despite very aggressive tightening cycles. The important lesson for markets is not to underestimate central bank capacity to continue tightening. Certainly, markets should not be pricing in easing cycles for H2. “Higher for longer” is the mantra for most central banks, not just the Fed.

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