Dollar Limps into the Weekend

June 24, 2022

U.S. yields remain low as recession fears rise; the U.S. yield curve is flattening but nowhere near inverting; Fed Chair Powell broke no new ground in his testimony before the House; Fed expectations have softened a bit; housing data will remain in focus as weakness in that sector persists; Mexico hiked rates 75 bp to 7.75%, as expected
June German IFO business climate came in soft; ECB tightening expectations have softened; U.K. reported soft May retail sales; BOE tightening expectations have eased after the weak data; U.K. politics are heating up
Japan reported May national CPI readings; Philippines central bank downplayed the need for FX intervention

The dollar is soft as the week winds down. DXY is trading near 104.2 today and has yet to mount a serious challenge to the new cycle high from last week near 105.788. The euro remains heavy near $1.0550 as weak German IFO reading adds to recession risks (see below). The weakening trend in the yen has stalled, with USD/JPY trading near 135 after making a marginal new high for this cycle 136.70 earlier this week. As risk-off impulses fade and BOJ dovishness is maintained, we believe the pair will eventually test the August 1998 high near 147.65. Sterling has been unable to make a clean break above $1.33 as weak data and rising political risks weigh on the outlook (see below). For now, the period of consolidation continues but when all is said and done, we believe the U.S. economy will prove to be more resilient than the rest of DM and so we look for continued dollar gains.


U.S. yields remain low as recession fears rise. The 10-year yield traded as low as 3.00% yesterday after ending last week near 3.23% but has since recovered to 3.11% currently. Similarly, the 2-year yield traded as low as 2.87% yesterday after ending last week near 3.18% but has since recovered to 3.03% currently. We acknowledge that U.S. recession fears are likely to keep yields depressed near-term, but would add that we feel those fears are overblown. Yes, the U.S. economy is slowing but that is exactly what the Fed wants. We do not see any signs yet of an abrupt recession. When all is said and done, however, we believe monetary policy divergences remain the dominant driver for FX. As the U.S. economic outlook remains the strongest and the Fed the most hawkish relative to its DM peers, the dollar uptrend should remain intact.

The U.S. yield curve is flattening but nowhere near inverting. Yes, some portions of the curve have inverted but faithful readers will know that we favor the 3-month to 10-year curve as a recession signal. At 153 bp, it is the flattest since early March but still far from inverting. This suggests very low odds of recession over the next 12 months.

Fed Chair Powell broke no new ground in his testimony before the House. He reiterated that the Fed’s commitment to fighting inflation was “unconditional” and added that “We have a labor market that is sort of unsustainably hot and we’re very far from our inflation target.” Governor Bowman added to the hawkish chorus. She said “Based on current inflation readings, I expect that an additional rate increase of 75 bp will be appropriate at our next meeting as well as increases of at least 50 bp in the next few subsequent meetings, as long as the incoming data support them. Depending on how the economy evolves, further increases in the target range for the federal funds rate may be needed after that.”

Fed expectations have softened a bit. WIRP still suggests nearly 85% odds of a 75 bp hike in July, while 50 bp hikes are largely priced in for September and November. However, the swaps market is now pricing in a terminal Fed Funds rate near 3.50% vs. 3.75% at the start of this week. Bullard and Daly speak today and are likely to sound hawkish.

It’s worth noting that tightening expectations have softened for most major central banks. The slowdown is not just being felt in the U.S., but also in the eurozone and the U.K. Both ECB and BOE tightening expectations have been pared back too (see below) and so the 2-year differentials with the U.S. are moving back in the dollar’s favor. We are not yet near the recent cycle peaks but we’ll eventually get there. Why? Simply put, the U.S. economy went into this period of elevated risks in a much stronger position than the eurozone, U.K., and Japan. The U.S. is likely to prove more resilient and the Fed more willing to tighten policy aggressively. Stay tuned.

Housing data will remain in focus as weakness in that sector persists. May new home sales will be reported and are expected at -0.2% m/m vs. -16.6% in April. Keep an eye on supply of new homes, which has risen sharply in recent months. Earlier this week, May existing home sales came in at -3.4% m/m vs. -3.7% expected and -2.4% in April. This dragged the y/y rate down to -8.6% vs. -6.0% in April while the supply of existing homes for sale rose to 2.6 months, the highest since last August. Yet this is exactly what Fed tightening is supposed to do and should come as no surprise with mortgage rates rising sharply.

Preliminary June S&P Global PMI readings came in weak. Manufacturing came in at 52.4 vs. 56.0 expected and 57.0 in May, services came in at 51.6 vs. 53.3 expected and 53.4 in May, and the composite came in at 51.2 vs. 53.0 expected and 53.6 in May. This composite was the lowest since July 2020 and will surely feed recession fears. Elsewhere, regional Fed manufacturing surveys for June continue to come in soft. Kansas City Fed reported yesterday at 12 vs. 10 expected and 23 in May. Last week, Empire came in at -1.2 and Philly Fed came in at -3.3.

Banco de Mexico hiked rates 75 bp to 7.75%, as expected. What’s noteworthy is the that the decision was unanimous and the bank signaled willingness to continue hiking at this pace if necessary as it said “For the next policy decisions, the Board intends to continue raising the reference rate and will evaluate taking the same forceful measures if conditions so require.” Next policy meeting is August 11 and another 75 bp hike to 8.5% seems likely as price pressures remain high. Ahead of the decision, mid-June CPI came in higher than expected at 7.88% y/y, a new high for this cycle and further above the 2-4% target range. The swaps market is pricing in another 200 bp of tightening over the next 12 months that would see the policy rate peak near 9.75%.


June German IFO business climate came in soft. Headline came in at 92.3 vs. 92.8 expected and 93.0 in May. The current assessment came in at 99.3 vs. 99.0 expected and a revised 99.6 (was 99.5) in May, but expectations came in at 85.8 vs. 87.4 expected and 86.9 in May. IFO President Fuest warned that “The likelihood of a recession is clearly increasing. There’s a lot of pessimism about the gas situation.” Italy reported June consumer and manufacturing confidence, with the former falling to 98.3 vs. 102.7 in May and the later rising to 110.0 vs. a revised 109.4 (was 109.3) in May.

ECB tightening expectations have softened. WIRP suggests a 25 bp hike July 21 is fully priced in. Then, 50 bp hikes are no longer fully priced in for the subsequent three meetings on September 8, October 27, and December 15 that would take the deposit rate to near 1.0% by year-end vs. 1.25% at the start of this week. Looking ahead, the swaps market is now pricing in 250 bp of tightening over the next 24 months that would see the deposit rate peak near 2.0% vs. 2.25% at the start of this week. Centeno, de Cos, and Guindos all speak today.

U.K. reported soft May retail sales. Headline sales came in at -0.5% m/m vs. -0.7% expected and a revised 0.4% (was 1.4%) in April, while sales ex-auto fuel came in at -0.7% m/m vs. -0.9% expected and a revised 0.2% (was 1.4%) in April. However, the y/y readings came in weaker than expected at -4.7% and -5.7%, respectively. The large downward revisions to April more than offset the upside miss in May and the outlook for consumption is only going to get worse as headwinds grow. June GfK consumer confidence was reported late yesterday. It was expected to remain steady at -40 but instead fell a point to -41, the lowest reading ever in the nearly 50-year history of the series.

Bank of England expectations have eased after the weak data. WIRP suggests a 50 bp hike move at the August 4 meeting is nearly 95% priced in, but no longer fully priced in for the subsequent meetings September 15 and November 3. Looking ahead, the swaps market is now pricing in 175-200 bp of tightening over the next 12 months that would see the policy rate peak between 3.0-3.25%, down from 3.75% at the start of this week and 3.50% at the start of last week. Pill and Haskel speak today. Of note, Saunders, Mann, and Haskel dissented last week in favor of a larger 50 bp move.

U.K. politics are heating up. Tory Chairman Dowden resigned after his party lost two parliamentary seats. The Liberal Democrats won the special election in Tiverton and Honiton, a seat that had been held by the Tories since its creation in 1997. Elsewhere, Labour won back one of the so-called Red Wall seats in Wakefield that it lost in 2019. Prime Minister Johnson said “I’ve got to listen to what people are saying. We’ve got to recognize there is more we’ve got to do and we certainly will -- we will keep going addressing the concerns of people until we get through this patch.” These results will simply add to the perception that his days are numbered.


Japan reported May national CPI readings. Headline remained steady at 2.5% y/y while core (ex-fresh food) remained steady at 2.1% y/y, both as expected. Of note, core ex-energy also remained steady at 0.8% y/y, as expected. The Bank of Japan sent a clear signal last week that it will maintain ultra-loose policy for the foreseeable future. Next meeting is July 20-21 and updated macro forecasts will be released then that should support its dovish stance. What is implicit in this is a weaker yen, as monetary policy divergences are set to widen as the Fed continues hiking.

Philippines central bank downplayed the need for FX intervention. Incoming Governor Medalla said “We don’t defend. We reduce volatility. Markets can overshoot.” Elsewhere, Senior Assistant Governor Iluminada Sicat said “If we defend the currency just to make sure that we achieve a certain level, it would only deplete our gross international reserves. It’s a lost cause.” Even the 25 bp hike from the central bank this week couldn't stop USD/PHP from making a new cycle high just below 55 today, the highest since November 2005. Of note, Bank Indonesia stood pat this week, which we think invites further IDR weakness after USD/IDR made a new cycle high this week near 148881. Indeed, Asia in general has been the most dovish of the EM regions and so their currencies should continue to underperform in the coming months.

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