The Fed Continues to Fuel the Dollar Rally

March 24, 2022
  • Fed messaging remains hawkish; market pricing for Fed tightening continues to adjust as one would expect; regional Fed manufacturing surveys for March will continue to roll out; weekly jobless claims will be of interest; Mexico is expected to hike rates 50 bp to 6.5%
  • Preliminary eurozone and U.K. March PMI readings were reported; Chancellor Sunak offered no surprises in his budget statement; Norges Bank hiked rates 25 bp to 0.75%, as expected; SNB kept rates steady at -0.75%, as expected; reports suggest central bank Governor Nabiullina resigned after Ukraine was invaded but was rejected by President Putin; SARB is expected to hike rates 25 bp to 4.25%.
  • Japan reported firm preliminary February PMI readings; BOJ minutes from the January 17-18 meeting were released; markets are testing the BOJ’s resolve again; Philippines kept rates steady at 2.0%, as expected; reports suggest Russia will demand payment in rubles for natural gas shipments to Europe

The dollar remains firm as the hawkish Fed remains the major market driver. DXY is up for the second straight day and four of the past five days, trading near 98.80. This month’s cycle high near 99.418 should eventually be tested and after that, our next target is the May 25 2020 high near 99.975. The euro remains heavy and is stuck below $1.10. We still expect an eventual test of this month’s cycle low near $1.08. GBP bounce ran out of steam near $1.33 and is back trading below $1.32 in the wake of Chancellor Sunak’s underwhelming budget speech (see below). We look for an eventual test of this month’s new cycle low near $1.30 and then the November 2020 low near $1.2855. USD/JPY traded today at the highest since December 2015 and should eventually test the November 2015 high near 123.75. Between the likely return of risk-off impulses and the even more hawkish Fed outlook for tightening, we believe the dollar uptrend remains intact.

AMERICAS

Fed messaging remains hawkish. Daly said “If we need to do 50, that is what we’ll do. We’re prepared to do whatever it takes to ensure that we get price stability, which clearly no one thinks we have right now.” Mester said she favors raising rates to 2.5% this year and added that the Fed will “need to do some 50 bp moves” to get there. She stressed that “I don’t want to presuppose every meeting from here to July, but I do think we need to be more aggressive earlier rather than later.” Lastly, Bullard said “We have to think bigger maybe than we have in the past. The committee will have to make sure we maintain credibility on our inflation target.” Kashkari, Waller, Evans, and Bostic speak today.

Market pricing for Fed tightening continues to adjust as one would expect. WIRP suggests 50 bp moves are about 70% priced in for both May 4 and June 15. Swaps market is pricing in 225 bp of tightening over the next 12 months that would see the Fed Funds rate peak near 2.75%. We have been calling for such a move for weeks now, and we still see risks that this peak moves closer to 3% (or above) in the coming weeks. This move in U.S. rates higher should continue to support the dollar.

Regional Fed manufacturing surveys for March will continue to roll out. Kansas City Fed is expected at 26 vs. 29 in February. So far, the readings have been mixed as Richmond Fed came in at 13 vs. 1 in February, Empire Survey came in at -11.8 vs. 3.1 in February, and Philly Fed came in at 27.4 vs. 16.0 in February. S&P Global (formerly Markit) preliminary March PMI readings will also be reported. Manufacturing is expected at 56.6 vs. 57.3 in February, services is expected at 56.0 vs. 56.5 in February, and the composite PMI is expected at 54.7 vs. 55.9 in February. ISM PMI readings will be reported next week. Durable goods orders (-0.6% m/m expected) and Q4 current account (-$218 bln expected) will also be reported.

Weekly jobless claims will be of interest. That’s because continuing claims will be for the BLS survey week containing the 12th of the month, and are expected at 1.400 mln vs. 1.419 mln the previous week. Initial clams are expected at 210k vs. 214k the previous week, which was the lowest since the end of December. Consensus for March NFP currently stands at 450k vs. 678k in February, with the unemployment rate seen falling a tick to 3.7% and the participation rate seen rising a tick to 62.4%. More clues will be revealed in the coming days. That said, the real sector data have become largely irrelevant now that the economy is nearing full employment.. Instead, markets should be focusing on signs that inflation is peaking. Unfortunately, we are nowhere near that yet.

Banco de Mexico is expected to hike rates 50 bp to 6.5%. At the last meeting February 10, the bank hiked 50 bp and raised its inflation forecasts for 2022 and 2023 to 4.0% and 3.1%, respectively. The vote was 4-1 with the dissent in favor of a 25 bp move. However, one MPC member said the dilemma was 50 or 75 bp. Mid-March CPI will also be reported Thursday, with headline inflation expected at 7.33% y/y vs. 7.22% in mid-February. If so, inflation would remain well above the 2-4% target range. Swaps market sees the policy rate peaking near 9.0% over the next 12 months.

EUROPE/MIDDLE EAST/AFRICA

Preliminary eurozone March PMI readings were reported. Headline manufacturing came in at 57.0 vs. 56.0 expected and 58.2 in February, services came in at 54.8 vs. 54.3 expected and 55.5 in February, and the composite came in at 54.5 vs. 53.8 expected and 55.5 in February. Looking at the country composite PMIs, Germany came in at 54.6 vs. 53.8 expected and 55.6 in February and France came in at 56.2 vs. 54.5 expected and 55.5 in February. The weakness likely reflects the impact from the Ukraine crisis and this is likely to carry over into April. Italy and Spain will be reported with the final PMI readings due out in early April. March French business confidence came in 107 vs. 110 expected and a revised 113 (was 112) in February.

U.K. Chancellor Sunak offered no surprises in his budget statement. Simply put, the underwhelming measures include a fuel duty cut, a pledge to cut income taxes, an increase in the threshold for paying payroll taxes, another pledge to cut taxes on investment in the fall, and a smorgasbord of other modest measures. The growth forecast for this year was cut to 3.8% from 6.0% previously, while the FY22 budget deficit forecast was raised to -GBP99.1 bln. After the announcement, Sunak has come under fire for not doing more to help U.K. households cope with higher inflation and taxes. Of note, the Office for Budget Responsibility estimated that U.K. households face a -2.2% decline in disposable incomes in FY22, the biggest drop since records began. The OBR also said the tax cuts announced would offset only a sixth of the net tax rises introduced since Sunak took over two years ago, and that benefits will fall by almost -5% in real terms in FY22.

Preliminary March U.K. PMI readings were reported. Headline manufacturing came in at 55.5 vs. 57.0 expected and 58.0 in February, services came in at 61.0 vs. 58.0 expected and 60.5 in February, and the composite came in at 59.7 vs. 57.5 expected and 59.9 in February. The reopening boost to the economy appears to be wearing off, and the outlook for April is rather grim as the planned hikes in the payroll tax and the energy bill cap come into effect. Elsewhere, U.K. CBI released the results of its March distributive trades survey, with retailing reported sales coming in at 9 vs. 10 expected and 14 in February.

Norges Bank hiked rates 25 bp to 0.75%, as expected. New macro forecasts and an updated rate path were released that suggest a longer, great tightening cycle ahead. The bank now sees the policy rate peaking near 2.5% in 2024 vs. 1.75% previously. The bank said the rate will mostly likely be hiked again at the June 23 meeting, adding “The committee was concerned with the prospect that the war in Ukraine could result in weaker-than-expected global growth amid rising inflation. If there are prospects of persistently high inflation, the policy rate may be raised more quickly.” Next policy meeting is May 5 and rates are likely to remain steady as the bank sticks to quarterly hikes for the time being. Swaps market is pricing in 75 bp of tightening over the next 12 months but is now followed by another 75 bp over the following 12 months, taking the policy rate up to an expected peak near 2.25% vs. 1.75% at the start of the week.

Swiss National Bank kept rates steady at -0.75%, as expected. The SNB still characterized the franc as “highly valued” and pledged to continue FX interventions as necessary. Governor Jordan noted that Swiss inflation is much lower than the eurozone and that differential, coupled with other FX market trends, meant the SNB could tolerate some slight CHF strengthening. Jordan said maintaining negative rates is still important for the bank, and that it never waits for another central bank on what to do. He sees low second-round inflation risks, and added that Russia so far poses no risks to Switzerland’s financial sector. There was a sharp upward revision to the 2022 inflation forecast to 2.1%, but the 2023 and 2024 (just added) forecasts of 0.9% suggest liftoff won’t be seen until 2025 at the earliest. Swaps market is pricing in over 75 bp of tightening over the next 12 months, which seems too aggressive in light of today’s dovish forward guidance.

Reports suggest Russia central bank Governor Nabiullina resigned after Ukraine was invaded but was rejected by President Putin. Instead, she was just nominated for a new 5-year term last week. With most of its foreign reserves frozen and many local banks unable to transact internationally, the central bank has few tools to help the economy cope with sanctions. Of note, only one senior Russian official has actually resigned over Ukraine and that was long-standing economic reformer Anatoly Chubais, who just stepped down as Putin’s climate envoy this week and has reportedly left the country.

South African Reserve Bank is expected to hike rates 25 bp to 4.25%. Yesterday, South Africa reported February CPI and both headline and core were a tick lower than expected at 5.7% y/y and 3.5% y/y, respectively. Headline inflation remains within the 3-6% target range but the bank just hiked rates 25 bp to 4.0% in January. The bank’s models suggest quarterly 25 bp hikes in 2022 and 2023 and so a hike today would seem to accelerate the timing. The next policy meeting is May 19 and another 25 bp hike to 4.5% seems likely. Growth is already sluggish and so this SARB tightening cycle will simply add to the headwinds.

ASIA

Japan reported firm preliminary February PMI readings. Headline manufacturing came in at 53.2 vs. 52.7 in February, services came in at 48.7 vs. 44.2 in February, and the composite came in at 49.3 vs. 45.8 in February. February department store sales were also reported. Nationwide sales came in at -0.7% y/y vs. 15.6% in January, while Tokyo sales came in at 5.1% y/y vs. 23.9% in January. Much of the blame for soft Q1 data can be pinned on the spread of omicron and there is a risk that GDP contracts. Bloomberg consensus sees -0.1% SAAR vs. 4.6% in Q4, but rebounding to 5.2% in Q2. Reports have recently emerged that the government is looking at an extra fiscal stimulus package, but we suspect policymakers will hold off until the Q2 outlook becomes clearer.

Bank of Japan minutes from the January 17-18 meeting were released. The bank delivered a dovish hold then and the minutes were consistent with this. Many BOJ board members stressed the importance of communicating the bank’s intention to continue with easing measures until its 2% inflation goal is met in a stable and sustainable manner. One felt the BOJ should “thoroughly” explain its goal isn’t just to hit the 2% target but also to support economic growth and wage gains. One said the BOJ should stress that exiting from pandemic measures isn’t the same as an exit from monetary easing. One said that nominal wage growth above 2% is necessary for achieving the 2% inflation target. Last Friday, the bank also delivered a dovish hold and minutes to that meeting will be released May 9.

Markets are testing the BOJ’s resolve again. The 10-year JGB yield traded as high as 0.23% today, just shy of the 0.25% upper limit under Yield Curve Control. However, this is the level where the BOJ last intervened back in early February. If yields continue to rise, we fully expect the BOJ to buy an unlimited amount of 10-year JGBs to defend YCC Still, it’s worth noting that the rise in JGB yields is part of a global trend and we’d note that Japan rates have not adjusted as much as other major bond markets.

Philippine central bank kept rates steady at 2.0%, as expected. Governor Diokno said “The Monetary Board sees scope to maintain the BSP’s policy settings in order to safeguard the momentum of economic recovery amid increased uncertainty even as it continues to develop its plans for the gradual normalization of its extraordinary liquidity measures.” He added that the bank stands ready to address second-round inflation but stressed that sustaining the economic recovery remains its priority. The bank raised its 2022 inflation forecast to 4.3% vs. 3.7% previously. Of note, February CPI came in steady at 3.0% y/y, the lowest since November 2020 and right at the center of the 2-4% target range. Bloomberg consensus sees steady rates through H1, with liftoff seen in Q3. We believe that is still the most likely timeframe as today’s decision suggests a move in Q2 is very unlikely.

COMMODITIES

Reports suggest Russia will demand payment in rubles for natural gas shipments to Europe. President Putin said “I have taken a decision to switch to ruble payments for our natural gas supplies to the so-called hostile states” and has ordered the central bank to develop a mechanism to accept ruble payments within a week. This will clearly ratchet up tensions with the West. Such a demand would have the impact of boosting the ruble and replenishing foreign reserves. However, Italy, the biggest buyer of Russian gas after Germany, said it would not comply. Government economic adviser Francesco Giavazzi said “My view is that we pay in euros because paying in rubles would be a way to avoid sanctions, so I think we keep paying in euros.” The order likely means that some terms of Russian contracts with European customers will need to be renegotiated and would likely lead to more supply disruptions, which have already led benchmark gas prices to rise more than 50% YTD.

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