Dollar Remains Firm Ahead of CPI Data

April 12, 2022

Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.

  • U.S. rates continue to move higher; Fed officials remain hawkish; Fed tightening expectations remain elevated; March CPI data will be reported; Brazil central bank President Roberto Campos Neto said he was surprised by recent inflation data
  • German April ZEW survey came in slightly better than expected; ECB tightening expectations remain heightened; U.K. monthly data dump continued with labor market data; BOE tightening expectations remain steady; Israel delivered a hawkish surprise
  • Official concern over the weak yen remains high; Japan reported February PPI; China Premier Li Keqiang is sounding the alarm about the economy

The dollar remains firm as U.S. rates continue to adjust. DXY is up for the ninth straight day and trading at a new cycle high near 100.23. After a clean break of the psychological 100 level, the March 2020 high near 103 is our next big target. The euro has given up the entire post-French election bounce and is back trading below $1.09. A test of the March 7 low near $1.0805 is still in the cards. The relentless rise in USD/JPY continues as it is up for the eighth straight day and trading just below yesterday’s new cycle high near 125.75. Until the BOJ changes its ultra-dovish stance, the yen is likely to continue weakening despite rising official concerns (see below). Sterling remains heavy and is trading just above $1.30. We still look for a test of the November 2020 low near $1.2855 and then possibly the September 2020 low near $1.2675. 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

U.S. rates continue to move higher. The 10-year yield traded at a new cycle high near 2.83% and is on track to test the October 2018 high near 3.26%. With inflation expectations remaining somewhat subdued, the real 10-year yield has risen to -0.14%, the highest since March 2020 and poised to move into positive territory for the first time since before the pandemic. We continue to believe that the combination of QT and high inflation will continue to drive U.S. yields higher at the long end for the time being. At some point during the tightening cycle, the curve will likely resume flattening but for now, we favor the steepening trade. The 2-year yield is lagging, trading just above 2.50% but still on track to test the November 2018 high near 2.97%.

Fed officials remain hawkish. Waller said the Fed is doing all it can to avoid a hard landing, noting “When you have to use a brute-force tool, sometimes there’s some collateral damage that happens. We’re trying to do this in a way that there’s not much of it, but we can’t tailor policy.” He added “With housing -- can we cool off demand for housing without tanking the construction industry? Can we cool down the labor demand without causing employment to fall? That’s the tricky road that we’re on.” Elsewhere, Evans said a 50 bp hike in May “is obviously worthy of consideration. Perhaps it’s highly likely, even.” He added that the Fed needs to get the Fed Funds rate to a “neutral setting” that he sees in the 2.25-2.5% range. Evans said he preferred getting there by next March but “if we accelerated that, so that we were there in December, that would be OK too.” Brainard and Barkin speak today.

Fed tightening expectations remain elevated. WIRP suggests over 90% odds of back-to-back 50 bp hikes at the May 3-4 and June 14-15 FOMC meetings. Looking ahead, swaps market is pricing in nearly 275 bp of tightening over the next 12 months that would see the policy rate peak between 3.0-3.25%. We see room for the expected terminal rate to move even higher if inflation proves to be even more stubborn than expected.

March CPI data will be reported today. Headline is expected at 8.4% y/y vs. 7.9% in February, while core is expected at 6.6% y/y vs. 6.4% in February. The expected 1.2% m/m gain in headline CPI would be a new cycle high and suggests price pressures are still rising. PPI will be reported tomorrow. Headline is expected at 10.6% y/y vs. 10.0% in February, while core is expected to remain steady at 8.4% y/y. If anything, this data is likely to cement a 50 bp hike at the May 3-4 FOMC meeting. March budget statement will also be reported today.

Brazil central bank President Roberto Campos Neto said he was surprised by recent inflation data. He added that the bank is analyzing the data and that consumer prices were driven higher by gasoline and other staples such as food and clothing. He acknowledged that both headline and core readings are running high, adding “We are analyzing this surprise to see if it changes anything regarding the trends.” Note that the central bank had been sounding more dovish lately and signaling an end to the tightening cycle after a final 100 bp hike to 12.75% at the May 4 meeting. Now, there is added uncertainty as the bank may have to hike more than it expected. Swaps market sees the policy rate peaking near 13.5% over the next 6 months, up from 13% at the start of April.

EUROPE/MIDDLE EAST/AFRICA

German April ZEW survey came in slightly better than expected. Expectations came in at -41.0 vs. -48.5 expected and -39.3 in March, while current situation came in at -30.8 vs. -35.0 expected and -21.4 in March. However, the readings continue to fall and ZEW President Wambach warned “The experts are pessimistic about the current economic situation and assume that it will continue to deteriorate. The decline in inflation expectations, which cuts the previous month’s considerable increase by about half, gives some cause for hope. However, the prospect of stagflation over the next six months remains.”

ECB tightening expectations remain heightened. Some major banks have moved their liftoff calls up to September from December previously. However, market pricing is way ahead of them as WIRP suggests odds of liftoff June 9 are nearly 60% while July 21 is fully priced in. Swaps market is pricing in 125 bp of tightening over the next 12 months, with another 75 bp of tightening priced in over the following 12 months. This seems way too aggressive to us, especially in light of recent weakness in the real sector data.

U.K. monthly data dump continued with labor market data. Unemployment for the three months ending February fell a tick as expected to 3.8% while employment rose 10k vs. 53k expected and -12k previously. The unemployment rate matches the pre-pandemic low and so it’s no surprise that average weekly earnings rose 5.4% y/y vs. 4.8% previously. March jobless claims came in at -46.9k vs. a revised -58.0k (was -48.1k) in February and so the unemployment rate should continue to fall. The final slug of data comes tomorrow when March CPI data will be reported. Headline is expected at 6.7% y/y vs. 6.2% in February, CPIH is expected at 5.9% y/y vs. 5.5% in February, and core is expected at 5.3% y/y vs. 5.2% in February.

Bank of England tightening expectations remain steady. WIRP suggests another 25 bp hike to 1.0% is fully priced in for the next meeting May 5. Swaps market is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 2.5%. There are no BOE speakers scheduled for this week. So far, higher rates have done sterling no favors as it remains heavy near $1.30 support. Of the majors that have already started tightening, sterling is the worst performer at -3.8% YTD, trailing NOK (0.3% YTD), NZD (0.2%), and CAD (-0.1%). AUD is the best performer at 2.4% YTD even though the RBA has yet to start hiking rates.

Bank of Israel delivered a hawkish surprise. It started the tightening cycle with a 25 bp hike to 0.35% vs. 15 bp expected, noting “Conditions allow for the start of a gradual process of increasing the interest rate. The pace of raising the interest rate will be determined in accordance with activity data and the development of inflation, in order to continue supporting the attainment of the policy goals.” The bank sees the policy rate at 1.5% in Q1 23. The bank forecasts 3.6% inflation this year and 2.0% next year and forecasts 5.5% growth this year and 4.0% next year. Swaps market sees the policy rate peaking between 2.25-2.5% over the next 24 months.

ASIA

Official concern over the weak yen remains high. Finance Minister Suzuki warned “The government will closely monitor developments in the foreign exchange market, including the recent depreciation of the yen with a sense of vigilance. That includes the impact on the Japanese economy.” Elsewhere, Prime Minister Kishida said abrupt FX moves are undesirable and that stability is important. He declined to comment on specific currency levels in parliament but added that the government will continue to take a comprehensive approach in evaluating financial and economic trends and will do its utmost to use economic and fiscal policy as needed.

Japan reported February PPI. It rose 9.5% y/y vs. 9.2% expected and a revised 9.7% (was 9.3%) in January. The revised January gain was the biggest since 1980. So far, the surge in PPI has not translated into sharply higher CPI. Unless businesses are able to pass on these costs to consumers, profit margins will continue to get squeezed.

China Premier Li Keqiang is sounding the alarm about the economy. In his third warning in less than a week, Li said that policymakers should “add a sense of urgency” when implementing policies. He added that China will consider and adopt stronger economic policies as needed to support the economy. The warnings come as the economy continues to suffer from hard lockdowns in response to this latest wave of infections. Despite the announced loosening of some restrictions in Shanghai this week, it appears that the vast majority of its 25 mln residents are still subject to tight movement restrictions that will keep them largely in their homes.

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