Dollar Soft as China PMI Readings Trigger Risk On Impulses

March 01, 2023
  • U.S. yields continue to rise; Goolsbee seemed to downplay market reactions to new developments; ISM manufacturing PMI will be today’s data highlight; Canada GDP data came in soft
  • Eurozone February CPI data continue to roll out; the split in ECB officials remains in place; final eurozone manufacturing February PMI readings were reported; Italy’s budget deficits for the past three years were revised significantly higher; senior DUP official was lukewarm about the proposed Brexit deal; BOE Governor Bailey sounded more hawkish than usual
  • BOJ officials remain cautious; Australia reported January CPI and Q4 GDP; China reported firm official February PMIs; reports suggest the recovery has caught policymakers by surprise; Korea reported February trade data

The dollar is trading lower as strong China PMIs triggered risk on impulses. DXY is trading lower near 104.28 after trading Monday at a new high for this move near 105.359. We still look for a test of the January 6 high near 105.631. The euro is trading higher near $1.0665 after trading Monday at a new low for this move today near $1.0535. We still look for a test of the January 6 low near $1.0485. Sterling is underperforming and trading flat near $1.205 as DUP official was lukewarm on the recent Brexit deal (see below). We still look for cable to eventually test the January 6 low near $1.1840. Despite the risk on sentiment, USD/JPY is trading lower near 135.40 after trading at a new high for this move yesterday near 136.85. Dovish BOJ comments today (see below) had little impact but we still look for a test of the December 20 high near 137.50, right before the BOJ shocked markets with its YCC tweak. To state the obvious, the recent U.S. data have come around to support our more hawkish view on the Fed, which in turn supports our call for a stronger dollar. Today’s China-driven risk on sentiment is likely to fade eventually as Korea trade data for February (see below) suggest little positive impact on global trade and activity.


U.S. yields continue to rise. The 2-year yield traded near 4.86% today, a marginal new cycle high. The June 2007 high near 5.13% is up next, followed by the June 2006 high near 5.28%. The 10-year yield traded near 3.98% yesterday, the highest since November 10 and on track to test the November 8 high near 4.24%. After that, the next target is the October 21 cycle high near 4.34%. The move higher in yields coincides with renewed inflation concerns and a much-needed repricing of Fed tightening expectations. The dollar has recovered in recent weeks as a result and this process still has a ways to go, in our view. Markets are repricing Fed expectations and the key investment themes remain higher yields, lower equity markets, and a stronger dollar. The dollar uptrend has been interrupted today by stronger than expected China PMI readings. This has led to some risk on trading that has weighed on the dollar. While we remain skeptical about the global impact of China reopening, we do note that it is inflationary at the margin as commodity prices would tend to rise.

Fed tightening expectations remain elevated. WIRP suggests 25 bp hikes in March, May, and June are priced in that takes Fed Funds to 5.25-5.50%. Right now, the odds of a fourth hike in Q3 stand around 35% but should rise further if the data continue to run hot. Strangely enough, an easing cycle is still expected to begin in Q4, albeit at much lower odds. Eventually, it should be totally priced out into 2024 in the next stage of Fed repricing. Kashkari speaks today and is expected to retain his mantle as the current uber-hawk on the FOMC.

Yesterday, Goolsbee seemed to downplay market reactions to new developments. In his first public speech since taking office last month, Goolsbee said it is tempting to interpret the market reaction to incoming news “But it is a danger and a mistake for policymakers to rely too heavily on market reactions” and added that “Our job is ultimately judged by what happens in the real economy.” To us, one obvious implication of Goolsbee’s statement is that the Fed doesn’t put too much weight on financial conditions, which include market variables (bond spreads, equity markets, and other financial indicators). This would be in keeping with Powell’s reluctance to fully address loose financial conditions at the most recent FOMC meeting. That said, the Chicago Fed’s measure of financial conditions for the week ending February 24 should come out today. For the week ending February 17, financial conditions were the loosest since mid-February 2022 and its adjusted measure was the loosest since early February 2022.

ISM manufacturing PMI will be today’s data highlight. Headline is expected at 48.0 vs. 47.4 in January. Keep an eye on prices paid and employment, which stood at 44.5 and 50.6 in January, respectively. ISM services PMI will be reported Friday and the headline is expected at 54.5 vs. 55.1 in January. Keep an eye on prices paid and employment, which stood at 67.8 and 50.0 in January, respectively. Yesterday, Chicago PMI came in at 43.6 vs.45.5 expected and 44.3 in January. Despite this, the preliminary S&P Global PMI readings reported last week suggest potential for upside surprises for the ISM readings. Manufacturing came in at 47.8 vs. 47.2 expected and 46.9 in January, services came in at 50.5 vs. 47.3 expected and 46.8 in January, and the composite PMI came in at 50.2 vs. 47.5 expected and 46.8 in January.

Other minor data will be reported. January construction spending (0.2% m/m expected) and February vehicle sales (14.78 mln annualized expected) will be reported. The manufacturing sector is clearly slowing, as is the housing sector. However, the services sector has remained strong enough to keep the economy humming along. The Atlanta Fed’s GDPNow model is currently tracking 2.7% SAAR growth in Q1, up from 2.5% previously. The next model update comes today after the data.

Canada GDP data came in soft. Growth was flat SAAR vs. 1.6% expected and a revised 2.3% (was 2.9%) in Q3 and was the weakest since Q2 2021. For December alone, GDP fell -0.1% m/m vs. 0.1% expected and this dragged the y/y rate down to 2.3% vs. 2.8% in November. February S&P Global manufacturing PMI will be reported today. Bank of Canada expectations are little changed. No change is expected at the next meeting March 8 but WIRP suggests a final 25 bp hike to 4.75% is still priced in for Q3.


Eurozone February CPI data continue to roll out. Germany reports later today and its EU Harmonised CPI is expected to fall two ticks to 9.0% y/y. German state data already reported suggest upside risks to the national number. Yesterday, France and Spain EU Harmonised CPI both came in higher than expected at 7.2% y/y and 6.1% y/y, respectively. Italy reports tomorrow and its EU Harmonised CPI is expected to fall to 9.5% y/y vs. 10.7% in January. Eurozone also reports tomorrow and its headline is expected at 8.3% y/y vs. 8.6% in January while core is expected to remains steady at 5.3%. vs. 5.7% expected and 5.9% in January. So far, the recent CPI data support our view that the global fight against inflation is far from over and that it is turning out to be more difficult than markets assumed.

The split in ECB officials remains. Villeroy said that “It seems to me desirable to reach this terminal rate by the summer, that is to say by September at the latest.” He added that “According to our forecasts, inflation should reach its peak in this first half and could have halved by the end of the year.” On the other hand, Muller said “I think that the optimism from a few months ago on the financial markets, where there was an expectation that perhaps by the summer the central bank would raise interest rates to a certain level and then fairly quickly they would start to come down again — perhaps that was truly wishful thinking that the decline in interest rates would be so fast.” Lastly, Nagel said “One thing is clear: the interest-rate step announced for March will not be the last. Further significant interest-rate steps might even be necessary afterwards, too.” He added that he would like to accelerate the pace of Quantitative Tightening starting in July but does not envisage outright sales of its holdings.

ECB tightening expectations have move higher. WIRP suggests a 50 bp hike March 16 is nearly priced in. Looking further ahead, a 50 bp hike May 4 is about 60% priced. Another 25 bp hike June 15 is fully priced in, as is a 25 bp hike July 27. Odds of another 25 bp hike by year-end top out near 80% that would result in a peak policy rate near 4.0%, up from 3.75% at the start of this week and 3.5% at the start of February. For now, it appears that the hawks remain in the driver’s seat. Visco also speaks today.

Final eurozone manufacturing February PMI readings were reported. Headline was steady at 48.5 but the country breakdown is worth noting. Germany fell two ticks to 46.3 while France fell half a point to 47.4. Italy and Spain were reported for the first time and improved more than expected to 52.0 and 50.7, respectively. Final February services and composite PMIs will be reported Friday. Germany reported February unemployment at 2.0k vs. -10.0k expected and a revised -11.0k (was -22.0k) in January.

Italy’s budget deficits for the past three years were revised significantly higher. Officials at Eurostat decided to reclassify existing tax breaks including the so-called “superbonus” to show a bigger initial impact on the public finances. The budget deficits were revised up to -9.7% of GDP in 2020, -9.0% in 2021, and -8.0% in 2022. The 2021 and 2022 deficits were significantly higher than previously estimated and the 2022 revision was more than two percentage points above the prior official forecast. Of note, the Meloni government halted the “superbonus” policy last month, which Finance Minister Giancarlo Giorgetti called “reckless.” We have been surprised how well peripheral spreads have tightened in recent months even as ECB tightening puts greater stress on the weak links in the eurozone. Perhaps this news on Italy will provide a wake-up call, though Italian spreads to Germany are actually tighter today.

Senior Democratic Unionist Party official was lukewarm about the proposed Brexit deal. DUP Chief Whip Wilson said the party is still studying details of the deal and won’t make a knee-jerk decision on whether to accept it. Wilson was critical of the involvement of King Charles III, who met with the EU’s Ursula von der Leyen on Monday. Wilson said that was “an indication that the government knew this deal was not a great deal and was trying to persuade unionists to accept it on the basis that we have great respect for the monarchy.” As we wrote yesterday, we suspect the deal will eventually be passed but there is absolutely nothing to get bullish about. When all is said and done, the U.K. has still left the E.U. and will continue to pay the price economically for this choice. In recent months, we have gotten all sorts of studies that have quantified the huge negative impact of Brexit on U.K. productivity, growth, inflation, etc. Those costs aren’t going away after this latest compromise on Northern Ireland.

BOE Governor Bailey sounded more hawkish than usual. He said “If we do too little with interest rates now, we will only have to do more later on. The experience of the 1970s taught us that important lesson.” Bailey said tightening so far is having an impact on the economy and that some “further increase in Bank Rate may turn out to be appropriate.” Lastly, he noted that “We have to keep a very close eye on domestic inflationary pressures reflecting a tight labor market. Inflation has been slightly weaker, and activity and wages slightly stronger, though I would emphasize slightly in both cases.” WIRP suggests a 25 bp hike March 23 is priced in. After that, a 25 bp hike is about 80% priced in for May 11 while one last 25 bp hike in September or November is nearly 75% priced in. The expected terminal rate has drifted higher to 4.75% vs. 4.5% at the start of this week. This is still well below the peak near 6.25% right after the disastrous mini-budget back in September.


Bank of Japan officials remain cautious. Nakagawa said the BOJ needs to continue with its monetary easing to support the economy. She added that there are some promising signs of high corporate profits and wage increases and that the December tweak to YCC made it easier to pass on the effects of monetary easing. Lastly, Nakagawa said she wants to watch financial markets for a bit longer to determine the impact of the YCC tweak, particularly on corporate bond issuance market conditions for securing funds. She is clearly in no hurry to remove accommodation.

Expected BOJ liftoff is not imminent. Next BOJ policy meeting March 9-10 will be the last one under current Governor Kuroda and while no change is expected, we simply cannot rule out one last surprise. WIRP suggests over 25% odds of liftoff April 28, rising to over 50% June 16 and then nearly 85% for July 28. That said, the actual tightening path is seen as very mild as the market is pricing in 20 bp of tightening over the next 12 months followed by only 30 bp more over the subsequent 24 months. That is why we expect the knee-jerk drop in USD/JPY after liftoff to be fairly limited.

Australia reported January CPI. Headline came in at 7.4% y/y vs. 8.1% expected and 8.4% in December. This was the first deceleration since October but is still well above the 2-3% target range. As such, we think there is still pressure on the RBA to continue tightening. WIRP suggests over 75% odds of a 25 bp hike at the next meeting March 7, while the swaps market is pricing in a peak policy rate near 4.35% over the next 12 months followed by an easing cycle over the subsequent 12 months, highlighting the “higher for longer” theme.

Q4 GDP data was also reported. Growth came in at 0.5% q/q vs. 0.8% expected and a revised 0.7% (was 0.6%) in Q3. The y/y rate fell as expected to 2.7% vs. 5.9% in Q3 and was the slowest since Q1 2021.

China reported firm official February PMIs. Manufacturing came in at 52.6 vs. 50.6 expected and 50.1 in January, while non-manufacturing came in at 56.3 vs. 54.9 expected and 54.4 in January. As a result, the composite rose sharply to 56.4 vs. 52.9 in January and is the highest since the series began in 2017. Caixin also reported its manufacturing PMI at 51.6 vs. 50.7 expected and 49.2 in January. Caixin reports its services and composite PMIs Friday, with services expected at 54.5 vs. 52.9 in January. The economy should continue to pick up from reopening but the benefits to China’s major trading partners has so far been very limited.

Reports suggest the recovery has caught policymakers by surprise. Unnamed source said that the wave of Covid infections that followed the abrupt end of Covid Zero ended faster than senior officials had expected. That outbreak was expected to last at least through February or March but much of the population was already infected by the end of January, allowing the economy to recover sharply. Furthermore, another unnamed source said that state media were told to convey at next week’s National People’s Congress that China’s leaders are satisfied with the economic recovery and that the need for stimulus is moderate for now. The source added that the government is looking to “hold up” the economy rather than give added support.

Korea reported February trade data. Exports came in at -7.5% y/y vs. -8.8% expected and -16.6% in January and imports came in at 3.6% y/y vs. 4.1% expected and a revised -2.8% (was -2.6%) in January. As a result, the trade deficit was -$5.3 bln vs. -$6.01 expected and a revised -$12.65 (was -$12.69 bln) in January. However, when adjusted for the number of working days, exports came in at -15.9% y/y and showed little improvement from January. Exports to China fell-24% y/y but would have been even weaker if adjusted for the number of working days.

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