Dollar Soft as Market Sentiment Improves

March 30, 2023

Win Thin

Fed Chair Powell is sticking with the Dot Plots; only minor data is on the schedule for today; Mexico is expected to hike rates 25 bp to 11.25%; Colombia is expected to hike rates 25 bp to 13.0%
Eurozone preliminary March CPI data have started rolling out; ECB Executive Board member Elderson said inflation remains too high; Swiss National Bank policymakers speak later today; South Africa is expected to hike rates 25 bp to 7.5%
Australia Treasurer Chalmers said he will publicly release findings from the RBA review next month

The dollar is trading softer as risk sentiment continues to improve. While the banking crisis is still simmering, it appears that no news is good news for the markets. DXY is down slightly and trading just below 102.50. A clean break below 102.466 sets up a test of last week’s low near 101.915. We believe that markets are overestimating the Fed’s capacity to ease and so the dollar should eventually recover when these expectations are repriced. The euro is trading higher near $1.0885 while sterling is trading higher near $1.2355. USD/JPY continues to have trouble breaking above 133 and is trading back near 132.60. With the BOJ seen on hold for the foreseeable future and banking sector tensions easing, we believe USD/JPY remains a buy at current depressed levels. Bottom line: we expect the dollar rally to resume after this current bout of market turmoil fades and markets are one again able to focus on the fundamentals.

AMERICAS

Fed Chair Powell is sticking with the Dot Plots. Reports suggest that when he was asked in a private meeting with U.S. lawmakers how much further rates will go, Powell defaulted to the March Dots, which suggest one more hike this year. Representative Hern, who is chairman of the Republican Study Committee, said that “The most recent one that they’ve acknowledged is they anticipate one more rate hike this year.” The fact that the March Dot Plots were basically unchanged meant that no one except perhaps Bullard really wanted to jack up their rate calls right now with so much uncertainty still lingering. Recall that Powell acknowledged after the FOMC meeting that the Fed considered a pause but then added that it’s too soon to say how Fed policy has been impacted by the banking crisis. This is probably the main reason that the Dot Plots were basically unchanged.

The next FOMC meeting is May 2-3 and WIRP suggests around 50% odds of 25 bp hike then. After that, it’s all about the cuts. Nearly two cuts by year-end are still priced in. In that regard, Powell said that Fed officials “just don’t see” any rate cuts this year. We concur. Barkin, Collins, and Kashkari speak today. Note that over the weekend, Kashkari said that the banking sector crisis has increased the risks of recession but added that it was too soon to say what it means for Fed policy. This too supports the view that the Fed really had no choice but to keep its outlook steady.

Only minor data is on the schedule for today. Weekly jobless claims and another Q4 GDP revision will be reported. Initial claims are expected at 195k vs. 191k last week and continuing claims are expected at 1.700 mln vs. 1.694 mln last week. Of note, consensus for March NFP currently stands at 240k vs. 311k in February. The Q4 GDP data is old news and markets are looking ahead to Q1 and beyond. The Atlanta Fed’s GDPNow model is currently tracking 3.2% SAAR for this quarter. The next model update comes tomorrow after the data.

Banco de Mexico is expected to hike rates 25 bp to 11.25%. At the last meeting February 9, the bank delivered a hawkish surprise and hiked rates 50 bp to 11.0% vs. 25 bp expected. Last week, bi-weekly headline CPI slowed to 7.12% y/y while core slowed to 8.15% y/y. If inflation continues to ease, we may be near the end of the tightening cycle. The market is pricing in a peak policy rate near 11.25% but we are not sure the tightening cycle has ended yet and so see risks of a slightly higher peak rate.

Colombia central bank is expected to hike rates 25 bp to 13.0%. However, nearly a third of the analysts polled by Bloomberg look for a larger 50 bp move. At the last policy meeting January 27, the bank delivered a dovish surprise and hiked rates 75 bp to 12.75% vs. 100 bp expected. Governor Villar said then that “With today’s decision, monetary policy is nearing the stance required to cause inflation to slow to its 3% over the medium term.” He added that the bank hasn’t necessarily ended the tightening cycle but it seems clear to us that we are nearing the end. The market is pricing in a peak policy rate between 13.0-13.25%, followed by the start of an easing cycle over the next six months.

EUROPE/MIDDLE EAST/AFRICA

Eurozone preliminary March CPI data have started rolling out. Note that high base effects due to Russia’s invasion of Ukraine last year will lead to sizable drops in the y/y readings. Spain and Germany kick things off today. Spain’s EU Harmonised inflation is came in at 3.1% y/y vs. 3.7% expected and 6.0% in February. However, its core reading only fell a tick to 5.6% y/y and highlights just how difficult it will be to get underlying price pressures lower. Germany reports later today and its headline is expected at 7.5% y/y vs. 9.3% in February. France and Italy report tomorrow. France’s EU Harmonised inflation is expected at 6.5% y/y vs. 7.3% in February and Italy’s is expected at 8.8% y/y vs. 9.8% in February. Eurozone-wide inflation data will also be reported Friday. Headline is expected at 7.1% y/y vs. 8.5% in February and core is expected at 5.7% y/y vs. 5.6% in February.

ECB Executive Board member Elderson said inflation remains too high. He called the bank’s decision to hike rates 50 bp this month “robust” but added that with uncertainty now so high, future moves are not pre-set and will be data dependent. While the hawks are clearly not happy about it, this is the new default stance for the ECB, just as it is for the Fed. The next policy meeting is May 4 and WIRP suggests nearly 80% odds of a 25 bp hike then. After that, another 25 bp hike is almost priced in for Q3 but nothing after that and so the peak policy rate is seen near 3.5%.

Swiss National Bank policymakers speak later today. Of note, we erroneously had them speaking yesterday. Governing Board members Maechler and Moser will both appear at an SNB event and they will surely be asked about the banking sector outlook after the UBS/CS deal. Of note, Maechler is in charge of markets and this is likely to be perhaps her final speech as she will depart at the end of June to become deputy head of the Bank for International Settlements. Last week, the bank hiked rates 50 bp to 1.5% and flagged more hikes ahead as Governor Jordan said “It cannot be ruled out that additional rises in the SNB policy rate will be necessary to ensure price stability over the medium term.” We concur. The market is pricing in a peak policy rate between 2.0-2.25% over the next year, which sounds about right.

South African Reserve Bank is expected to hike rates 25 bp to 7.5%. At the last policy meeting January 26, the bank delivered a dovish surprise and hiked rates 25 bp to 7.25% vs. 50 bp expected. Governor Kganyago said then that the outlook for economic growth appeared even more uncertain than normal as the bank cut its forecast for this year to 0.3% vs. 1.1% previously. He also estimated that ongoing power blackouts will shave an estimated 2 percentage points off of growth this year. As such, we suspect the SARB is nearing the end of its tightening cycle and that market pricing for a peak policy rate near 7.5% seems about right.

ASIA

Australia Treasurer Chalmers said he will publicly release findings from the RBA review next month. He said “My commitment is to receive it tomorrow and to release it with some of our initial views between then and the budget so I’d like to put it out in April. Some of the recommendations that will be in the Reserve Bank review will require legislative change if we go down that path.” Local press is reporting that the review will recommend an overhaul of the structure of the RBA board, fewer policy meetings, and regular press conferences to explain monetary policy decisions. Reserve Bank of Australia meets April 4 and WIRP suggests rates are likely to be kept steady at 3.60% vs. nearly 10% odds of a rate cut that was priced in at the start of this week. A pause next week makes total sense. A cut? Not so much. A cut is nearly priced by year-end and this still seems very unlikely. Indeed, we are not totally convinced that the tightening cycle has ended as the labor market remains very tight.

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