Dollar Rangebound Ahead of the Holidays

December 24, 2021
  • There are no central bank meetings, Fed speakers, or major data releases scheduled for the rest of the year; markets will be thin next week and we certainly can’t rule out some wild year-end swings; November core PCE came in higher than expected; weekly jobless claims are worth a mention
  • Brexit will come roaring back into the headlines in early January; TRY trading remains volatile; reports suggest Turkey may sign foreign currency swap deals with the UAE and Azerbaijan
  • Japan reported November national CPI, PPI services, and housing starts; it’s clear why the BOJ is not very concerned about inflation risks

The dollar remains rangebound heading into the holidays. DXY is down modestly and testing support near 96. This is smack in the middle of the 95-97 trading range that has largely held since mid-November. The euro continues to struggle above $1.13, while sterling is still trading above $1.34 as markets continue to gain confidence in another BOE hike in February. USD/JPY is edging higher to trade at the highest level since November 26 near 114.50. We are likely in a consolidative period for now given the lack of any major new drivers. Looking ahead to an eventful January, we believe the underlying trend for a stronger dollar remains intact. U.S. rates are already moving back in the dollar’s favor and we expect that to continue.

AMERICAS

There are no central bank meetings, Fed speakers, or major data releases scheduled for the rest of the year. That calm will break when we get the December jobs report January 7, CPI data January 12, PPI data January 13, and retail sales January 14. There will be a small two-week window for Fed speaking engagements in early January, as the media blackout for the January 25-26 FOMC meeting takes effect at midnight January 14. The Beige Book for that meeting will be released January 12. Our only point is that investors should enjoy this period of relative calm now, as things are likely to heat up quickly when markets reopen after the holidays.

That said, markets will be thin next week and we certainly can’t rule out some wild year-end swings. However, looking through the potential noise, we believe the true signal remains one of dollar strength. The U.S. economy remains poised to outperform in 2022, which in turn will give the Fed greater confidence in normalizing policy over the course of the year. This stands in stark contrast to the ECB and BOJ and so the central bank divergence theme should continue to drive currency markets next year. Lastly, the removal of global monetary accommodation is the major reason we remain negative on EM. This asset class thrives on cheap and abundant global liquidity and it’s clear that there will be less and less of that as we move through 2022.

November core PCE came in higher than expected. It came in at 4.7% y/y vs. 4.5% expected and 4.1% in October. This upside surprise certainly cements the Fed's hawkish pivot This is the highest reading since February 1989 and will keep the Fed on high alert as we move into 2022. Of note, the Fed’s latest core PCE forecasts saw 2021 revised up to 4.4% from 3.7% and 2022 revised up to 2.7% from 2.3%. 2023 was revised up a tick to 2.3% while 2024 was kept steady at 2.1%. We note again that a terminal Fed Funds rate of 1.5% and core PCE at 2% would result in a negative real policy rate at the end of a tightening cycle, which is highly unlikely. Personal income and spending were reported at the same time, with the former at 0.4% m/m and the latter at 0.6% m/m.

The data helped push U.S. yields up a bit yesterday. The 10-year yield traded as high as 1.50%, the highest since December 13 and further above the 1.37% trough from Monday. At the short end, the 2-year yield traded as high as 0.69%, the highest since December 15 and further above the 0.59% trough from Monday. Lastly, the 10-year breakeven inflation rate traded as high as 2.50%, the highest since December 16 and further above the 2.38% trough from Monday. The U.S. Treasury market is closed today.

Weekly jobless claims are worth a mention. Initial claims came in as expected at 205k, unchanged from a revised reading (was 206k) the previous week. Of note, this reading was for the BLS survey week containing the 12th of the month and is the first major clue for NFP, where consensus currently stands at 450k vs. 210k in November while the unemployment rate is seen falling a tick to 4.1%. The Fed’s latest unemployment forecasts saw 2021 revised down to 4.3% from 4.8% and 2022 revised down to 3.5% from 3.8%. Both 2023 and 2024 were kept steady at 3.5%. The US economy continues to chug along. While the full impact of omicron is yet to be known, the US goes into this wave in much stronger shape than Europe and the UK. Continuing claims are reported with a 1-week lag and so next week’s reading will be for the survey week. Here, continuing claims came in at 1.859 mln vs. 1.835 mln expected and a revised 1.867 mln (was 1.845) mln the previous week.

EUROPE/MIDDLE EAST/AFRICA

Brexit will come roaring back into the headlines in early January. Senior French official said that “At the start of January, January 4 to be precise, we will have meetings with the EU commissioners to define the process and the measures that need to be taken. Between January 4 and January 6, there are very important meetings to begin the legal process against the U.K.” The official added the row regarding fishing rights would likely be referred to a court, where a negative ruling could result in retaliatory measures such as tariffs. While the matter appeared to have been somewhat settled with the issuance of additional fishing licenses to the EU, reports suggest French fishermen are still waiting for 73 of them to be handed out by the U.K.

TRY trading remains volatile. After trading as low as 10.25 yesterday, USD/TRY is currently back near 12. There is no real news today, but we suspect positioning and stealth intervention will continue to dominate the price action. Treasury and Finance Minister Nebati acknowledged today that it was mostly small local investors that got burned by the lira’s sharp rally this week, adding “We warned them, saying it was a bubble. We told them numerous times not to buy into it.” Yet it seems too early to declare victory, as the underlying fundamentals remain poor. Even if the lira stabilizes, there are still strong inflationary impulses in the economy that will continue to erode the value of any local currency holdings. We will get a glimpse of this January 3, when December CPI data will be released. Headline inflation is expected at 26.20% y/y vs. 21.31% in November, which would be the highest since May 2003. Back then, the policy rate was 41.0% as the nation was emerging from crisis, which goes to show just how out of sync the current policy rate of 14.0% really is.

Reports suggest Turkey may sign foreign currency swap deals with the UAE and Azerbaijan. More specifically, talks between Turkey’s central bank and those of UAE and Azerbaijan are wrapping up talks on the swap lines and a deal is likely before year-end. This news probably added to yesterday’s outsized TRY gains. Yet when all is said and done, it is just another band-aid. Swap lines can provide a temporary boost to foreign reserves but they will eventually have to be paid back. This news comes after reports earlier this month that Qatar announced an extension to an existing swap line that had expired. The original line was agreed to in August 2018 for three years.

ASIA

Japan reported November national CPI, PPI services, and housing starts. Headline and core (ex-fresh food) inflation came in a tick higher than expected at 0.6% y/y and 0.5% y/y, respectively. Both also accelerated from 0.1% y/y in October. Core is the highest since February 2020 but still well short of the 2% target. That said, base effects are playing a big part and will continue to do so in December and January as well. Energy costs are also pushing core inflation up. Elsewhere, PPI services rose 1.1% y/y vs. 1.0% in October. The BOJ will issue updated macro forecasts at the January 17-18 meeting. In the October forecasts, the BOJ saw targeted core inflation at 0.0% in FY21, 0.9% in FY22, and 1.0% in FY23, suggesting no urgency to tighten. FY24 will be added to the forecast horizon at the April 28 meeting but is unlikely to show a significant rise from FY24.

It’s clear why the Bank of Japan is not very concerned about inflation risks. The bank just delivered a dovish hold last week, announcing plans to pare back its commercial paper and corporate bond holdings over the next five years whilst extending its loan support program to small- and medium-sized firms for another six months through September. Governor Kuroda acknowledged the slow pace of BOJ policy normalization, saying “Each country decides their monetary policy seeking stability in their economy and prices. It’s only natural that there’ll be directional differences.”

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