Dollar Bid as Risk-Off Impulses Return

March 31, 2022
  • Some risk-off sentiment is creeping back into the markets; February core PCE will be very important; March Chicago PMI will be closely watched; Canada January GDP will be reported; Colombia is expected to hike rates 150 bp to 5.5%.
  • Key eurozone CPI data continue to emerge; meanwhile, the real sector data remain weak; ECB tightening expectations have eased a bit; final U.K. Q4 GDP data were revised higher; BOE tightening expectations have eased a bit; Czech National Bank is expected to hike rates 50 bp to 5.0%
  • BOJ announced it will boost its bond purchases in Q2; China reported soft official March PMI readings; oil prices fell sharply on reports the Biden administration is considering plans for a massive drawdown of its oil reserves

The dollar is up as risk-off impulses creep back into global markets. DXY is dup after two straight down days and is trading back above 98. This month’s cycle high near 99.418 should eventually be tested, but a clean break below the March 17 low near 97.7272 would signal a deeper correction. The euro traded today at the highest since March 1 near $1.1185 as higher than expected CPI data continue to boost ECB tightening expectations (see below). It has since reversed to trade near $1.11. We still expect an eventual test of this month’s cycle low near $1.08, but a clean break above $1.1170 would signal a deeper correction. The yen has held on to its recent gains, with USD/JPY still trading near 122, which is where it ended last week. We look for further yen weakness but the pace should be slower as it eventually tests the June 2015 high near 125.85. Sterling remains heavy as it trades just above $1.31. We still look for an eventual test of this month’s new cycle low near $1.30 as BOE messaging has tilted more dovish of late. 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

Some risk-off sentiment is creeping back into the markets. Global bond yields are mostly lower, while global equity markets are mostly lower. In FX markets, the dollar and yen are outperforming, while EM FX is mostly lower. There have been no new headlines out of Ukraine but recent signs suggest that optimism over Russia’s withdrawal was misplaced. Fighting continues and talks have yet to yield any real breakthroughs. Weaker than expected PMI readings out of China aren’t helping sentiment (see below).

February core PCE will be very important. The Fed’s preferred measure of inflation is expected to pick up three ticks to 5.5% y/y. If so, it would be the highest since March 1983 and further above the 2% target. Fed tightening expectations remain elevated, with WIRP still showing 70% odds of 50 bp hikes at both the May 3-4 and June 14-15 FOMC meetings. Williams speaks today. Personal income and spending will also be reported at the same time. Both are expected at 0.5% m/m. March Challenger job cuts and weekly jobless claims will also be reported.

March Chicago PMI will be closely watched. Headline is expected at 57.0 vs. 56.3 in February. Yesterday, ADP reported its private sector jobs data. It came in at 455k vs. 450k expected and points to a solid NFP reading tomorrow. Consensus sees 490k vs. 678k in February, while the unemployment rate is expected to fall a tick to 3.7% and average hourly earnings are expected to pick up a few ticks to 5.5% y/y. The other usual clues won’t come until after the employment report, as ISM manufacturing PMI will be reported later tomorrow morning and ISM services PMI will be reported next week.

Canada January GDP will be reported. It is expected at 3.6% y/y vs. 3.9% in December. Overall, the economy remains strong even as inflation remains high. As such, Bank of Canada tightening expectations are running hot after it started the cycle with a 25 bp hike to 0.5% earlier this month. WIRP suggests nearly 60% odds for 50 bp hikes at both the next policy meeting April 13 and the subsequent meeting June 1. Looking ahead, swaps market sees the policy rate at 2.75% over the next 12 months and at 3.0% over the following 12 months.

Colombia central bank is expected to hike rates 150 bp to 5.5%. A few analysts are looking for a 125 bp move and one is looking for 175 bp. Headline inflation was 8.01% y/y in February, the highest since August 2016 and further above the 2-4% target range. The central bank delivered a hawkish surprise at the last meeting January 28, hiking 100 bp to 4.0% vs. 75 bp expected. Bloomberg consensus sees the policy rate peaking near 7.5% by year-end, but we see upside risks to this.

EUROPE/MIDDLE EAST/AFRICA

Key eurozone CPI data continues to emerge. France and Italy reported March CPI. Headline EU Harmonized CPI for France came in at 5.1% y/y vs. 4.9% expected and vs. 4.2% in February, while Italy came in at 7.0% y/y vs. 7.2% expected and 6.2% in February. Yesterday, headline EU Harmonized CPI for Spain came in at 9.8% y/y vs. expected at 8.4% y/y vs. 7.6% in February, while Germany’s came in at 7.6% y/y vs. 6.8% expected and 5.5% in February. Eurozone CPI will be reported Friday. Headline is expected at 6.7% y/y vs. 5.8% in February, while core is expected at 3.1% y/y vs. 2.7% in February.

Meanwhile, the real sector data remain weak. Germany reported February retail sales at 0.3% m/m vs. 0.5% expected and a revised 0.0% (was 2.0%) in January. Elsewhere, France reported consumer spending at 0.8% m/m vs. 1.1% expected and a revised -2.0% (was -1.5%) in January. Part of the weakness is from the spread of omicron, but that just means that the eurozone economy was already losing momentum ahead of the Ukraine crisis. Germany also reported unemployment at -18.0k vs. -20k expected and -33.0k in January.

ECB tightening expectations have eased a bit. Swaps market is now pricing in 110 bp of tightening over the next 12 months, down from 125 bp yesterday but up from 70 bp at the start of last week. Another 65 bp of tightening is priced in over the following 12 months. This still seems way too aggressive to us, especially in light of recent weakness in the real sector data. Guindos warned that inflation is set to accelerate further in the coming months but expressed hope that most of the drivers are temporary and that “so far we haven’t seen much in terms of wage increases.” Elsewhere, Lane said that it’s important for the ECB to maintain optionality and that this optionality should be “two-sided.”

Final U.K. Q4 GDP data were revised higher. GDP grew 1.3% q/q vs. 1.0% preliminary, while the y/y rate was revised up a tick to 6.6%. Private consumption was revised to 0.5% q/q vs. 1.2% preliminary, government spending was revised to 1.5% q/q vs. 1.9% preliminary, and GFCF was revised down to 1.1% q/q vs. 2.2% preliminary. How then did we get an upward revision? Exports were revised up to 6.9% q/q vs. 4.9% preliminary. This is hardly cause for celebration as strong exports can’t be counted on to continue in 2022. It’s much more important to keep domestic activity going and here, the story goes from bad to worse in April when the planned payroll tax hike and increase in the cap on household energy costs go into effect.

BOE tightening expectations have eased a bit. WIRP suggests a hike at the next meeting May 5 is fully priced in, with less than 25% odds of a 50 bp move then vs. 50% at the start of this week. Swaps market sees the policy rate at 2.25% over the next 12 months, up from 2.0% at the start of last week. Risks of another 25 bp of tightening over the following 12 months have been largely priced out, however. Despite the BOE tightening cycle, sterling is the second-worst major currency at -3% YTD, ahead of only JPY at -5.5% YTD. This underperformance has been driven by growth fears as sell as poor BOE messaging, factors that are likely to continue in Q2.

Czech National Bank is expected to hike rates 50 bp to 5.0%. However, a few analysts are also looking for 25 and 75 bp moves. Headline inflation was 11.1% y/y in March, the highest since June 1998 and further above the 1-3% target range. The central bank delivered the expected 75 bp hike to 4.5% last month and we see some odds of a hawkish surprise this week. Swaps market sees the policy rate peaking near 5.25% over the next 12 months, but we still see upside risks here.

ASIA

The Bank of Japan announced it will boost its bond purchases in Q2. The bank boosted its buying per operation to JPY475 bln for 1- to 3-year paper and 3- to 5-year paper from JPY450 bln previously and boosted its buying per operation to JPY500 bln for 5- to 10-year paper from JPY425 bln previously. However, it cut its buying per operation to JPY125 bln for 10- to 25-year paper from JPY150 bln previously. Lastly, it increased the frequency of its buying operations for maturities between 10-25 years and longer than 25 years. This is the first change in the BOJ’s buying operations in nearly a year. While the tweaks are fairly minor, the signal is clear: Yield Curve Control will be vigorously defended in Q2. Elsewhere, Japan reported IP and housing starts. IP rose 0.1% m/m vs. 0.5% expected and -0.8% in January, while housing starts rose 6.3% y/y vs. 1.2% expected and 2.1% in January. Overall, data so far suggest Q1 is shaping up to be weak due to the spread of the virus. As the numbers fade, Q2 should recover.

China reported soft official March PMI readings. Manufacturing PMI came in at 49.5 vs. 49.8 expected and 50.2 in February, while non-manufacturing PMI came in at 48.4 vs. 50.3 expected and 51.6 in February. As a result, the composite fell sharply to 48.8 vs. 51.2 in February, the lowest since February 2020. Caixin reports its manufacturing PMI tomorrow and is expected at 49.9 vs. 50.4 in February. However, there are clear downside risks after the official readings. Given that the lockdowns have spread and intensified, we expect April readings to be even worse. The economy is clearly slowing from the latest pandemic wave and the growth target for this year of “around 5.5%” looks increasingly difficult to achieve. As a result, it’s clear that more stimulus measures will be seen soon, both fiscal and monetary. We believe central bank divergence and narrowing interest rate differentials will continue to weaken the yuan.

COMMODITIES

Oil prices fell sharply on reports the Biden administration is considering plans for a massive drawdown of its oil reserves. Reports suggest a plan to release close to 1 mln bbl/day from the Strategic Petroleum Reserve, with a total release of as much as 180 mln bbl/day being discussed. The drawdown also would be coordinated by the International Energy Agency to include other countries as well. The White House said in a statement that President Biden will speak today about efforts to reduce energy prices “and lower gas prices at the pump for American families.”

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