Dollar Soft Ahead of the Weekend

March 25, 2022
  • Fed officials are clearly open to a 50 bp hike at the May 3-4 meeting; manufacturing data have come in largely firmer in March; weekly jobless claims point to a tight labor market; Brazil reports mid-March IPCA inflation; central bank divergence continues to play a large part in the EM story
  • German IFO business climate survey came in soft; the ECB will begin phasing out collateral-easing measures that were introduced early in the pandemic; U.K. reported weak February retail sales; SARB hiked rates 25 bp to 4.25%, as expected
  • Japan reported March Tokyo CPI; BOJ Governor Kuroda remains ultra-dovish; it’s clear that officials are not yet concerned about yen weakness; reports suggest Prime Minister Kishida will order a package of stimulus measures next week

The dollar is softer as markets consolidate ahead of the weekend. DXY is down modestly after two straight up days, trading near 98.65. This month’s cycle high near 99.418 should eventually be tested and after that, our next target is the May 25 2020 high near 99.975. The euro remains heavy even as it makes another run at $1.10. We still expect an eventual test of this month’s cycle low near $1.08. Sterling is having trouble staying above $1.32 in the wake of Chancellor Sunak’s underwhelming budget speech and weak data (see below). We look for an eventual test of this month’s new cycle low near $1.30 and then the November 2020 low near $1.2855. USD/JPY traded today at the highest level since December 2015 near 122.45 today but has since fallen back below 122. Officials show little concern about yen weakness (see below) and so this pair should eventually test the November 2015 high near 123.75. 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

Fed officials are clearly open to a 50 bp hike at the May 3-4 meeting. Yesterday, it was Evans’ turn to weigh in and he said he’s “comfortable” with raising interest rates by 25 bp increments but remains “open” to a bigger 50 bp move if needed. He stressed that “We want to be careful, we want to be humble and nimble, and get to neutral before too long -- maybe 50 helps, I’m open to that. I would be comfortable with each meeting increasing by a quarter point.” He expressed some concern that a bigger hike at one meeting would then create a messaging challenge for the next one. WIRP suggests that 50 bp hikes for both May 4 and June 15 are about 75% priced in. Looking ahead, the swaps market is pricing in 225 bp of tightening over the next 12 months that would take the policy rate up to a peak of 2.75%.

Manufacturing data have come in largely firmer in March. S&P Global flash manufacturing PMI came in at 58.5 vs. 56.6 expected and 57.3 in February, services came in at 58.9 vs. 56.0 expected and 56.5 in February, and the composite PMI came in at 58.5 vs. 54.7 expected and 55.9 in February. That was the highest reading for their composite since July 2021. ISM PMI readings will be out in early April and will hopefully reflect this strength. Elsewhere, the Kansas City Fed manufacturing survey came in at 37 vs. 26 expected and 29 in February. These strong manufacturing readings should help ease some of the concerns about the unexpectedly large -2.2% m/m drop in February durable goods orders, the first drop since September and the biggest since April 2020.

Weekly jobless claims point to a tight labor market. Initial claims fell to 187k vs. 210k expected and a revised 215k (was 214k) the previous week. This is the lowest level since 1969. Elsewhere, continuing claims fell to 1.35 mln vs. 1.40 mln expected and a revised 1.417 mln (was 1.419 mln) the previous week. This reading was for the BLS survey week containing the 12th of the month and suggests a solid NFP number next Friday. Consensus is 450k vs. 678k but to be honest, the jobs data have become largely irrelevant. At this point, the Fed is on track to hike aggressively to help limit inflation even as the economy approaches full employment. Pending home sales (1.0% m/m expected), and final March University of Michigan consumer sentiment will be reported today.

Brazil reports mid-March IPCA inflation. Headline inflation is expected at 10.69% y/y vs. 10.76% in mid-February. If so, inflation would remain well above the 2-5% target range. COPOM just delivered the expected 100 bp hike to 11.75% and signaled another hike of the same magnitude at the next meeting May 4. However, the bank is now hinting that would likely end the tightening cycle. After the bank published its quarterly inflation report yesterday, President Campos Neto said that while it’s appropriate to look for a 100 bp hike at the May meeting, an additional hike at the subsequent meeting June 16 “is not the most probable outlook, as we indicate in the minutes to the last meeting. But, we are facing a very volatile outlook and we need to consider different possibilities.” This is more dovish message than the one delivered with the March 16 hike, when the bank warned of the inflationary impact of the Ukraine crisis and that “If those shocks prove to be more persistent or larger than anticipated, the Committee will be ready to adjust the size of the monetary tightening cycle.” Swaps market now sees the policy rate peaking near 13.25% over the next 6 months, down from 13.5% earlier this week.

Central bank divergence continues to play a large part in the EM story. In EM, Asia has been most dovish in hiking rates while Latam has been the most hawkish. EMEA is somewhere in between but moving closer to Latam. We don't think it's any coincidence that the best performing EM currencies YTD are BRL, ZAR, CLP, COP, PEN, and MXN. Of note, USD/BRL is trading at the lowest since March 2020 and a break below 4.7555 would set up a test of the January 2020 low near 4.00.

EUROPE/MIDDLE EAST/AFRICA

German IFO business climate survey came in soft. Headline came in at 90.8 vs. 94.2 expected and a revised 98.5 (was 98.9) in February. Current assessment came in at 97.0 vs. 96.6 expected and 98.6 in February, while expectations slumped to 85.1 vs. 92.0 expected and a revised 98.4 (was 99.2) in February. Elsewhere, Italy economic sentiment fell to 105.5 vs. a revised 107.9 (was 108.2) in February. Looking at the components, consumer confidence came in at 100.8 vs. 112.4 in February and manufacturing confidence came at 110.3 vs. a revised 112.9 (was 113.4) in February.

The European Central Bank will begin phasing out collateral-easing measures that were introduced early in the pandemic. These measures were introduced in April 2020 to facilitate collateral availability but will be gradually removed in a three-step process starting July 2022 and ending March 2024. The details are too numerous to list here, but suffice to say that this is simply another step in normalizing its monetary policy settings. Of note, the ECB said it would continue accepting Greek bonds until the reinvestment period of PEPP ends. Elsewhere, February eurozone M3 growth slowed a tick to 6.3% y/y, as expected. Swaps market is pricing in 75-100 bp of tightening over the next 12 months, followed by 50-75 bp over the following 12 months. Given the trends were seeing in confidence and money growth, such an aggressive tightening cycle is highly unlikely.

U.K. reported weak February retail sales. Headline sales were expected to rise 0.7% m/m but instead fell -0.3% vs. 1.9% in January, while sales ex-auto fuel were expected to rise 0.5% m/m but instead fell -0.7% vs. 1.7% in January. While it’s only one month, the data certainly raises concerns whether consumption can hold up in the face of still-rising inflation, rate hikes, the payroll tax hike, and the higher cap on household energy costs. Sunak’s budget is really only a band-aid solution to a wound that’s likely to fester and worsen without stronger measures. Elsewhere, U.K. GfK consumer confidence fell to -31 vs. -30 expected and -26 in February. This was the lowest since November 2020 and is only going to get worse in the coming months.

South African Reserve Bank hiked rates 25 bp to 4.25%, as expected. However, the vote was 3-2 with the two dissents in favor of a 50 bp move. The bank warned that inflation is likely to breach the 3-6% target range in Q2 and raised its 2022 inflation forecast to 5.8% vs. 4.9% previously. Its repo rate forecasts were tweaked modestly to 5.06% by end-2022 vs. 4.91% previously, 6.1% by end-2023 vs. 5.84% previously, and 6.68% by end-2024 vs. 6.55% previously. That is an even more aggressive rate path than we expected for a country that still has 35% unemployment and is struggling to grow. The bank forecasts GDP growth of 2% in 2022 vs. 1.7% previously, followed by 1.9% in both 2023 and 2024. This is already quite underwhelming and the SARB tightening cycle will simply add to the headwinds.

ASIA

Japan reported March Tokyo CPI. Headline came in a tick higher than expected at 1.3% y/y vs. 1.0% in February, while core (ex-fresh food) came in a tick higher than expected at 0.8% y/y vs. 0.5% in February. Core is the highest since December 2019 but remains well below the 2% target and certainly justifies the Bank of Japan’s ongoing ultra-dovish stance. Last week, national CPI for February was reported. Headline came in at 0.9% y/y and core came in at 0.6% y/y, both up from January. The Tokyo readings suggest national inflation will pick up in March, but much of this is due to energy. Both Tokyo and national CPI ex-fresh food and energy are down y/y.

Bank of Japan Governor Kuroda remains ultra-dovish. He said stable inflation near the 2% target would trigger a policy change, not yen weakness. Speaking in parliament, Kuroda stuck to his view that a weak yen is positive for the economy overall. He added that “I think it’s appropriate for the BOJ to aim for stable, sustainable inflation and keep up current powerful easing tenaciously to prop up the economy recovering from the pandemic.” Kuroda stress that the current spike in inflation was driven by higher energy prices and won’t lead to inflation that’s sustainably above the 2% target. He did warn that high inflation would cut disposable household income and corporate earnings and could harm the economy. Lastly, Kuroda says the bank continues to watch currency moves carefully and added that he doesn’t think markets have lost faith in the yen.

It’s clear that officials are not yet concerned about yen weakness. As it is, the yen broke a 5-day losing streak against the dollar. However, it has fallen in 13 of the past 15 days and so some sort of correction was long overdue. That said, the fundamental story argues for further yen weakness as the central bank divergence story remains the strongest driver for the USD/JPY pair. If memory serves, the last time the BOJ intervened to support the yen was back in 1998. Over the course of a year, the yen weakened more than 30%. Compare this to the current bout of yen weakness that has seen losses of a little less than 20% since early 2021.

Reports suggest Prime Minister Kishida will order a package of stimulus measures next week. Finance Minister Suzuki said “I believe there’ll be instructions from the prime minister next week, so we’ll consider measures based on those orders. There needs to be a solid response to reduce the impact of rises in oil and grain prices on citizens and firms.” Kishida has come under increasing pressure to do something to help households and firms cope with rising fuel and commodity prices. While we thought that Kishida would wait until Q2 to better gauge the situation, it appears that he is willing to move sooner rather than later. Of note, the Cabinet Office kept its monthly economic assessment unchanged in March after downgrading its view last month. It maintained its view that the economy is continuing to show signs of picking up despite weakness in some areas. However, the report warned of downside risks going forward due to the impact of the war in Ukraine, the rise in commodity prices, and heightened volatility in the financial markets.

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