Euro Boosted by Hawkish ECB Comments

March 29, 2022
  • U.S. rates continue to move in the dollar’s favor; demand weakened for the first leg of Treasury’s heavy coupon issuance this week; portions of the U.S. yield curve remain inverted; Chile is expected to hike rates 175 bp to 7.25%.
  • ECB officials continue to tilt hawkish; ECB tightening expectations have picked up further; Governor Bailey acknowledged that the BOE softened its guidance on rate hikes this month to reflect the high level of economic uncertainty
  • Finance Minister Suzuki expressed concern that the weaker yen is harming the economy; Prime Minister Kishida called for measures to cushion the impact of soaring energy prices no households; Australian Treasurer Josh Frydenburg presented the annual budget and was able pull off a tricky balancing act; RBA tightening expectations continue to rise

The dollar is a bit softer as hawkish ECB comments have boosted the euro. DXY is back below 99 and trading near 98.75. 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 is trading back above $1.10 as ECB officials are sounding hawkish (see below). That said, we still expect an eventual test of this month’s cycle low near $1.08. As we expected, the yen has clawed back some of its outsized losses, with USD/JPY trading near 123.55 after trading yesterday above 125 for the first time since August 2015. We look for further yen weakness but the pace should slow as it eventually tests the June 2015 high near 125.85. Sterling is trading heavy below $1.31 and 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. 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

U.S. rates continue to move in the dollar’s favor. The 2-year yield traded as high as 2.44% today, the highest since May 2019. Charts point to an eventual test of the November 2018 high near 2.97%. Similarly, the 10-year yield traded as high as 2.55% yesterday, also the highest since May 2019 but today near 2.50%. Here, charts point to an eventual test of the October 2018 high near 3.26%. The 2-year differentials with Germany, Japan, and the U.K. continue to rise to multi-year highs and point to further weakness in the euro, yen, and sterling vs. the dollar. Harker and Bostic speak today. January S&P CoreLogic house prices, February JOLTS job openings (11.0 mln expected), and March Conference Board consumer confidence (107.0 expected) will be reported.

Demand weakened for the first leg of Treasury’s heavy coupon issuance this week. $50 bln of 2-year and $51 bln of 5-year notes were sold yesterday. Bid/cover ratio for the 2-year auction was 2.46 vs. 2.64 at the previous auction and indirect bidders took 55.0% vs. 65.6% at the previous auction, resulting in a yield of 2.365%. Elsewhere, bid/cover ratio for the 5-year auction was 2.53 vs. 2.49 at the previous auction and indirect bidders took 60.2% vs. 67.8% at the previous auction, resulting in a yield of 2.543%. $47 bln of 7-year notes will be sold today. Bid/cover ratio at the last 7-year auction was 2.36 and indirect bidders took 63.9%.

Portions of the U.S. yield curve remain inverted. The 3- and 5- to 10-year curves inverted this week, and the 2- to 10-year curve is getting close to inverting. While these are not the typical 3-month to 10-year inversion that presages a recession, markets are nevertheless on heightened alert. Please see our recent piece here that discusses the predictive power of an inverted yield curve and will show why we are not yet concerned that one will materialize.

Chile central bank is expected to hike rates 175 bp to 7.25%. However, the market is split as nearly half the analysts polled by Bloomberg see a 200 bp move. Headline inflation was 7.8% y/y in February, the highest since November 2008 and further above the 2-4% target range. The central bank delivered a hawkish surprise at the last meeting January 26, hiking 150 bp to 5.5% vs. 125 bp expected. Swaps market sees the policy rate peaking near 9.0% over the next 6 months.

EUROPE/MIDDLE EAST/AFRICA

ECB officials continue to tilt hawkish. Chief Economist Land acknowledged liftoff could be seen later this year, noting “There are scenarios where it would be appropriate to start to normalize interest rates later this year. And then, of course, there are scenarios where it could be appropriate to move at a later point.” However, Lane stuck with his baseline that “Inflation will decline later this year and will be a lot lower next year and the year after compared to this year.” He added that he sees “quite significant and substantial” drops in sentiment indexes for consumers and businesses and are a “major concern.” Elsewhere, de Cos warned that the Ukraine crisis increases the risks of second round effects on inflation but may also have significant negative impact on growth. He added that the March inflation data will be “particularly negative.”

ECB tightening expectations have picked up further. Swaps market is pricing in 100 bp of tightening over the next 12 months, up from 70 bp at the start of last week. Another 70 bp of tightening is priced in over the following 12 months, up from 60 bp at the start of this week. This still seems way too aggressive to us, especially in light of recent weakness in the real sector data. February Spain retail sales came in at 0.9% y/y vs. 1.0% expected and a revised 4.1% (was 4.0%) in January. Germany reports February retail sales Thursday and is expected at 0.5% m/m vs. 1.4% in January, while France reports consumer spending and is expected at 1.1% m/m vs. -1.5% in January. The eurozone-wide measure won’t be reported until April 7.

Governor Bailey acknowledged that the Bank of England softened its guidance on rate hikes this month to reflect the high level of economic uncertainty. At the March 17 decision, the bank said that further tightening of policy “might be” appropriate in the coming months vs. the forward guidance in February, when such a move was seen as “likely.” Bailey said that while it’s been appropriate for the BOE to tighten policy under current circumstances, forward guidance should reflect the current heightened uncertainty. WIRP suggests a hike at the next meeting May 5 is fully priced in, with around 30% odds of a 50 bp move then vs. 50% before Bailey’s comments. Swaps market now sees the policy rate peaking near 2.25% over the next 24 months, down from 2.5% before Bailey’s comments but still up from 2.0% at the start of last week.

ASIA

Finance Minister Suzuki expressed concern that the weaker yen is harming the economy. He said “We need to closely monitor the impact of the yen on the economy with a sense of urgency. We need to keep watching closely to see whether the weaker yen is starting to have a bad impact.” This comes after . Chief Cabinet Secretary Matsuno yesterday said policymakers are paying close attention to FX market trends and that rapid FX moves are not desirable. The first step in FX intervention is typically verbal but we are likely still far away from actual market intervention. 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 more than 20% since early 2021. The fundamental story argues for further yen weakness as the central bank divergence story remains the strongest driver for the USD/JPY pair.

As expected Prime Minister Kishida called for measures to cushion the impact of soaring energy prices on households. Kishida ordered the measures in a cabinet meeting, according to Finance Minister Suzuki. Kishida already rolled out JPY360 bln ($3 bln) of measures to offset rising crude prices earlier this month. Under the existing plan, the government is currently paying oil refiners a subsidy of JPY18.6 (15 cents) per liter of gasoline, up from an earlier JPY5 subsidy that began in January. Subsidies for gasoline and other oil products are capped at JPY25 and were due to end this month before it was extended to end of April, according to Trade Minister Hagiuda. Elsewhere, Japan reported February labor market data. The unemployment rate fell a tick to 2.7% while the job-to-applicant rose a tick to 1.21. Both were expected to remain steady from January.

Australian Treasurer Josh Frydenburg presented the annual budget. The deficit is forecast at -AUD78 bln (-3.4% of GDP) in FY22/23 ending June 2023 and narrowing to -AUD43.1 bln (-1.6% of GDP) in FY25/26. It is seen at -AUD79.8 bln seen for the FY21/22. GDP is expected to grow 3.5% in FY22/23 vs. 4.25% in FY21/22 before slowing to 2.5% in each of the following three FYs. Frydenberg noted that “A strong economy means a stronger budget” but acknowledged that “Events abroad are pushing up the cost of living at home. Higher fuel, food and shipping costs are increasing inflation and stretching household budgets.” Key budget announcements include a 50% cut to fuel excise taxes over the next six months for a total cost of about AUD5.6 bln, a one-off, AUD250 “cost of living payment” for six mln Australians over the next several weeks at a cost of AUD3.9 bln, and a separate one-off AUD420 tax offset for low- and middle-income earners starting July 1. There was also a boost to spending on women’s safety and economic security, with more than half of the AUD2.1 bln earmarked going toward protecting women and children against violence.

Frydenburg was able pull off a tricky balancing act. The government was able to deliver relief to households suffering from high living costs whilst still repairing fiscal balances damaged by the pandemic. After the budget was announced, S&P noted that Australia’s fiscal outlook is improving faster than expected as the economic recovery gains traction, adding “These fiscal outcomes mirror our forecasts underpinning our ‘AAA’ rating and stable outlook.” February retail sales were reported up 1.8% m/m vs. 0.9% expected and 1.8% in January. The budget comes just two months ahead of the May 21 deadline for Prime Minister Morrison to call a general election. Polls show Morrison’s Liberal-National coalition trailing opposition Labor by a margin close to 10 percentage points. However, one should recall the 2019 elections, when polls showed Labor similarly ahead 54-46% before Morrison’s coalition emerged the winner.

RBA tightening expectations continue to rise. WIRP suggests liftoff is fully priced in for the June 7 meeting now. At the beginning of March, liftoff was priced in for the August 2 meeting. Swaps market sees 225 bp of tightening over the next 12 months and another 125 bp over the following 12 months that would see the policy rate peak near 3.75%, up from 3.5% at the start of the week. AUD is nearing a test of the October high near .7555. A break above that would set up a test of the May 2021 high near .7890. it is the best performing major YTD, followed by NOK, CAD, and NZD. Similar to what we’ve seen in EM FX, it’s not a coincidence that this group is made up of countries that are major commodity exporters and tightening (or about tighten) monetary policy.  

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