Dollar Gets Traction as Yields Rise Post-FOMC

April 29, 2021

-U.S. yields are climbing as markets continue to digest the FOMC decision; the Fed delivered a dovish hold, as expected; markets are starting to look for signs of tapering and that was the first question for Powell; we get our first look at Q1 GDP; weekly jobless claims will be reported
-Germany reports April CPI; U.K. political risk remains elevated on a number of fronts; Sweden’s Q1 GDP data surprised on the upside; the Turkish central bank is trying to build up some credibility
-The yuan appreciated to CNY6.47 overnight, the strongest level in almost two months

The dollar is getting some traction as yields rise post- FOMC.  DXY is up slightly today after earlier trading at a new low for this move near 90.424.  The euro traded as high as $1.2150 today but is currently trading just above the figure.  Sterling continues to struggle and has been unable to break above the $1.40 level and is currently trading just above $1.39.  Lastly, USD/JPY is leading this move higher for the dollar and is trading at the highest level since April 14 just above 109.  We continue to look for resumed dollar strength but this will require a more significant turnaround in U.S. yields. 

AMERICAS

U.S. yields are climbing as markets continue to digest the FOMC decision.  The 10-year yield is trading at highest level since April 13 near 1.66%.  Of note, 1.65% is the 50% retracement of the March-April drop.  The 62% comes in near 1.68% and we need a break above that to set up a test of the March 30 high near 1.77%.  Inflation expectations for 5- and 10-years continue to move higher, as measured by breakeven rates.  However, the 30-year outlook is till rangebound, giving credence to the average inflation targeting (AIT) framework.  Still, markets seem priced to perfection on the inflation front, which leaves us somewhat nervous. 
 
The Fed delivered a dovish hold, as expected.  There were no changes in any policy settings or forward guidance.  There were no new macro forecasts or Dot Plots but the official statement was more upbeat in noting that “Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened. The sectors most adversely affected by the pandemic remain weak but have shown improvement. Inflation has risen, largely reflecting transitory factors.”  It also noted that “risks to the economic outlook remain” but this was upgraded from previous language that referred to “considerable risks.”  If the economy continues to gain momentum, we think Fed forecasts will  be upgraded at the next meeting in June.

Markets are starting to look for signs of tapering and that was the first question for Powell.  He said without hesitation that it’s not time yet to have a conversation about tapering.  Most analysts are now looking for Fed tapering in late 2021.  In order to (hopefully) avoid another taper tantrum, the Fed will have to start preparing markets for the likelihood of tapering late in the year.  This meeting was clearly too early but the June 15-16 meeting is a much better candidate as new macro forecasts and Dot Plots will be released then.  Much will depend on how the US economy evolves, of course, but right now, it is red hot and is feeding into market expectations for tapering to happen sooner rather than later.  We view the March foray into open-ended QE as an emergency setting and it’s hard to say the emergency persists with the economy growing nearly 7% for the whole year. 

We get our first look at Q1 GDP.  Consensus sees 6.6% SAAR vs. 4.3% in Q4.  The Atlanta Fed’s GDPNow model suggests Q1 growth is 7.9% SAAR, while the New York Fed’s Nowcast model suggests Q1 and Q2 growth of 6.9% and 4.6% SAAR, respectively.  Consensus sees core PCE picking up to 2.4% SAAR in Q1 from 1.3% in Q4.  Tomorrow, March core PCE will be reported and is expected to pick up to 1.8% y/y from 1.4% in February.  If so, this would be the highest since February 2020.  These core PCE readings will surely test the bond market’s conviction that inflation will remain low. 

Weekly jobless claims will be reported.  Regular initial claims are expected at 540k vs. 547k the previous week, while regular continuing claims are expected at 3.590 mln vs. 3.674 mln the previous week.  Both of those readings last week were cycle lows.  Regular and emergency initial claims together fell to 700k last week, a cycle low and for the BLS survey week containing  the 12th of the month.  Of note, the continuing claims data are reported with a one-week lag and so this week’s reading will be for the BLS survey week.  Overall, the claims data should continue to improve given the accelerated vaccinations and reopening seen in recent weeks.  Bottom line:  the labor market continues to heal and fuel job growth but progress can be spotty week-to-week.  Current consensus for April NFP is 888k vs. 916k in March, with unemployment seen falling a couple of ticks to 5.8%. 

With the media embargo ended, Fed speakers start up again.  Today, Quarles speaks.  March pending home sales (4.4% m/m expected) will also be reported.

EUROPE/MIDDLE EAST/AFRICA

Germany reports April CPI.  Headline inflation is expected to remain steady at 2.0% y/y (EU Harmonized).  German state data already released today suggest upside risks to the national reading.  German unemployment rose 9k vs. -10k expected and a revised -6k (was -8k in March).  Elsewhere, Spain reported April headline inflation of 1.9% y/y (EU Harmonized) vs. 1.7% expected and 1.2% in March.  Eurozone reports April CPI tomorrow.  Headline inflation is expected to pick up to 1.5% y/y from 1.3% in March, but today’s country data suggest upside risks there as well.  However, the ECB has already signaled little concern with the expected uptick in inflation, which is views as transitory.  Of note, core inflation is seen slowing a tick to 0.8% y/y.

U.K. political risk remains elevated on a number of fronts.  Now, it’s Northern Ireland turn in the spotlight after Arlene Foster resigned as Northern Ireland’s First Minister.  Foster plans to step down as head of the pro-British Democratic Unionist Party next month and as First Minister at the end of June. She has been under internal party pressure to step down, in large part due to her failure to stop the creation of a border between Northern Ireland and mainland Britain as part of the Brexit deal. In all fairness, there was little she could do to prevent this after the U’K. decision to leave the EU. Observes believe that any successor will step up the campaign against the border, where tensions with the EU have already ratcheted up after the U.K. unilaterally extended the transition period with no border checks.  Recent BBC poll of Northern Ireland shows 49% want to remain part of the U.K. and 43% want to leave.  Of note, this lead has narrowed in recent years and we suspect Brexit may have been the final straw.

Sweden’s Q1 GDP data surprised on the upside, rising 1.1% q/q, more than double the consensus. Both domestic and external drivers helped accelerate growth, as seen by the recent data for manufacturing and exports.  Retail sales and services have lagged due to the pandemic but that should play some catch-up as the economy reopens.   Still, the Riksbank remains in dovish mode and just delivered a dovish hold this week by extending its flat rate path by another quarter to Q2 2024.  Of note, the Riksbank raised its 2021 growth forecast to 3.7% (3.0% previously) but cut its 2022 and  2023 forecasts to 3.6% (3.9% previously) and 2.0% (2.4% previously), respectively.

The Turkish central bank is trying to build up some credibility.  New Governor Kavcioglu released the banks inflation report, raising this year’s forecasts from 9.4% to 12.2% and next year’s from 7.0% to 7.5%. The statement assured markets that rates will remain above “actual and expected rate of inflation.” Yet the bank may be a bit too optimistic about the inflation trajectory, especially after the lira depreciated some 17% since late February. In any case, this is a positive development at the margin, but far from enough to reestablish institutional credibility. The true test will come at the next policy meeting May 6.  Consensus sees steady rates of 19% but he will be under immense pressure to cut.  The lira continues to recover, in part aided by the weaker dollar, and it has now appreciated for the last four consecutive sessions. Local rates and CDS prices have been mostly stable over the last few sessions.


ASIA

The yuan appreciated to CNY6.47 overnight, the strongest level in almost two months, but largely following the broad dollar trend. We think authorities are happy to let to the yuan continue appreciating as this will help move the economy down the path of the “dual circulation” policy. In short, this is a rebranding of the old rebalancing theme by which China aspires to rely more on domestic growth engines versus external demand, which a stronger currency will by drive import substitution. The yuan is 1.3% stronger on the month and 1% stronger since the start of the year, making it one of the best performing EM currencies year to date.

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