Dollar Remains Under Pressure as Key FOMC Week Begins

April 26, 2021

-The latest Bloomberg survey shows growing expectations of Fed tapering in Q4; yields are picking a bit ahead of the two-day FOMC  meeting that begins tomorrow and ends with a decision Wednesday afternoon; Fed manufacturing surveys for April will continue to roll out
-Germany’s April IFO survey came in on the weaker side; weekly ECB asset purchases will be reported; U.K. politics could get even messier; the outlook for Turkey continues to darken
-The BOJ two-day meeting began today and ends with a decision tomorrow; new forecasts will be the only unknown and will be closely watched; recent corporate developments in China are causing some jitters; the divergent performance in commodity prices continues

After a long period of divergence, the euro’s correlation with yields spreads has been re-established. Looking at 10-year yields, the spread between the U.S. and Germany has narrowed some 20 bp since the start of the month. The euro appreciated 3.1% over the same time period. Better prospects for the vaccine rollout in the region have certainly helped, but this seems to be a broader U.S. story. U.S. longer-dated yields have given back some of the earlier rally as concerns about an inflation overshoot simmered down, while the dollar has weakened against all G10 currencies this month.
 
The dollar is likely to remain under pressure this week.  With U.S. yields still depressed, DXY is  trading at new lows for this move near 90.682 and on track to test the February 25 low near 89.683.  The euro is poking above $1.21 and is on track to test the February 25 high near $1.2245.  Sterling traded above $1.40 last week but has struggled after the lack of any follow-through buying.  Lastly, USD/JPY remains heavy and continues to trade below 108.  We continue to look for resumed dollar strength but this will require a turnaround in U.S. yields.
 

AMERICAS

The latest Bloomberg survey shows growing expectations of Fed tapering in Q4.   About 45% of the economists responding expect the Fed to announce tapering in Q4, with 14% seeing an even earlier start in Q3.  That means nearly 60% see tapering announced this year.  The results are a noticeable shift from its March survey, when a majority 51% of respondents saw tapering as a 2022 or later event.  The survey of 49 economists was conducted between April 16-21.  Of note, the minutes to the March 16-17 meeting showed that tapering was not even discussed then.  Recall that the Fed is buying $120 bln per month of USTs and mortgage-backed securities.  The 10-year UST yield is currently around 1.58% and the 30-year around 2.26%, both firming off their recent lows but well below their March highs near 1.77% and 2.51%, respectively.

Yields are picking a bit ahead of the two-day FOMC  meeting that begins tomorrow and ends with a decision Wednesday afternoon.  No changes are expected in any policy settings or forward guidance.  There will be no new macro forecasts or Dot Plots.  That said, market are clearly starting to look for signs of tapering and Powell will surely be asked about the timing.  With many analysts now looking for Fed tapering in 2021, the Fed will have to start talking about it soon in order to give markets time to prepare and (hopefully) avoid another taper tantrum.  This meeting is clearly too early but the June 15-16 meeting seems to be a better candidate as new macro forecasts and Dot Plots will be released then.  If not, then there is the July 27-28 meeting, though that would seem to be a tad too late.  Some sort of taper signal from the Fed will likely be the missing ingredient for higher US yields. 

Fed manufacturing surveys for April will continue to roll out.  Dallas reports today and is expected at 30.0 vs. 28.9 in March.  Richmond reports Tuesday and is expected at 22 vs. 17 in March.  So far, Kansas City came in at 31 vs. 26 in March, Philly Fed came in at 50.2 vs. 44.5 in March and Empire survey came in at 26.3 vs. 17.4 in March, both stronger than expected.  The U.S. manufacturing sector remains in solid shape, with services expected to catch up quickly as lockdowns end.  March durable goods orders (2.5% m/m expected) will also be reported.

EUROPE/MIDDLE EAST/AFRICA

Germany’s April IFO survey came in on the weaker side.  Headline business climate came in at 96.8 vs. 97.8 expected and 96.6 in March.  The expectations component fell slightly to 99.5 vs. 101.2 expected, while the current assessment rose by more than 1 point to 94.1 but slightly below the expected 94.1.  Germany has a busy week ahead, as GfK consumer confidence for May (-4.2  expected) will be reported Wednesday, April CPI (2.0% y/y expected) and unemployment (-10k expected) will be reported Thursday, and Q1 GDP data (-1.5% q/q expected) will be reported Friday.

Weekly ECB asset purchases will be reported.   For the week ending April 16, redemptions were a whopping EUR12.1 bln and so gross purchases were EUR28.4 bln, the largest since June 2020.  The ECB bought a net EUR16.3 bln the week ending April 16 vs. EUR17.1 bln the previous week.  Of note, eurozone yields have been creeping higher even as US yields have dropped.  The 10-year Bund yield is currently around -26 bp and nearing the February high near -21 bp, while the 10-year BTP yield is currently around 78 bp and nearing the February high near 84 bp.  As such, the 10-year US-German spread has narrowed to around 180 bp, the lowest since early March.  We think the ECB may have to accelerate its purchases further if eurozone yields continue to climb.  The accelerated pace should be maintained until at least the June 10 meeting, when the ECB will likely reassess its program.  At last week’s meeting, the bank acknowledged that it expects the decision then to be difficult.  

U.K. politics could get even messier.  Scotland and Ireland are already providing some drama and now it appears that No. 10 Downing Street is in the news.  Quite literally.  It appears Prime Minister Johnson tried  to get a major Tory donor to pay for cost overruns in remodeling his official residence.  Overruns are of course inevitable but his predecessors Cameron and May paid for them with their own personal funds.  Perhaps more harmful are claims that Johnson said he would rather see “bodies pile high in their thousands” than order a third U.K. lockdown.  Ex-aide Dominic Cummings is the source of these allegations and so Johnson can claim this is nothing but sour grapes.  Still, these reports couldn’t have come at a worse time for the Tories ahead of local and mayoral elections May 6.  Cabinet Secretary Simon Case will be questioned today  over these allegations at a parliamentary inquiry so markets should be prepared for some fireworks.

The outlook for Turkey continues to darken. The latest catalyst has been rising diplomatic tensions with the U.S. after President Biden formally recognized the Armenian genocide. The Turkish government responded by saying the decision “undermines our mutual trust and friendship.” All of this is happening against the background of crumbling confidence in the government’s economic policy and central bank credibility. The lira is down nearly -11% on the year, by far the underperformer amongst major EM currencies. CDS prices are at around 430 bp, rising steadily over the last few days but not year near the highs of 480 bp in late March.
 

ASIA

The Bank of Japan two-day meeting began today and ends with a decision Tuesday.  Recall that the bank unveiled its policy review at its last meeting March 19.  It was underwhelming, as we expected.  The bank widened its target range for the 10-year JGB yield to +/- 25 bp around 0% vs. +/- 20 bp previously.  In a lengthy analysis, the BOJ concluded that capital spending is mostly unaffected by fluctuations that are within 0.5 percentage point.  This suggests it is unlikely that the bank will widen the band further.  Officials also eliminated the JPY6 trln annual target for ETF purchases while keeping the JPY12 trln annual ceiling in place.  It also shifted the focus of its ETF purchases on the wider Topix rather than the Nikkei 225, and implemented a lending incentive to help banks deal with negative rates. 

New forecasts will be the only unknown and will be closely watched. Currently, the bank sees targeted core inflation of 0.5% for FY2021 and 0.7% for FY2022.  FY23 forecasts will be added at this meeting and reports suggest it will be around 1.0%.  Bottom line is that even with these policy tweaks, inflation is likely to remain below the 2% target through FY23 as well.  As such, the BOJ will be sending  a signal that it intends to keep policy accommodative until FY24 at least.

Recent corporate developments in China are causing some jitters.  The government has reportedly launched an antitrust probe of food-delivery giant Meituan.  The State Administration for Market Regulation announced the investigation, which is looking into alleged monopolistic abuses including forced exclusivity arrangements.  The company said it will actively cooperate with the probe and step up efforts to comply with regulations.  This news comes after Huarong delayed its 2020 earnings reports past an April 30 deadline as the company said its auditors need more time to finalize an unspecified transaction before it can publish the results.  It already missed an earlier March 31 deadline to announce preliminary results, while trading in the company’s shares have been suspended since April 1.  The bottom line is that policymakers appear to be cleaning house at the same time it is encouraging deleveraging and rebalancing.  That is a lot of balls to juggle and the law of unintended consequences suggests investors should remain on alert.
 

COMMODITIES AND ALTERNATIVE ASSETS

The divergent performance in commodity prices continues with industrial metals and agriculture outperforming precious metals and energy.  Copper prices hit a 10-year high and driven by the usual factors: re-opening optimism, U.S. spending plans, robust demand from China, and the link to ESG technologies. It’s a similar story for iron ore, minus the green-technology boost. Agricultural commodities are rallying on concerns of shortages for some crops such as soybean, and also propelled by an increase in investment activity in the space. According to Bloomberg data, speculative futures contracts in soybeans futures rose to the highest since last September.  These price movements should keep markets on heightened alert for potential inflationary impulses.

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