Dollar Recovers as US Yields Rise After Dovish FOMC Decision

March 18, 2021

•    The FOMC delivered exactly what was expected; Chair Powell stuck with the party line; US yields continue to climb in the wake of yesterday’s FOMC decision; Brazil delivered a stronger tightening in its first move of the cycle
•    BOE decision is due out shortly; Norges Bank delivered a hawkish hold; Turkey is expected to hike rates 100 bp to 18.0%.
•    Reports suggest the BOJ will widen the target yield band tomorrow; Australia reported firm February jobs data; Taiwan kept rates steady at 1.125%, as expected

For asset prices, the net result from the Fed decision has been a bear steepening of the US Treasury curve, strong equities (ex- tech), and a mixed performance dollar and commodities. Global bond yields are tracking US Treasuries higher but to a lesser extent, except for JGBs (see below).  We were a bit perplexed by the post-FOMC sell-off but that appears to have been more of a technical move than a fundamental one.  Higher US rates should continue to underpin the dollar.
 
Indeed, the dollar has recouped some of its knee-jerk post-FOMC losses.  DXY found support near 91.30 and is poised to retest the 92 area as the Fed gave markets a green light to take US rates higher.  DXY now needs to break above the 92.044 area to set up a test of the March 9 high near 92.503.  The euro feels heavy after being unable to break above $1.20.  A break below $1.19 is needed to set up a test of last’s week’s low near $1.1835.  Sterling is outperforming today and is testing the $1.40 high from last week.  A break above $1.4060 would set up a test of the February 24 high near $1.4235.  The rise in USD/JPY has stalled a bit after trading at a new cycle high Monday near 109.35, but we believe the pair remains on track to test the June 5 high near 109.85.

AMERICAS

The FOMC delivered exactly what was expected.  All policy settings were kept steady and its dovish forward guidance was not changed.  The Summary of Economic Projections were upgraded.  The median GDP forecasts (December) are now 6.5% (4.2%) in 2021, 3.3% (3.2%) in 2022, and 2.2% (2.4%) in 2023 while the median core PCE forecasts are now 2.2% (1.8%) in 2021, 2.0% (1.9%) in 2022, and 2.% (2.0%) in 2023.  Unemployment is now seen at 4.5% (5.0%) in 2021, 3.9% (4.2%) in 2022, and 3.5% N(3.7%) in 2023.  So, according to the Fed’s latest projections, it will have meet its dual mandate by the end of 2023 but no rate hike is seen until 2024. 

Chair Powell stuck with the party line.  That is, the Fed is nowhere close to removing accommodation as the expected rise in inflation is seen as transitory.  When asked about rising US yields, Powell said financial conditions remain highly accommodative and that this is very important.  He added the he would be concerned by disorderly market conditions. Basically, he signaled that the Fed is not concerned with the current level of yields but is well aware that a pace that becomes disorderly may need stronger action.

US yields continue to climb in the wake of yesterday’s FOMC decision. The 10-year yield is up 8 bp to trade near 1.72%, the highest since last January, while the 30-year is up 7 bp to2.48%, the highest since August 2019.  The 3-month to 10-year curve is at 171 bp, the highest since March 2017 and on track to test the December 2016 high near 210 bp.  Elsewhere, the 2- to 10-year curve is at 157 bp, the highest since July 2015 and on track to test the June 2015 high near 176 bp. 
 
The Dot Plots still showed a median expectations of no rate hikes through 2023.  However, there was a notable shift beneath the surface.  14 of 18 members now see no hikes through 2022 and 11 of 18 members now see no hikes through 2023.  Back in December, 16 of 17 members saw no hikes through 2022 and 12 of 17 members saw no hikes through 2023.  Christopher Waller became the 18th member of the FOMC when he was confirmed back in January.  There is still one vacancy left on the Board of Governors that President Biden needs to fill.   

Despite Powell’s pushback, market pricing for the first Fed hike still shows solid odds of a Q3 2022 liftoff.  For an extended period, Q1 2023 was penciled in but that shifted to Q4 2022 as US data improved and is now moving into Q3 2022.  If that timetable continues to accelerate, the Fed will have to push back more forcefully against any notions of tightening coming sooner rather than later.  At the margin, enhanced Fed tightening expectations should help boost the dollar, as other central banks are likely to follow the Fed much, much later.  We saw a similar dynamic play out during the financial crisis. 

Fed manufacturing surveys for March will continue to roll out.  The Philly Fed survey is expected at 23.3 vs. 23.1 in February.  Earlier this week, Empire survey came in at 17.4 vs. 15.0 expected and 12.1 in February.  These are the first snapshots for March and will help set the tone for other data to come.  The US manufacturing sector remains solid, and services are expected to catch up as the vaccine roll out accelerates. 

Weekly jobless claims will be closely watched.  They are expected to show continued incremental improvements, with initial claims seen at 700k vs. 712k last week and continuing claims seen at 4.034 mln vs. 4.144 mln last week.  Of note, initial claims will be for the BLS survey week containing the 12th of the month and will be the first clue for NFP.  Currently, consensus sees +625k vs. +379k in February and reflects the reopening seen this month in some of the major states such as Texas and Florida.

The Brazilian Central Bank (BCB) delivered a stronger tightening in its first move of the cycle. The bank hiked rates by 75 bp to 2.75%, with most analysts calling for only 50 bp. It was the first hike since mid-2015 and the bank also effectively guaranteed another hike of the same magnitude in the next meeting May 5, suggesting a front-loaded (but perhaps shorter) cycle. We expect BRL to open strong on the move but until the political and fiscal outlooks improve, it’s still hard to see local assets in a favorable light for long-term investors.



EUROPE/MIDDLE EAST/AFRICA

The Bank of England decision is due out shortly.  It is widely expected to remain on hold whilst acknowledging an improved economic outlook.  Recent comments suggest little official concern yet about rising yields and so we believe gilt yields are likely to continue rising, lending sterling some support.  Please see our preview here.

Norges Bank delivered a hawkish hold.  Rates were kept at zero but the bank updated its rate path to show hikes starting in Q4 2021 and the policy rate near 1.0% by mid-2023 and 1.5% by end-2024.  At the last meeting January 21, the bank kept the rate path steady, showing a likely lift-off in H1 2022 and the policy rate near 1.0% by end-2023.  Norway just reported February CPI headline inflation of 3.3% y/y vs. 2.5% in January, while underlying remained steady at 2.7% y/y.  With the Swedish Riksbank on hold for the foreseeable future, we see scope for the NOK/SEK cross to reach the 2020 high near 1.0715 and then potentially the 2019 high near 1.1055.

The updated macro forecasts were mixed.  While the GDP forecasts reflect the improved growth outlook and justify a sooner lift-off in rates, the rise in inflation is portrayed as transitory and may not justify a faster pace of tightening.  GDP growth is forecast at 3.8% (vs. 4.0% in December) in 2021, 3.4% (3.1%) in 2022, and 1.2% (1.6%) in 2023.  2024 was just added to forecast horizon at 1.0%.  On the other hand, CPI inflation is forecast at 2.8% (vs. 2.2% in December) in 2021, 1.1% (2.0%) in 2022, and 1.5% (1.7%) in 2023.  2024 was just added to forecast horizon at 1.7%. 

Turkey central bank delivered a hawkish surprise.  It hiked the policy rate 200 bp to 19.0% vs. 100 bp expected and said it decided to implement a front-loaded tightening.  The bank also pledged to deliver additional tightening if needed.  CPI rose 15.61% y/y in February, higher than expected and the highest since July 2019.  With real rates falling since the last hike in December, the bank was right to deliver a larger than expected hike to reinforce market confidence.  We had warned of a hawkish surprise like we saw with the Brazilian Central Bank.


ASIA

Reports suggest the Bank of Japan will widen the target yield band in tomorrow’s policy review. This idea has been floated by BOJ officials before, and sources say it will be widened to  0% +/- 25 bp from +/- 20 bp currently.  If it materializes, we don’t see this a very consequential in the near term given that the 10-year JGB hasn’t threatened the upper limit of the band since YCC was introduced back in 206.  That said, the move would signal that the BOJ is becoming more sensitive to the upward pressure in yields.  However, by allowing a wider band in a rising rate environment, we think the BOJ is only inviting a further rise in yields, which in turn would tend to strengthen the yen.  The report also says officials will abolish the ETF purchase target, intervening in the sector only when needed,  When all is said and done, the policy review will result in some cosmetic changes that are likely to have very little market significance.  Please see our preview here.
 
Australia reported firm February jobs data.  The total gain of 88.7k jobs compares to 30k expected and a revised 29.5k (was 29.1k) in January, while the unemployment rate fell sharply to 5.8% vs. 6.3% expected and a revised 6.3% (was 6.4%) in January.  Details were good, with full-time jobs rising 89.1k and part-time jobs falling -0.5k, while the participation rate was steady at 66.1%.  Yet despite the continued improvement in the labor market, the RBA has signaled that it has a long way to go to before it improves enough to consider removing accommodative policy.  Preliminary February retail sales will be reported Friday, with sales expected to rise 0.6% m/m vs. 0.5% in January. 

Taiwan central bank kept rates steady at 1.125%, as expected.  The bank upgraded its macro forecasts but stressed that the economy was not overheating.  GDP is seen growing 4.53% in 2021 vs. 3.68% forecast in December, while CPI is seen rising 1.07% vs. 0.92% in December.  While the central bank does not have an explicit inflation target, relatively low price pressures should allow it to keep policy steady through 2021.  That said, the bank is preparing markets for eventual tightening as Governor Yang said any decision on raising interest rate would depend on factors that include inflation and rates in the US. 
 

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