Dollar Trading Back at Pre-FOMC Levels

March 19, 2021

• US Treasury yields are off their recent highs but the situation remains tense; market pricing for the first Fed hike continues to adjust; strong US data should keep pressure on US rates to move higher; Canada reports January retail sales

• BOE delivered a dovish hold, as expected; Reports suggest the UK and EU may reach an agreement on financial regulation by the end of this month; Russia opted to kick off the tightening cycle

• The BOJ policy review was underwhelming, as we expected; ahead of the BOJ decision, February national CPI was reported; Australia reported soft preliminary February retail sales; oil prices have seen sharp declines this week

Despite all the volatility and concerns about risk taking, global equity markets are ending the week only modestly lower. In fact, the EuroStoxx 600 is set to gain 0.4% for the week, at current prices. Chinese stocks are underperforming, with the Shanghai Composite down 1.4%, though the CSI 300 has seen a nearly 3% fall this week. Looking at futures, both the S&P 500 and the Nasdaq are on track for modest declines on the week. There is nothing on the US calendar for today and so trading may be choppy and technically-driven.

The dollar has recouped all of its knee-jerk post-FOMC losses. We think the backdrop remains dollar positive and were puzzled by the sell-off, which now looks more and more technical in nature rather than fundamental. DXY is testing the 92 area again and a break above the 92.044 area would set up a test of the March 9 high near 92.503. The euro remains heavy after being unable to break above $1.20. A clean break below $1.19 is needed to set up a test of last’s week’s low near $1.1835. Sterling continues to outperform, pushing the EUR/GBP cross down to a cycle low .8533. The rise in USD/JPY has stalled a bit after trading at a new cycle high Monday near 109.35. While the BOJ has muddied the waters a bit by widening its YCC trading band (see below), we believe the pair remains on track to test the June 5 high near 109.85.



US Treasury yields are off their recent highs but the situation remains tense. The 10-year is now at 1.69%, down from an intrasession high of 1.75% yesterday. Yesterday’s 10-year TIPS auction was on the strong side with high participation of indirect bidders at the expense of primary dealers taking a small share of the re-opening. Still, implied breakeven rates from have been ticking higher in the back end, a sign for concern if it continues. We think it may take some days for markets to digest the Fed’s message but we think its acceptance of higher yields came in loud and clear. 


Market pricing for the first Fed hike continues to adjust. Higher odds are creeping further into Q3 2022 and a hike is fully priced in by Q1 2023. This is at odds with the Fed’s Dot Plots showing steady rates through 2023. If the timetable continues to accelerate, the Fed may 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. 

The weekly jobless claims are worth a mention. Regular initial claims rose to 770k vs. 700k expected and a revised 725k (was 712k) the previous week. The good news is that regular and PUA initial claims together fell to 1.03 mln, the lowest since late November. These readings are for the BLS survey week containing the 12th of the month and suggests a good NFP number. Regular continuing claims came in at 4.124 mln vs. 4.034 mln expected and a revised 4.142 mln *was 4.144 mln) the previous week. We'll know more next week, as continuing claims data are reported with a 1-week lag and will be for the BLS survey week. This week, emergency plus regular continuing claims fell nearly 1.5 mln to 17 mln. If this improvement is sustained, then should get an even better NFP number. Consensus is now 625k but that should move higher.

Elsewhere, the March Philly Fed manufacturing survey came in at a whopping 51.8 vs. 23.3 expected and 23.1 in February. The employment component was 30.1 vs. 25.3 in February and this is just more good news for the US economy. With Powell giving the green light for higher US yields, strong US data simply adds to the selling pressures on bonds. 

Canada reports January retail sales. Headline sales are expected to fall -3.0% m/m vs. -3.4% in December, while sales ex-auto are expected to fall -2.7% m/m vs. -4.1% in December. Canada reported strong job growth in February and so the outlook for consumption is improving. That said, Canada’s vaccine program greatly lags that of the US and so the economic recovery is likely to continue lagging as well. The Bank of Canada just delivered a dovish hold last week and is seen remaining on hold while fiscal policy carries the load in 2021. Next policy meeting is April 21 and no change is expected then.



The Bank of England delivered a dovish hold, as expected. All policy settings were kept steady but there were two takeaways worth mentioning. First, the bank said MPC members put different weights on the balance of risks. The BOE was a little too upbeat at its last meeting and so we think the differing views of risks reflects a little pushback. This means that any removal of accommodation is nowhere close. Secondly, like the Fed, the BOE doesn't seem overly concerned with the rise in gilt yields yet. It noted "An aggregate measure of UK financial conditions has been broadly unchanged since the February Report." This means that markets have a green light to take yields higher. There were no updates to the macro forecasts, which will with the Monetary Policy Report that accompanies the next decision May 6. UK reported February public sector net borrowing ex-banks at GBP19.1 bln vs. GBP21.4 bln expected and a revised GBP3.1 bln (was GBP8.8 bln) in January. 

Reports suggest the UK and EU may reach an agreement on financial regulation by the end of this month. Unnamed officials noted that once a deal on financial regulation is reached, the EU could then grant the UK so-called partial regulatory equivalence for some financial products. Yet this may be just wishful thinking from the UK side. As things stand, the potential deal would call for a joint forum for discussing regulations and sharing information. It also includes provision for informal consultations concerning decisions to adopt, suspend or withdraw equivalence, but that is no guarantee that partial equivalence would be quickly granted by the EU. The issue of Northern Ireland remains a source of tension, along with vaccine supplies. Stay tuned.

As we had suspected, the Russian central Bank opted to kick off the tightening cycle. Earlier than most analysts had expected, the bank delivered a surprise rate hike of 25 bp to 4.50% in today’s meeting and indicated the possibility of another move at the next meeting. We see many variables here that likely tipped the balance, including inflation at 5.7% (the highest in four years), downward pressure on the ruble, the downward move in oil prices, and the rising risk of sanctions. Though the bank would never explicitly admit it, the deteriorating diplomatic outlook for US and Russia is a risk that is worth pre-empting. Our base case is for a benign set of sanctions, but the risks of a stronger response are certainly rising, including sanctions related to the Nord Stream pipeline with Germany.



The Bank of Japan’s policy review 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. It also implemented a lending incentive to help banks deal with negative rates. All of these changes were well-telegraphed but will ultimately have little impact on policy or the economy. When all is said and done, the BOJ should have just sat back and let the market take USD/JPY higher rather than rock the boat with what we view as mostly cosmetic tweaks. 

Ahead of the BOJ decision, February national CPI was reported. Headline fell -0.4% y/y vs. -0.6% in January, while core (ex-fresh food) fell -0.4% y/y vs. -0.6% in January. Both came in as expected. March Tokyo CPI will be reported next Friday, with headline and core expected at -0.3% y/y and -0.2% y/y, respectively. Currently, the bank sees targeted core inflation at 0.5% for FY2021 and for FY2022 at 0.7%. These forecasts will be updated at the April 26-27 meeting, when FY23 forecasts will be added. Bottom line is that even with these policy tweaks, inflation is likely to remain below the 2% target through FY23 as well.

Australia reported soft preliminary February retail sales. Sales were expected to rise 0.6% m/m but instead fell -1.1% and compares to a 0.5% gain in January. Lockdowns in Victoria and Western Australia were the cause, as sales declined by -4% and -6% in those states, respectively. As those lockdowns have ended, the outlook for sales in March (and beyond) remains solid.


Oil prices have seen sharp declines this week, though futures are about 1% higher this morning. Still, Brent is down 7% on the week, as some of the reflation trade enthusiasm gets unwound. Hefty long positioning is surely a big part of the story, but concerns about sustainable demand and a stronger dollar have also contributed to move. The decline in prices was much larger in the short end of the futures curve, so some of the strong backwardation has been removed.

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