Dollar Soft as Markets Recalibrate Fed Lift-Off Expectations

April 08, 2021
  • Market expectations for Fed tightening continue to move the other way; FOMC minutes are worth a mention; Fed policymakers continue to stress the new outcome-based strategy; weekly jobless claims should show resumed improvement in the labor market; Mexico reports March CPI; Peru is expected to keep rates steady at 0.25%.
  • Doubts about the AstraZeneca vaccine persist despite several announcements made yesterday; as a result, sterling should continue to underperform for now; the EU is struggling with the AstraZeneca fallout even as vaccinations lag; weekly ECB asset purchases were reported; Germany reported weak February factory orders
  • The performance divergence in Asia equity markets continues to widen; Japan reported February current account data

The dollar remains under modest pressure. DXY traded yesterday at the lowest level since March 23 before finding support just above the 92 area. Despite this week’s setback, we believe the fundamental story remains positive for the dollar. However, a break below the 92.117 area would suggest a deeper correction to the March 18 low near 91.30. The euro has led this move but is softer today after being unable to sustain a break above the $1.1895 area (200-day moving average). Sterling has been underperforming lately (see below) but cable has stabilized a bit on broad dollar weakness. Still, the break below $1.3765 sets up a test of the March 25 low near $1.3670. USD/JPY remains heavy after the failed test of the 111 level last month. The pair is testing the key 109.40 level and a break below would set up a test of the March 23 low near 108.40.



Market expectations for Fed tightening continue to move the other way . As Q2 began, a hike by mid-2022 was nearly a third priced in by the Fed Funds futures strip, moving to being almost fully priced in by end-2022. Since April 2, those odds have fallen to around 20% and 60%, respectively. At the margin, this shift in market expectations is dollar-negative, just as they were positive on the way up in March. We continue to think that this week's dollar weakness is technical in nature, with the rally to resume on the red hot US economic outlook. US long yields have stabilized for now but should move higher in the coming weeks.

FOMC minutes are worth a mention. At the March 16-17 meeting, the Fed continued to show no inclination to talk about tapering or tightening. The key passage to us was “Participants judged that the Committee's current guidance for the federal funds rate and asset purchases was serving the economy well. They noted that a benefit of the outcome-based guidance was that it did not need to be recalibrated often in response to incoming data or the evolving outlook. Participants also noted the importance of communicating to the public that the existing guidance, together with the new monetary policy framework as delineated in the revised Statement on Longer-Run Goals and Monetary Policy Strategy, meant that the path of the federal funds rate and the balance sheet depend on actual progress toward reaching the Committee's maximum-employment and inflation goals. In particular, various participants noted that changes in the path of policy should be based primarily on observed outcomes rather than forecasts.”

Fed policymakers continue to stress the new outcome-based strategy. Yesterday, Governor Brainard said “our monetary policy forward guidance is premised on outcomes, not the outlook. And so it is going to be some time before both employment and inflation have achieved the kinds of outcomes that are in that forward guidance. We are actually going to have to see that in the data.” Meanwhile, Bullard, Powell, and Kashkari all speak today and are likely to continue pushing the dovish narrative. For now, it seems the US bond market is in board with the Fed. The next FOMC meeting is April 27-28 and no change in its dovish tone nor its policy is expected then.

Weekly jobless claims should show resumed improvement in the labor market. Regular initial claims are expected at 680k vs. 719k last week, which rose unexpectedly after the previous week’s 658k that was the lowest reading since pre-pandemic March. Regular continuing claims are expected at 3.638 mln vs. 3.794 mln last week, which was the lowest reading since pre-pandemic March. Together with emergency PUA and PEUC claims, total continuing claims fell to 17.1 mln, the lowest since mid-April. As vaccinations continue and more states reopen, we expect another month of solid job growth in April.

Mexico reports March CPI. Inflation is expected at 4.67% y/y vs. 3.76% in February. If so, it would be the highest since December 2018 and above the 2-4% target range for the first time since last October. Banxico minutes will also be released today. At that March 25 meeting, rates were left steady at 4.0% after a 25 bp cut at the February 11 meeting. Next policy meeting is May 13. If inflation remains above target, then we see rates on hold then. Consensus sees potential for one last cut in 2021 and then steady rates through much of 2022. We concur.

Peru central bank is expected to keep rates steady at 0.25%. Inflation was 2.60% y/y in March, near the cycle high of 2.68% in January and near the top of the 1-3% target range. Consensus sees steady rates through 2021, with odds of a hike rising as we move into 2022. We concur. High copper prices should help the economy rebound fairly quickly this year. Political uncertainty is running high ahead of this Sunday’s presidential vote. Polls suggest a tight race between Yonhy Lescano, Hernando de Soto, and Veronika Mendoza. If no candidate wins 50% (which seems likely), then a second round with the top two vote-getters will be held in June.



Doubts about the AstraZeneca vaccine persist despite several announcements made yesterday. The UK Medicines and Healthcare products Regulatory Agency said it found a “reasonably plausible link” between blood clots and the vaccine but did not block its usage. However, it recommended that people aged 18-29 should use an alternative vaccine whenever possible. After the MHRA statement, Health Secretary Hancock said the UK is “on track” with its target to offer a first vaccine dose to all adults by the end of July. Obviously, this news has the greatest implications for sterling as it is the backbone of the UK vaccination program, developed with scientists at Oxford University.

As a result, sterling should continue to underperform for now. While cable remains hostage to broad movements in the dollar, it traded today at a new low for this move near $1.3720 and is on track to test the March low near $1.3670 and then the February low near $1.3565. Elsewhere, the EUR/GBP cross should continue to rebound after trading at a new cycle low last week near .8493. The pair traded yesterday at the highest level since March 3 and is on track to test the February 26 high near .8731.

On the continent, the EU is struggling with the AstraZeneca fallout even as vaccinations lag. EU Health Commissioner Kyriakides told member country health ministers that they needed to forge “a coordinated European approach.” She added that “This will be key for us to speak with one voice” as the EU needs “an approach which does not confuse citizens and that does not fuel vaccine hesitancy.” Of note, the European Medicines Agency found a “strong association” between the vaccine and blood clots. However, it did not issue any guidelines about age, leaving it up to member states. So much for “one voice.” Italy just followed Germany and France in recommending the AstraZeneca vaccine only for people over 60. Prime Minister Draghi’s government has urged other EU members to implement the same policy. Elsewhere, Germany is starting to negotiate the acquisition of the Russian Sputnik vaccine, though it would require EU approval.

Weekly ECB asset purchases were reported. Net purchases came in at EUR10.6 bln, about half the pace seen the past two weeks. Of course, holidays last Friday and this past Monday will lead to lower than usual purchases for both weeks. Today, we should get more details about redemptions and gross purchases from last week. The ECB also releases the account of its March 10-11 meeting today and it is expected to show a deeply divided ECB.

Germany reported weak February factory orders. They rose as expected by 1.2% m/m but the January gain was revised down to 0.8% from 1.4% in previously. German IP, trade, and current account data will be reported tomorrow. IP is expected to rise 1.5% m/m vs. -2.5% in January, while exports are expected to rise 1.0% m/m vs. 1.5% in January and imports are expected to rise 2.1% m/m vs. -4.0% in January. Of note, the German government is looking into new legislation allowing it to impose targeted lockdowns. The proposal would allow it to tighten mobility restrictions in the regions suffering the most with the virus. With France going back into nationwide lockdown and both Italy and Germany extending partial lockdowns, the weak eurozone outlook is likely to carry over into Q2.



The performance divergence in Asia equity markets continues to widen. Chinese equities are still down about 2% on the year due to persistent concerns the regulatory crackdown on the tech sector as well as official comments about speculative froth in real estate and equity markets. In contrast, many other large EM Asian indices continue to steam ahead. Taiwan’s TWSE index is up 15% on the year, while Hong Kong’s Hang Seng and Korea’s Kospi are both up some 6.5%. Of note, Japan’s Nikkei is outperforming most EM indices this year, up 8.2%, though when adjusted for yen weakness, the dollar return falls to just 1.3% YTD.

Japan reported February current account data. The adjusted JPY1.8 trln surplus was nearly twice the JPY1.02 trln that was expected. More importantly, the data showed Japanese investors sold JPY643 bln of Australian government debt that month, the biggest sale on record dating back to 2005. Japanese investors turned net sellers of US government debt for the first time since August, selling a net JPY618.7 bln in February. We don’t want to read too much into the data, as the selling came ahead of the end of the fiscal year and amidst a deepening global sell-off in bonds that both culminated in late March. Reports suggest that Japanese investors will once again buy higher yielding US and Australia debt in the new fiscal year but we won’t see the April data for a couple of months. Stay tuned.

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