Dollar Steady Ahead of FOMC Decision

March 17, 2021

•    The FOMC ends a two-day meeting with a likely dovish hold this afternoon; markets are clearly not on board with the Fed’s messaging on rates US rates are at the highs ahead of the decision; February retail sales data are worth discussing; Canada reports February CPI; Brazil is expected to hike rates 50 bp to 2.5%.
•    Italy and France signaled they may start using the AstraZeneca vaccine if the European Medical Agency (EMA) advises that it is safe; Governing Council member Kazimir said the ECB is pushing  back against higher bond yields in large part due to slow fiscal stimulus; yet ECB asset purchases remain underwhelming
•    Japan reported disappointing February trade data; BOJ starts a two-day meeting tonight with a decision on Friday

The dollar remains steady ahead of the FOMC decision.  DXY has flat-lined the last two days after two straight up days but has run into resistance near 92 ahead of the FOMC.  If the Fed fails to reassure the markets about rising yields, then we see potential for another leg higher in the dollar.  DXY needs to break above the 92.068 area to set up a test of last week’s high near 92.503.  The euro is still finding some support just ahead of $1.19 but feels heavy.  A break below that would set up a test of last’s week’s low near $1.1835.  Sterling is outperforming today and is trading back above $1.39 after finding support near $1.38 yesterday.  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 ends a two-day meeting with a likely dovish hold this afternoon. No change in policy is expected but the messaging and forward guidance will be crucial for bond yields.  This is especially true since the Fed is likely to mark up its growth forecasts with its quarterly update to its Summary of Economic Projections, due to a healthy combination of accelerated vaccine roll out and aggressive fiscal stimulus.  The Dot Plots are still expected to show no rate hikes through 2023 but things could get tricky.  In the December Dot Plots, five policymakers envisioned a hike in 2023.  If four more shift to that view, then the median would no longer show no hikes.

Markets are clearly not on board with the Fed’s messaging on rates.  Despite the significantly improved US economic outlook, we do not think the Fed will shift its guidance now to validate market pricing for the first Fed hike that is creeping into Q3 2022.  For an extended period, Q1 2023 was penciled in but that has 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. 

US rates are at the highs ahead of the decision.  If the Fed is unable to shift market expectations away from rising yields, then we would expect rates to spike even higher.  This would give the dollar further fuel to rise.  As it is, the 3-month to 10-yrear curve continues to steepen to new highs for this move near 163 bp, with the 2- to 10-year mirroring this with a move to 149 bp.  Inflation breakeven rates are also at the highs for this cycle.  Please see our FOMC preview here.

February retail sales data are worth discussing.  Headline sales plunged -3.0% m/m vs. -0.5% expected, but January was revise up to 7.6% from 5.3% previously.  Similarly, sales ex-autos fell -2.7% m/m vs. +0.1% expected and a revised 8.3% (was 5.9%) in January.  Lastly, the so-called control group used for GDP calculations fell -3.5% m/m vs. -0.6% expected and a revised 8.7% (was 6.0%) in January.  The big upward revisions to January were almost as big as the downside misses.  Some payback was to be expected after January’s surge, and was likely made worse by bad weather.  Still, we suspect markets will look through this weakness towards another likely blockbuster reading for this month, as stimulus checks are reportedly being sent out as we write.  February building permits (-7.2% m/m expected) and housing starts (-1.3% m/m expected) will be reported today. 

Canada reports February CPI.  Headline inflation is expected to rise 1.3% y/y vs. 1.0% in January, while common core is expected to rise 1.4% y/y vs. 1.3% in in January.  Headline inflation is currently at half of the 2% target and there is plenty of slack in the economy to prevent a significant and sustained acceleration anytime soon.  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.

Brazil COPOM is expected to hike rates 50 bp to 2.5%.  Some analysts look for a smaller 25 bp hike.  However, implied rates from Brazilian swap markets show investors are split between a 50 and 75 bp hike today.  We are leaning towards 75 bp.  IPCA inflation came in at 5.20% y/y in February, higher than expected and the highest since January 2017.  It is also approaching the top of the 2.25-5.25% target range and requires a stronger response from the central bank.  We suspect the exchange rate may be the deciding factor between a 50 or 75 bp move.  The context of currency under pressure and growing risk of fiscal slippage means this is an ideal time for the bank to anchor credibility by surprising on the upside. It would make sense for them to frontload the cycle and then cut it short of outlook changes then to risk falling behind the curve. Moreover, the recent higher-than-expected growth and inflation numbers should give officials the necessary backing to do so. 


EUROPE/MIDDLE EAST/AFRICA

Italy and France signaled they may start using the AstraZeneca vaccine if the European Medicines Agency (EMA) advises that it is safe. The EMA has already said it was safe and that the move risked undermining trust in vaccines. Its official verdict is expected tomorrow, and it is widely expected to say that the benefits outweigh the risks.  However, reports suggest individual country decisions to halt vaccine use were made without any sort of coordination or consultation with the EU’s decision-making bodies in Brussels.  This is just the latest to befall Europe, where the vaccine roll out continues to disappoint. 

Governing Council member Kazimir said the ECB is pushing  back against higher bond yields in large part due to slow fiscal stimulus.  He said “My concern is that, compared with the enormous US fiscal impulse, the effects of the European one will kick in with a major delay - we’re talking months and years.”   He added that last week’s ECB decision to accelerate asset purchases was “a reaction to the spillover of the market move triggered by the approval of the US fiscal package.”  Lastly, he stressed that with regards to rising yields, “What’s important is that such an increase reflects economic fundamentals and that there aren’t some speculative, unwarranted moves.” 

Yet ECB asset purchases remain underwhelming.  Yesterday, it was reported that redemptions last week were EUR4.6 bln, which translates into gross purchases of EUR18.7 bln.  That's slightly higher than EUR18.2 bln, EUR16.9 bln, and EUR18.3 bln totals for the previous three weeks but not by very much.  At some point, we think the market calls the ECB out on this.


ASIA

Japan reported disappointing February trade data.  Exports fell -4.5% y/y vs. -0.2% expected and 6.4% in January, while imports rose 11.8% y/y vs. 12.0% expected and -9.5% in January. The adjusted balance fell into a rare deficit of -JPY37.7 bln, the first since last June.  The slump in exports is particularly disappointing, as much of Asia is enjoying string shipments in Q1. Domestic activity has slumped in Q1 due to the lockdowns, and it appears the external sector is adding to the soft economic outlook.  

The Bank of Japan starts a two-day meeting tonight with a decision on Friday.  While no change is expected in its main policy settings for rates and YCC, the bank will also release the results of its policy review and there are some possible tweaks to its ETF purchases and other minor changes.  It will likely pay some lip service to a possible rate cut but one is highly unlikely.  We do not think the BOJ should allow greater fluctuations in its YCC policy, not in the current rising rate environment.  When all is said and done, the BOJ really should just sit back and let the market take USD/JPY higher rather than rock the boat with some cosmetic changes in policy.  We will be sending out a BOJ preview later today. 

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