Dollar Recovery Continues on Higher Yields and Improving Data

February 17, 2021
  • January retail sales data will be the US data highlight; January PPI data will also hold some interest; some cracks may be starting to appear; FOMC minutes will be released this afternoon; Canada reports January CPI
  • Bond investors gave Draghi a big thumbs up; the currency market is not reacting to Draghi as one might expect; UK reported January CPI
  • Japan reported firm January trade and December core machine orders; RBA Assistant Governor Kent estimated that AUD would be 5%higher without its QE program; the exchange rate is very much on the RBA’s collective minds; oil prices are likely to remain elevated as nearly a third of US crude production has been impacted by the freezing weather

The dollar continues to recover on the back of rising US yields and improving data. DXY yesterday recorded an outside up day and this points to further dollar gains. So far, it has retraced nearly half of this month’s drop and a break above 91.035 is needed to set up a test of this month’s high near 91.602. Similarly, the euro recorded an outside down day and needs to break below the $1.2035 area to set up a test of this month’s low near $1.1950. Sterling is succumbing to the resurgent dollar but continues to outperform and so the EUR/GBP made a new cycle low today below .87 before recovering. USD/JPY is trading at the highest level since September and is on track to test the August high near 107. We are increasingly confident that the dollar can carve out a bottom in Q1 as the vaccination rollout continues and the economy recovers. However, the recent volatile price action suggests its recovery won’t be a straight line.


January retail sales data will be the US data highlight. Headline sales are expected to rise 1.1% m/m vs. -0.7% in December, while sales ex-autos are expected to rise 1.0% m/m vs. -1.4% in December. The so-called control group used for GDP calculations is expected to rise 1.0% m/m vs. -1.9% in December. All three measures have fallen three straight months and some bounce back is expected. Signs of life in the US economy would go a long way for the dollar right now. The greenback had been trading on its back foot ever since the weak January jobs number but has started to recover. Yesterday’s Empire manufacturing survey is a good start (see below) but if retail sales can bounce back despite the poor labor market, the dollar outlook should improve further.

January PPI data will also hold some interest. Headline PPI is expected to rise 0.9% y/y vs. 0.8% in December, while core PPI is expected to rise 1.1% y/y vs. 1.2% in December. Last week, CPI came in lower than expected, with both headline and core rising 1.4% y/y. Despite weak price pressures, US yields continue to edge higher. An upside surprise in PPI today would likely keep that trend going, thereby boosting the greenback as well.

Indeed, the US curve continues to steepen to new highs. Our favored metric (3-month to 10-year) rose to 128 bp yesterday, the highest since February 2018 and on the way to testing that month’s high near 137 bp. The 2- to 10-year spread rose to 120 bp, the highest since March 2017 and nearing the December 2016 high near 134 bp. Both remain near those highs today. Yet the steepening has so far not been very disruptive as equity markets power higher to record highs and spread product continues to narrow.

However, some cracks may be starting to appear. Yesterday, EM FX as measured by MSCI fell the most since January 22, and it is adding to those losses today. Leading those losses are MXN and ZAR, two of the typically high beta group. Are they the canaries in the coal mine? We need to watch these two closely in the coming days. To repeat our current dollar call, we believe that it will bottom against EUR, JPY, GBP, and CHF in Q1. However, the global growth and liquidity stories remain positive for EM and the growth-sensitive majors (dollar bloc and Scandies). This divergence may be too nuanced, at least in the early stages of the dollar’s recovery. As such, our thesis will likely be tested often in the coming weeks.

Fed manufacturing surveys for February started to roll out. Empire survey came in yesterday at 12.1 vs. 6.0 expected and 3.5 in January. Philly Fed survey is out tomorrow and is expected at 20.0 vs. 26.5 in January. Markit reports preliminary February PMI readings Friday, with manufacturing expected at 58.5 vs. 59.2 in January and services expected at 58.0 vs. 58.3 in January. These are the first snapshots for February and will help set the tone for other data to come. Of note, January IP will be reported today and is expected to rise 0.4% m/m vs. 1.6% in December, while December business inventories are expected to rise 0.5% m/m.

FOMC minutes will be released this afternoon. The Fed delivered a dovish hold at the January meeting and the minutes should reflect that. Recall that Chair Powell said the path ahead remains uncertain and the Fed remains committed to its dual mandate. He noted that the US is a long way from full recovery and that policy will remain accommodative until the Fed’s goals are reached. Most importantly, he stressed that the whole focus on an exit strategy is premature and that it’s too early to talk about tapering. Ahead of the minutes, Barkin and Rosengren speak this morning.
Canada reports January CPI. Headline inflation is expected to rise 0.9% y/y vs. 0.7% in December, while common core is expected to rise 1.4% y/y vs. 1.3% in December. There are no policy implications. For now, the Bank of Canada is on hold while fiscal policy carries the load in 20221. Next policy meeting is March 10 and no change is expected then. The Loonie is struggling with two opposing drivers right now. Higher oil prices tend to support it, but the broad-based USD recovery is offsetting this. For now, the latter is in the driver’s seat as USD/CAD is trading at the highest level since last week. It has retraced nearly half of its drop this month and a break above the 1.2755 area would set up a test of this month’s high near 1.2845.


Bond investors gave Draghi a big thumbs up. At the first 10-year BTP auction yesterday since he was named Prime Minister, orders were over EUR110 bln and more than 10 times the amount offered. As a result of strong demand, the Italian Treasury cut the yield to 4 bp above the existing 10-year yield from initial guidance of 8 bp. That move was not taken well, as orders for the 10-year dropped sharply to EUR65 bln. Still, the sale was a success and underscores market confidence in the Draghi government. Draghi faces a confidence vote in the Senate today and the lower house tomorrow, both of which should easily pass.

What’s interesting is that the currency market is not reacting to Draghi as one might expect. Heightened political drama typically weighs on the euro, while its resolution later boosts it. Instead, the euro has greeted Draghi’s weekend appointment with a big yawn as it trades at its weakest level since February 9. This despite Draghi making very euro-positive comments, such as calling for a common EU budget that would better support member countries during recessions. A break below the $1.2035 area would set up a test of the February 5 low near $1.1950.

UK reported January CPI. Both headline and CPIH came in a tick higher than expected at 0.7% y/y and 0.9% y/y, respectively. Yet inflation is still only about a third of the 2% target and we believe it is unlikely to challenge that level anytime soon. Even if price pressures were to move higher, inflation shouldn’t be an issue for the BOE (and most other central banks) right now as reaction functions have shifted to favor growth and employment. We expect expansionary fiscal and monetary policies to continue this year as a result. Next Bank of England decision is March 18. We believe the bank was much too optimistic at this month’s meeting. Indeed, it forecasts inflation hitting the 2% target this year and rising to 2.3% next year. If the data disappoint in Q1, the bank may have to acknowledge more downside risks ahead. Deputy Governor Ramsden speaks today.


Japan reported firm January trade and December core machine orders. Exports rose 6.4% y/y vs. 6.8% expected and 2.0% in December, while imports fell -9.5% y/y vs. -5.5% expected and -11.6% in December. Export growth is the strongest since October 2018 and have risen y/y two straight months. Shipments to Asia and China in particular were strong. While GDP is widely expected to contract due to the domestic lockdowns, it appears that exports and the external sector may help offset some of those headwinds. Core machine orders were surprisingly strong, rising 5.2% m/m vs. -6.1% expected and 1.5% in November. This pushed the y/y rate up to 11.8% y/y, the strongest gain since June 2019.

RBA Assistant Governor Kent estimated that AUD would be 5%higher without its QE program. Noting the 40% rise in iron ore prices since early November, Kent said historical relationships with the currency would have implied a much stronger currency, adding “While history only provides a rough guide, this difference suggests that the bank’s policy measures have contributed to the Australian dollar being as much as 5% lower than otherwise, in trade-weighted terms.”

The exchange rate is very much on the RBA’s collective minds. In the minutes from last week’s meeting, the RBA justified extending its QE by noting that if it had had allowed QE to end in mid-April, AUD would likely have risen. For now, the RBA is clearly on hold with risks of further QE as risks lie ahead. Next RBA policy meeting is March 2 and no change is expected then. This recent USD recovery has seen AUD turned back from testing the January high near .7820. That’s good news for AUD bears, as a break above that would put .80 in the market’s sights.


Oil prices are likely to remain elevated as nearly a third of US crude production has been impacted by the freezing weather. Industry analysts estimate around 3.5 mln bbl/ day of US output has been halted as a cold blast freezes oil well operations as well as power outages across the central US. This could continue for days, possibly weeks. And it’s not just the US. Cold weather is curtailing oil output in Russia was well and has dropped below its OPEC+ quota. The big question is whether OPEC+ will react. Yes, the drop in output is temporary and weather-related but can the global economy cope with an energy price spike right now? If push comes to shove, we would expect OPEC+ to temporarily boost output if the price spike extends enough to risk the global recovery. Stay tuned.  

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