Dollar Gains With Markets in Risk-On Mode

March 03, 2021

February ADP private sector jobs report will be the highlight; the US growth outlook remains strong; Fed releases its Beige Book report; measures of inflation expectations in the US are showing a mixed picture; Banco de Mexico releases its quarterly inflation report
UK Chancellor Sunak  presents his budget; ECB Executive Board member Panetta continued the jawboning; subsequent reports suggest ECB officials see no need to take drastic action to limit rising yields; final eurozone February services and composite PMIs were reported; inflation in Turkey came in slightly higher than expected; Poland is expected to keep rates steady at 0.10%
Australia reported final services and composite PMIs and Q4 GDP data;  Caixin services and composite PMI readings were reported; OPEC+ is set to start increasing crude production

Risk appetite has strengthened.  The US stimulus package is set for presentation at the Senate while UK Chancellor Sunak continued to pledge strong support for the UK economy as it recovers from the pandemic. Equities across the APAC region were higher, with the Hang Seng +2.7% and Nikkei +0.5%.  European bouses are mostly higher at midday, while US futures are pointing to a higher open.  That the dollar is up during a risk-on period is noteworthy.  DXY traded at the highest level yesterday since February 5 ear 91.394 before reversing to close lower.  Today, it is clawing back some of those losses and we believe it remains on track to test that February high near 91.602.  Break above that would set up a test of the November 23 high near 92.80.  The euro traded below $1.20 yesterday for the first time since February 5 before recovering but feels heavy and remains on track to test that day’s low near $1.1950.  Sterling is having trouble moving back above $1.40 ahead of the UK budget (see below).  USD/JPY continues its march higher and is trading at the highest level since August, testing that month’s high near 107.05.  Break above that sets up a test of the July high near 108.15.

AMERICAS

February ADP private sector jobs report will be the highlight.  It is expected at 200k vs. 174k in January.  ISM services PMI also comes out and is  expected to remain steady at 58.7.  The employment component will be watched closely for clues to NFP.  Consensus sees 195k jobs added vs. 49k in January, with unemployment steady at 6.3%.  Both average hourly earnings and average weekly hours are expected to fall a tick to 5.3% y/y and 34.9 hours, respectively.  Canada reports January building permits, which are expected to rise 2.5% m/m.  Yesterday, February auto sales came in at a 15.67 mln annual pace vs. 16.0 mln expected and 16.63 mln in January.

The US growth outlook remains strong.  Atlanta Fed's GDPNow model shows Q1 growth tracking at 10% SAAR, up from around 4.5% at the start of February.  Elsewhere, the NY Fed's Nowcast model shows Q1 growth tracking at 8.7% SAAR, up from around 5% at the start of 2021.  Both are subject to revision but the pickup in momentum is undeniable.  Contrast this with the eurozone, where Bloomberg consensus sees a -0.9% q/q (-3.6% annualized) contraction in Q1.

The Fed releases its Beige Book report.  Since the January 26-27 FOMC meeting, the economic outlook has improved significantly and Fed must acknowledge this.  January retail sales were off the charts, while manufacturing surveys are showing continued strength in February.  At the same time, the Beige Book will likely try to sound a note of caution as the labor market likely remains under stress in many Fed districts.  Harker, Bostic, and Evans also speak today. 

Measures of inflation expectations in the US are showing a mixed picture. As seen through the lens of breakeven rates, the 5-year measure continues to climb unabated, now at nearly 2.5%. However, the 10- and 30-year breakeven rates seem to have stabilized recently and have subsided somewhat to 2.2% and 2.1%, respectively. This decline in the long end rates can also be seen in the nominal 10-year, now at 1.45%. The 10-year is up a few basis points today but it’s well off the recent high near 1.60%.
 
Banco de Mexico releases its quarterly inflation report.  Minutes released last week showed that three of the five MPC members see room for further easing after it cut 25 bp in a unanimous decision at the February 11 meeting.  Deputy Governor Esquivel said last week that he saw scope for two more cuts this year, with one possible at the next meeting March 25.  He did warn that an expected spike in headline inflation due to higher fuel prices could delay that cut and so the inflation report will be very important.

EUROPE/MIDDLE EAST/AFRICA

UK Chancellor Sunak  presents his budget.  Higher spending is a given.  Last night, officials confirmed that the jobs furlough program will be extended through the end of September. The government will continue to pay 80% of wages through June, after which that amount will decline over the following three months.  The big question is how spending will be financed.  We do not think he will  announce any tax hikes just yet, not when the pandemic is still ongoing.  However, Sunak will likely signal that tax hikes will come in the not-so-distant future.  He promised a “fair” way to tackle budget deficits, suggesting a mix of personal and corporate tax hikes when the time comes.  Another budget is due in the fall and depending on how the reopening/recovery is going, Sunak may announce a more concrete timetable.  This week, it’s can-kicking time.

ECB Executive Board member Panetta continued the jawboning.  He said “The steepening in the nominal GDP-weighted yield curve we have been seeing is unwelcome and must be resisted.  We are already seeing undesirable contagion from rising U.S. yields into the euro area yield curve. If unaddressed, this would lead to a tightening of financing conditions that is inconsistent with our domestic outlook and inimical to our recovery.”  We stand by our long-standing call that the ECB will have to increase and extend PEPP again, perhaps around mid-year.  The March 11 meeting may see the ECB start to set the table for such a move with dovish guidance and downgraded macro forecasts.

Yet the ECB has yet to act forcefully with its asset purchases.  More detailed data about PEPP showed there was EUR4.9 bln of redemptions last week that pulled net ECB purchases down to EUR12 bln.  However, it's worth noting that gross purchases of EUR16.9 bln were still the lowest since late January.  Asset purchases made late in the week won't show up until this week's data due to settlement, but so far, the ECB's actions do not exactly signal great concern despite all the jawboning.

Indeed, subsequent reports suggest ECB officials see no need to take drastic action to limit rising yields. The article, which didn’t name sources, claims the ECB will rely on verbal intervention for now and added that the bar is high for increasing the overall asset purchase program. While this seems fair to us at these levels, we suspect that officials would be quick to change their minds if banks start to transmit higher yields through lending to consumers and corporates.  Given the mixed signals from the ECB, we fully expect the market to test the resolve of policymakers to keep yields low.
 
Firm final eurozone February services and composite PMIs were reported.  Headline services rose a full point from the preliminary to 45.7, dragging the composite PMI up to 48.8 from the preliminary 48.1.  France’s composite improved sharply to 47.0 from 45.2 preliminary, while Germany’s fell a couple of ticks to 51.1.  Spain and Italy composites improved significantly from January to 45.1 and 51.4, respectively.  Elsewhere, the final UK services and composite PMIs both fell a couple of ticks to 49.5 and 49.6, respectively.     

Inflation in Turkey came in slightly higher than expected.  This reinforces our view that the last meeting was a missed opportunity to reinforce credibility. February headline CPI rose to 15.61% vs. 15.4% expected and the highest since July 2019 and further above the 3-7% target range.  Core CPI and PPI readings were also higher than forecasts.  This puts Governor Agbal on the defensive again and means that the odds of another hike have increased and would come on top of the 675 bp he already has done since November. Higher energy price and the recent backup in USD/TRY from 7.0 to near 7.5 only strengthen this view.  Next policy meeting is March 18 and a hike then is getting more likely, especially if the lira continues to weaken.  It has remained on hold since the last 200 bp hike back in December.

 National Bank of Poland is expected to keep rates steady at 0.10%.  Central bank minutes for the February 3 meeting will be released Friday.  CPI rose 2.7% y/y in January, still near the center of  the 1.5-3.5% target range.  While some officials are talking about a possible rate cut, the policy rate of 0.10% leaves little room for easing.  While we cannot rule out a rate cut to 0%, we expect the bank to instead continue using asset purchases and FX intervention to provide more stimulus if needed.

ASIA

Australia reported final services and composite PMIs and Q4 GDP data.  Services fell to 53.4 vs. 54.1 preliminary and 55.6 in January, pulling the composite PMI lower to 53.7 from 54.4 preliminary and 55.9 in January.  Elsewhere, GDP grew 3.1% q/q vs. 2.5% expected and a revised 3.4% (was 3.3%) in Q3.  The economy has been performing well but signs of softness in the mainland China economy are cause for concern. Indeed, preliminary trade data showed a sharp -9% m/m drop in exports and this bears watching.  Final data will be reported tomorrow.  After peaking above .80 last week, AUD reversed sharply to trade below .77.  It has since recovered about a third of that drop but needs to break above the .7850 and .7885 levels to mount another challenge of that .8005 high. 

Caixin services and composite PMI readings were reported.  Services came in as expected at 51.5 vs. 52.0 in January, dragging the composite PMI lower to 51.7 from 52.2 in January. This is the lowest reading since April and compares the official composite PMI of 51.6 is the lowest since February.  

COMMODITIES AND ALTERNATIVE INVESTMENTS

OPEC+ is set to start increasing crude production but the news didn’t seem to weigh on energy futures much. According to Bloomberg, supply could increase from 500k-1.5 mln barrels a day, with Saudi again pushing for the lower end of that range. Brent is up 0.5% to $63 per barrel after four consecutive session of significant declines. Of note, the backwardation of the futures curve has started to revert somewhat, but the inversion in the curve remains at levels seen throughout the early stages of the pandemic.
 

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