Dollar Gains as Eventful Central Bank Week Begins

March 15, 2021

Reports suggest President Biden is planning a major tax hike to help pay for the infrastructure bill; the US curve continues to steepen ahead of the FOMC meeting; Fed manufacturing surveys for March start to roll out
• After last week’s ECB meeting, the weekly details of its bond-buying operations have taken on greater importance; regional elections in Germany delivered a blow to the Merkel’s ruling CDU; BOE Governor Bailey said rising UK interest rates reflects optimism in the economy; Russia is gearing up for a faster pace of tightening
• China’s batch of data came in mixed compared to expectations, but robust on balance; concerns about Bank Indonesia’s independence are back to the forefront; ;cryptocurrencies had another wild ride over the weekend

The dollar has resumed its climb. DXY found support near 91.40 last week and has already clawed back nearly half of last week’s losses. This supports our view that recent dollar softness was largely profit-taking and consolidative in nature. 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 trading just below $1.1950 and needs to break below $1.19 to set up a test of last’s week’s low near $1.1835. Sterling is softer after being unable to break back above $1.40 and is testing support near $1.39. The rise in USD/JPY has resumed and traded at a new cycle high today near 109.35 before falling back slightly. We believe the pair remains on track to test the June 5 high near 109.85.



Reports suggest President Biden is planning a major tax hike to help pay for the infrastructure bill. This should not come as a huge surprise, as Treasury Secretary Yellen has said parts of the next bill will have to be paid with higher taxes. Reports suggest that key advisers are now preparing for a package of measures that could include increases in both the corporate tax rate and the individual tax rate for high earners. Of note, senior officials appear to have ruled out an outright wealth tax along the lines of what Senator Warren has proposed. However, there will be a lot of horse-trading as the bill gets written and markets will likely be a bit apprehensive. Stay tuned.

The US curve continues to steepen ahead of the FOMC meeting. Our favored metric (3-month to 10-year) has risen to 159 bp, the highest since 2017 and on track to test the December 2016 near 210 bp. The 2- to 10-year spread has risen to 146 bp and is the highest since 2015 and on track to test the June 2015 near 176 bp. The pace of steepening has so far not been disruptive as US equity markets power higher and spread product holds up relatively well. That said, the Fed will have to address this move higher in rates before it snowballs into something it can no longer control. We will be sending out an FOMC preview later today.

Fed manufacturing surveys for March start to roll out. Empire survey will be reported and is expected at 14.5 vs. and 12.1 in February. This will be followed by the Philly Fed survey Thursday and is expected at 24.0 vs. 23.1 in February. These are the first snapshots for March and will help set the tone for other data to come. The US manufacturing sector remains solid, and services are expected to catch up as the vaccine roll out accelerates. January TIC data will also be reported, while Canada reports January manufacturing sales and February existing home sales.



After last week’s ECB meeting, the weekly details of its bond-buying operations have taken on greater importance. For the week ending March 5, net purchases fell to EUR11.9 bln from $12.04 bln the previous week, a new low since early January. Redemptions came in at a relatively high EUR6.3 trln. Without them, gross purchases were EUR18.2 bln, up from EUR16.9 bln the week prior but still lower than the three weeks prior of EUR18,3 bln, EUR19.6 bln, and EUR18.4 bln. Markets will be looking for a big increase this week. Mere jawboning will have little lasting impact and so the ECB has to step up its purchases significantly to show its resolve.

Regional elections in Germany delivered a blow to the Merkel’s ruling CDU. The Chancellor’s party saw its support fall 4 ppts to 23% in the Baden-Wuerttemberg region, with the Greens the most popular party at 31%. The Greens also saw gains in neighboring Rhineland-Palatinate, with the CDU suffered its worst ever results in both states. Recall that Germany is heading to its Federal Elections at the end of September. Whist currently allied with the CDU, the Greens appear to be positioning themselves as kingmakers then as leader Baerbock noted “There are now many different parties that can be in government.” The CDU has not yet decided on its candidate for chancellor, while coalition partner Social Democrats have indicated it won’t support another CDU-led administration. The intrigue continues.

Bank of England Governor Bailey said rising UK interest rates reflects optimism in the economy. This is the same tack that Fed Chair Powell has taken and markets are growing increasingly jittery. Recall that the BOE tilted less dovish at the last meeting February 4. Since that meeting, the UK curve has steepened by 40-45 bp at the long end and 55-60 bp in the intermediate range. During that time, sterling has gained 2% vs. the dollar and 3% vs. the euro. While Bailey’s comments suggest otherwise, we believe the BOE will eventually have to push back against the rise in UK yields. We will be sending out a BOE preview later this week.

The Russian central bank is gearing up for a faster pace of tightening. At least that’s what a Bloomberg report (without naming sources) claims, indicating that as much as 125 bps of hikes could be in store for this year, from 4.25% currently. The moves would be to offset a post-pandemic pickup in inflation and government spending. This is a lot faster than most analysts (including us) would have expected. One possible reason for accelerated tightening would be to cushion the currency from the US sanctions. But so far, there are no strong indications we know of suggesting the Biden administration is looking to impose measure that would seriously impact financial markets or the economy.



China’s batch of data came in mixed compared to expectations, but robust on balance. Industrial production increased 35.1% y/y (higher than the 32.2% forecast) for the first two months of the year, but fixed asset investment grew 35.0% y/y (well below the 40.9% expected). Retail sales grew 33.8% y/y, slightly higher than expected. January and February were combined to avoid y/y distortions from the timing of the Lunar New Year, but data were still highly impacted by base effects from the pandemic. Still, the take-away is that retail sales are still lagging other sectors of the economy. Of note, home prices in China grew for the fastest rate in six months at 0.36% m/m. Officials have already imposed some macroprudential policies to start cooling the sector, but concerns about the overheating sectors (along with froth in the equity markets) are feeding into fears of faster tightening.

Concerns about Bank Indonesia’s independence are back to the forefront with a new draft bill to change its mandate. The proposal would expand the bank’s objectives to consider taking into account the government’s economic strategy when setting monetary policy. It also calls on the BI to take employment and sustainable economic growth, alongside its current mandate of price stability and the currency. The good news is that it doesn’t impose government ministers onto the BI’s board, as other proposals had. Still, the big picture here is the institutional independence is deteriorating and will require a risk premium in local assets. Indeed, data on local bond ownership shows this trend of continuous divestment by foreign investors.



Cryptocurrencies had another wild ride over the weekend. Bitcoin reached another all-time high of $61,740, then sold off earlier this morning. Bitcoin is down some 10% from its peak on Sunday, but still remains about double the value it started the year. Despite the volatility, on-chain fundaments remain broadly positive with growing number of new wallets (suggesting growing retail adoption), coins leaving exchanges to external wallets (suggesting long-term holding), and continued anecdotal reports of growing institutional adoption. In addition, Canada launched the first bitcoin ETF in North America earlier this year and markets gearing up for the Coinbase IPO.

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