Dollar Bid as Risk Off Impulses Take Hold

October 27, 2021

The U.S. yield curve continues to flatten; U.S. data remain strong; BOC is expected to keep rates steady at 0.25%; Brazil COPOM meets and median consensus sees a 150 bp hike to 7.75%
Eurozone data were mixed today; significant slowing in the eurozone should lead to a dovish surprise from the ECB tomorrow; U.K. Chancellor Sunak gives his budget speech shortly
Japan Prime Minister Kishida plans to draw up an economic stimulus plan shortly after this Sunday’s general election; two-day BOJ meeting starts today; Australia reported mixed Q3 CPI; markets are testing the RBA’s forward guidance of steady rates until 2024

The dollar is bid as some risk off impulses take hold. DXY is trading around 94.0, which is the top of the trading range that has largely held since mid-October. JPY and CHF are outperforming, with USD/JPY trading back below 114 and EUR/CHF trading at new lows for this cycle near 1.06. The euro is trading just below $1.16, while sterling is trading back at the lower level since October 18 near $1.3720 ahead of Sunak’s budget speech (see below). It appears that the dollar smile is back in play again, with the greenback set to benefit from either risk-off trading or strong U.S. data. For DXY, we need a break above 94.15 to set up a test of the October 12 high near 94.561. For EUR, we need a break below $1.1580 to set up a test of that day's low near $1.1525.

AMERICAS

The U.S. yield curve continues to flatten. After peaking at 166 bp last week, the 3-month to 10-year curve is currently around 155 bp. The 2- to 10-year curve has flattened even more, falling to 110 bp currently from a peak near 130 bp earlier this month. The 2-year yield traded today near 0.51%, a new cycle high. However, the 10-year yield is trading below 1.60% and is at the low end of recent ranges. Fed lift-off is now fully priced in for Q3 22, with a second hike fully priced in for Q4 22. U.S. economic data remain firm and so we believe the upward trajectory in rates and the dollar remains intact.

The U.S. data remain strong. Yesterday, we hit a trifecta. Richmond Fed manufacturing survey came in at 12 vs. 5 expected and -3 in September, September new home sales jumped 14.0% m/m vs. 2.2% expected and a revised -1.4% (was 1.5%) in August, and October Conference Board consumer confidence came in at 113.8 vs. 108.0 expected and a revised 109.8 (was 109.3) in September. All were stronger than expected and underscores that despite supply chain issues and labor shortages, the U.S. economy continues to chug along. Yes, Q3 GDP out Thursday is going to soften from 6.7% SAAR Q2 but given the recent firm data, I think there are upside risks to the consensus 2.6% SAAR. September advance goods trade (-$88.3 bln expected), wholesale and retail inventories, and durable goods orders (-1.1% m/m expected) will be reported today.

Bank of Canada is expected to keep rates steady at 0.25%. A final round of tapering seems likely but markets will be looking for any perceived shift in forward guidance. Updated macro forecasts could hold some clues. Last week, September CPI came in at 4.4% y/y, more than double the 2% target and well above the 1-3% target range. Retail sales and jobs data have also come in strong lately, which has led the market to reprice BOC tightening expectations. Swaps market is pricing in nearly 100 bp of BOC tightening over the next twelve months, which is clearly at odds with current forward guidance for H2 22 liftoff. August GDP (0.7% m/m expected) will be reported Friday.

Brazil COPOM meets and median consensus sees a 150 bp hike to 7.75%. However, some analysts see a smaller 100 or 125 bp hike, while the CDI market sees potential for a larger 175 bp hike to 8.0%. Yesterday IPCA was reported up 10.34% y/y, higher than expected and the highest since February 2016. After that reading, we think there are some slight risks of a hawkish surprise today, though 175 bp seems too aggressive.

EUROPE/MIDDLE EAST/AFRICA

Eurozone data were mixed today. German GfK November consumer confidence came in at 0.9 vs. -0.5 expected and a revised 0.4 (was 0.3) in October. However, French October consumer confidence came in at 99 vs. 101 expected and a revised 101 (was 102) in September. Eurozone also reported September M3, which slowed as expected to 7.4% y/y vs. 7.9% in August. This was the slowest since March 2020 and suggests that the ECB’s monetary stimulus is close to running its course. This would also be an argument to keep QE going beyond March, when PEPP is set to end.

Significant slowing in the eurozone should lead to a dovish surprise from the ECB tomorrow. While we don't expect any revelations about QE until the December meeting, we expect the ECB to take a very dovish tone and push back against rising rates at the short end, which likely signify some heightened tightening expectations. Of note, net weekly asset purchases have remained high so far in Q4, averaging close to EUR18 bln over the last three weeks. This so far does not suggest a more “moderate” pace and supports our view that the ECB is really not ready to withdraw accommodation anytime soon.

U.K. Chancellor Sunak gives his budget speech shortly. Recent comments suggest Sunak will announce a cautious budget that begins to rein in the large-scale budget deficits sooner rather than later, whilst providing continued support for firms and families hurt most by the pandemic. The stronger than expected economic recovery should lead to significant revisions to the deficits forecasts, allowing Sunak to announce some increased spending for healthcare as well as an end to the public sector pay freeze. Many of these details have already been leaked. That said, we suspect planned tax hikes already announced will remain in place. Sunak faces a delicate balancing act even as the Bank of England looks set to tightening policy soon, perhaps as early as next week. If push comes to shove and the economy slows significantly next year, we expect the Treasury and BOE will both be willing to reverse course as needed.

ASIA

Japan Prime Minister Kishida plans to draw up an economic stimulus plan shortly after this Sunday’s general election. The size of the plan would be worth tens of trillions of yen and could be implemented as soon as early November. Economy Minister Yamagiwa said helping those who have suffered economically from the pandemic would be at the top of the agenda. Why did Kishida wait until after the election, when a stimulus plan comes too late to boost his support? A fiscal package has been talked about all summer and yet Kishida did not deliver anything beyond a vague announcement right before the vote. It makes no sense to us and this delay likely cost the LDP some votes.

Two-day Bank of Japan meeting starts today. A dovish hold is widely expected tomorrow. Updated macro forecasts will be released and reports suggest that the BOJ will lower its inflation forecast for FY21 to around 0% from 0.6% due to re-basing of the CPI. FY21 growth forecast will reportedly be cut too, but FY22 would be raised. Overall, we expect the updated forecasts to underscore that liftoff won’t be seen until FY24 at the earliest. FY24 will be added with the April 2022 Outlook Report and is likely to show inflation remaining well below the 2% target, which would suggest no liftoff until FY25 at the earliest.

Australia reported mixed Q3 CPI. Headline inflation came in a tick lower than expected at 3.0% y/y vs. 3.8% in Q2, while trimmed mean inflation came in three ticks higher than expected at 2.1% y/y vs. 1.6% in Q2. This puts headline inflation back to the top of the RBA’s 2-3% target range after spending one quarter above it. However, markets are focusing more on trimmed mean inflation being the highest since Q4 2015. Bond yields surged, with the yield on the targeted April 2024 government bond rising 5 bp to 0.18%, well above the 0.10% target and likely to force the RBA to intervene again.

Markets are testing the RBA’s forward guidance of steady rates until 2024. Swaps market now pricing in nearly 60 bp of RBA tightening over the next twelve months, up from 50 bp at the start of this week. Next policy meeting is November 2 and we believe the bank will push back against these market expectations rather than validate them. New macro forecasts will be released then and will be a big part of the forward guidance. We also think the RBA could push back against recent currency strength, though AUD gains have been capped around .7550, just below the 200-day moving average near .7560 currently.

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