Dollar Bid as U.S. Returns from Holiday

May 31, 2022

U.S. yields are recovering as inflation concerns rise; Fed officials remain hawkish; ahead of the jobs report, important survey data will be reported; Canada reports  Q1 GDP data

Eurozone May CPI data continue to worsen; the public ECB policy debate is likely to continue; Hungary is expected to hike  rates 50 bp to 5.90%

Japan reported mixed data; RBNZ Deputy Governor Hawkesby acknowledged a period of weaker consumption is likely; China reported firm official May PMI readings; oil prices are rallying after the EU reached a compromise to ban most Russian crude

The dollar is getting some traction as the U.S. returns from holiday.  DXY is trading near 102 after earlier making a new low for this move last week near 101.30.  The euro rally ran out of steam near $1.0785 and it is now trading back below $1.07 despite higher than expected May CPI readings (see below).  USD/JPY is trading at the highest level since May 19 near 128.35 and a break above 128.45 would set up a test of the May 17 high near 129.80.  Sterling is trading back below $1.26 after its rally ran out of steam near $1.2665.  We still view this recent move lower in the dollar as a correction within the longer-term dollar rally but acknowledge that further losses are possible until the market pessimism on the U.S. economic outlook improves (see below).  


With U.S. recession fears growing , this week’s U.S. data will be very important.  We get the first major indicators for May and markets will be looking for larger cracks in the U.S. economic outlook.  We acknowledge that some survey data have softened, but real sector data such as employment and retail sales have remained strong so far in Q2.  For now, the pendulum of market sentiment has swung against the U.S. in terms of the economic outlook and by extension against the dollar.  We believe it is only a matter of time before it swings back in favor of both.  Some strong data this week would certainly help.

U.S. yields are recovering as inflation concerns rise.  The 10-year yield is currently trading near 2.82%, up from last week’s low near 2.70% but still well below the May 9 peak near 3.20%.  Elsewhere, the 2-year yield is trading near 2.54%, up from last week’s low near 2.44% but still well below the May 4 peak near 2.85%.  The 2-year differentials with Germany, Japan, and the U.K. may have bottomed out but whether the rise in U.S. yields can be sustained will depend in large part how this week’s U.S. data come in.  Stay tuned. 

Fed officials remain hawkish.  Governor Waller said yesterday that he wants to keep hiking rates in 50 bp clips until inflation is moving back towards the 1% target.  Specifically, he said “I support tightening policy by another 50 bp for several meetings.  In particular, I am not taking 50 bp hikes off the table until I see inflation coming down closer to our 2% target.”  Waller and Bullard have consistently been the most hawkish at the Fed and have successfully dragged the rest of the Fed closer to their positions.      

Fed tightening expectations continue to adjust.  WIRP suggests 50 bp is fully priced in for June and July.  However, a third 50 bp that was fully priced in for September is now about 50% priced in vs. 35% last week.  After September, two more 25 bp hikes are fully priced in and a third is partially priced in that would take the Fed Funds ceiling to between 3.0-3.25%.  What’s really changed is that rates are seen peaking in mid-2023 before falling in H2 23 and beyond.  This would only happen if the U.S. were to fall into recession next year and while it is possible, it is not our base case.  Again, this week’s data will be very important for near-term market expectations.

Ahead of the jobs report, important survey data will be reported.  Chicago PMI will be reported today and is expected at 55.1 vs. 56.4 in April.  The regional Fed manufacturing surveys wrap up with Dallas today, which is expected at 1.5 vs. 1.1 in April.  So far, most of those have been significantly weaker with the exception of Kansas City.  Yet as we’ve point out before, S&P Global manufacturing PMI came in at 57.5 and so the regional Fed manufacturing surveys appear to be overstating weakness. May ISM manufacturing PMI will be reported tomorrow and is expected at 54.5 vs. 55.4 in April.   

Other data will round out the picture of the U.S. economy.  March S&P CoreLogic house prices and May Conference Board consumer confidence will also be reported.  Housing market data will be taking on greater importance as concerns about recession rise.  Here, prices are expected at 19.8% y/y vs. the 20.2% cycle peak in February.  Elsewhere, headline confidence is expected at 103.8 vs. 107.3 in April.  If so, it would be the lowest since February 2021 and yet it’s hard to put much weight on this reading when consumption remains strong.   

Canada reports  Q1 GDP data.  Growth is expected at 5.2% SAAR vs. 6.7% in Q4.  The economy remains firm even as the Bank of Canada meets tomorrow.  WIRP suggests a 50 bp hike is fully priced in with nearly 70% odds of a 75 bp move.  While bank officials have tilted very hawkish, we believe a 75 bp move is unlikely at this juncture.  Looking ahead, the swaps market is pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 3.0%. 


Eurozone May CPI data continue to worsen.  Headline CPI came in at 8.1% y/y vs. 7.8% expected and 7.4% in April, while core came in at 3.8% y/y vs. 36% expected and 3.5% in April.  France and Italy reported today, with EU Harmonized CPI coming at 5.8% and 7.3%, respectively.  Yesterday, Spain and Germany reported EU Harmonized CPI at 8.5% and 8.7%, respectively.  All readings were higher than expected.  Eurozone April PPI will be reported Thursday and is expected at 38.6% y/y vs. 36.8% in April.  For now, eurozone price pressures are showing no signs of letting up, especially with oil prices continuing to move higher (see below). 

The public ECB policy debate is likely to continue.  After the CPI data, the hawks will see even greater urgency to tighten more aggressively.  Villeroy, Visco, and Makhlouf speak today.  Visco said that “Particular attention will have to be paid to ensuring that the monetary policy normalization process takes place in an orderly manner and to preventing the emergence of any market fragmentation.”   Villeroy said “The latest inflation figures for May, in France and in the other countries, confirm the rise that we expected, and the necessity of a gradual but resolute monetary normalization.”  He added that “Clarity is needed: the increase in rates in an orderly and well-managed way will be favorable for the financial sector.  It should support the profitability of French banks by increasing net activity margins.”  WIRP suggests liftoff July 21 remains fully priced in.  So are follow up hikes in September, October, and December that would take the deposit rate to 0.5% by year-end.  Looking ahead, the swaps market is pricing in 200 bp of tightening over the next 24 months that would see the policy rate peaking near 1.5%.   

National Bank of Hungary is expected to hike  rates 50 bp to 5.90%.  Several analysts see a larger hike of 60 or 75 bp.  The bank is also expected to hike its 1-week deposit rate 30 bp to 6.75% at its weekly tender Thursday.  CPI rose 9.5% y/y in April, the highest since June 2001 and further above the 2-4% target range.  The swaps market is pricing in 135 bp of tightening over the next 12 months that would see the policy rate peak near 6.75%.  We see upside risks.  April PPI will also be reported Tuesday.  April retail sales will be reported Friday and are expected at 13.8% y/y vs. 16.2% in March.  


Japan reported mixed data.  April labor market, IP, retail sales, housing starts, and May consumer confidence were all reported.  Unemployment fell a tick to 2.5% while the job-to-applicant ratio rose a tick to 1.23.  IP came in at -1.3% m/m vs. -0.2% expected and 0.3% in March, while sales came in at 0.8% m/m vs. 0.9% expected and a revised 1.7% (was 2.0%) in March.  The labor market continues to heal but unlike many other developed countries, the unemployment rate has not yet fallen to pre-pandemic levels.   Lack of wage pressures is one of the major reasons cited by the Bank of Japan for keeping policy ultra-loose.  On the other hand, it appears supply chain disruptions in China helped push down IP, making for an uneven recovery in Q2 so far.  For now, all signs point to that policy being maintained through the end of Governor Kuroda’s term next spring. 

RBNZ Deputy Governor Hawkesby acknowledged a period of weaker consumption is likely.  He noted that higher rates are expected to impact household budgets and added that given the global and domestic risks, “a recession is well within the realms of possibility.”  However, he noted that current trends in core inflation and inflation expectations “give a clear message we need to continue removing stimulus.”  Lastly, Hawkesby said the bank needs to tighten beyond neutral, which he views as 2%.  Next policy meeting is July 13 and another 50 bp hike to 2.5% is expected.  Looking ahead, the swaps market is pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 4.0%. 

China reported firm official May PMI readings.  Manufacturing PMI came in at 49.6 vs. 49.0 expected and 47.4 in April, while non-manufacturing came in at 47.8 vs. 45.5 expected and 41.9 in April.  As a result, the composite rose to 48.4 vs. 42.7 in April, which quite frankly is unbelievable given the strict COVID Zero policies still in place.  While some restrictions in Beijing and Shanghai will be relaxed this week, it is likely too late to be reflected in the May PMI readings.  Caixin reports its May manufacturing PMI Wednesday and is expected at 49.5 vs. 46.0 in April. 


Oil prices are rallying after the EU reached a compromise to ban most Russian crude.  As with most sanctions, this latest one is imperfect in that it only limits oil products transported by sea and will take effect six months from adoption (eight months for refined products).  The concession was necessary to get land-locked Hungary to agree, as it will continue to receive Russian oil by pipeline.  Hungary reportedly received assurances from the EU that it would be able to receive replacement supplies if the pipelines were to be disrupted.  The full details have yet to be hammered out but the news has helped push crude oil prices higher.  Also at work is optimism that the mainland Chinese economy will pick up now that virus numbers appear to have peaked and movement restrictions are being eased.  Both Brent and WTI crude are trading at the highest since March 9 and are on track to test the post-invasion highs.  

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