Dollar Builds on Post-Data Gains

February 17, 2023
  • It appears that inflation is not so easily vanquished after all; U.S. yields continue to rise; Fed hawks are getting more vocal; we don't think 50 bp is likely at the March 15-16 FOMC; the labor market remains strong
  • ECB hawks are pushing back against the doves; ECB tightening expectations have picked up; U.K. reported firm January retail sales; BOE Chief Economist Pill continues to sound dovish
  • RBA Governor Lowe testified before Parliament; New Zealand Finance Minister Robertson acknowledge the likely impact of the Auckland floods due to Cyclone Gabrielle; the floods will certainly complicate the RBNZ’s job

The dollar is building on its post-data gains. DXY traded at a new high for this move near 104.556 today and is on track to test the January 6 high near 105.631. The euro is trading at a new low for this move near $1.0630 and is on track to test the January 6 low near $1.0485. Sterling is trading at a new low for this move near $1.1915 and is on track to test the January 6 low near $1.1840. USD/JPY is trading at a new high for this move near 135.10 and is on track to test the December 20 high near 137.50, right before the BOJ shocked markets with its YCC tweak. To state the obvious, the recent U.S. data have come around to support our more hawkish view on the Fed, which in turn supports our call for a stronger dollar. Market sentiment is finally swinging back in the dollar’s favor and we remain hopeful that the data continue to encourage this shift.


It appears that inflation is not so easily vanquished after all. January PPI data confirmed the CPI data out earlier this week, as headline came in at 6.0% y/y vs. 5.4% expected and a revised 6.5% (was 6.2%) in December and core PPI came in at 5.4% y/y vs. 4.9% expected and a revised 5.8% (was 5.5%) in December. The m/m readings were even more worrisome, as headline came in at 0.7% vs. 0.4% expected and a revised -0.2% (was -0.5%) in December and core came in at 0.5% vs. 0.3% expected and a revised 0.3% (was 0.1%) in December. To state the obvious, inflation is still running hot here in the U.S. Yes, it's falling slightly but the m/m gains are simply too big for the Fed to feel good about.

U.S. yields continue to rise. The 2-year yield traded near 4.71% today, the highest since November 8 and on track to test the November 4 cycle high near 4.80%. The 10-year yield traded near 3.93% today, the highest since November 10 and now on track to test the November 8 high near 4.24%. After that, the next target is the October 21 cycle high near 4.34%. The move higher in yields coincides with renewed inflation concerns and a much-needed repricing of Fed tightening expectations. This process still has a ways to go, in our view.

Fed hawks are getting more vocal. Mester said she saw a “compelling” case for a 50 bp hike at the last meeting. She added that “It’s not always going to be, you know, 25. As we showed, when the economy calls for it, we can move faster, and we can do bigger at any particular meeting. And it’s going to be driven by how the economy is evolving.” Elsewhere, Bullard said that he advocated for a 50 bp hike at the last meeting and added that he wouldn’t rule out supporting a 50 bp hike at the March meeting. He favors a peak policy rate of 5.25-5.5% and to reach it “as soon as you can.” He noted that “Continued policy rate increases can help lock in a disinflationary trend during 2023, even with ongoing growth and strong labor markets, by keeping inflation expectations low.” Bullard stays true to form but like the rest of this tightening cycle, he has dragged the rest of the Fed to his more hawkish view.

More analysts are starting to talk about a 6-handle on the Fed Funds rate and the way things are going, we can't argue forcefully against it. Recent strong data have changed the Fed outlook dramatically. To us, the simple laws of economics still hold in dealing with high inflation: in order to lower inflation, tighter monetary policy is needed. When the Fed hikes, the economy slows; when the Fed hikes aggressively, the economy goes into recession. There's no magic involved.

Despite the strong data, we don't think 50 bp is likely at the March 15-16 FOMC. That said, we can't totally rule it out yet either. We get one more set of premium data (jobs, CPI, PPI) before that decision and so let's see how the economy is faring then. At the very least, the Fed will extend the 25 bp hikes for a longer period of time as we see nothing, absolutely nothing, that justifies a pause anytime soon. At a minimum, we look for 25 bp hikes in March, May, and June that takes Fed Funds to 5.25-5.50%, with growing risks of 25 bp in July that takes us to 5.50-5.75%. WIRP is largely in line with this rate path except that there are no odds price in yet of that fourth 25 bp hike. This should eventually change. Strangely enough, an easing cycle is still expected to begin in Q4 but at much lower odds. Eventually, it should be totally priced out into 2024 in the next stage of Fed repricing. Barkin and Bowman speak today. Both are expected to maintain the same hawkish tone that Powell has established.

The labor market remains strong. Initial jobless claims came in at 194k vs. 200k expected and a revised 195k (was 196k) last week. As a result, the 4-week moving average for initial claims rose slightly to 189.5k from 189k last week. Of note, next week's initial claims data will be for the BLS survey week containing the 12th of the month. There is no Bloomberg consensus yet for NFP but if claims remain low, we’ll get another solid number (though obviously down from the whopping 517k in January). Continuing claims rose to 1.696 mln vs. 1.695 mln expected and a revised 1.680 mln (was 1.688 mln) last week. January import/export prices and leading index will be reported today.


ECB hawks are pushing back against the doves. Regarding inflation, Schnabel said “We are still far away from claiming victory.” She noted that “Markets are priced for perfection. They assume inflation is going to come down very quickly toward 2% and it is going to stay there, while the economy will do just fine. That would be a very good outcome, but there is a risk that inflation proves to be more persistent than is currently priced by financial markets.” Schnabel stressed that “A broad disinflation process has not even started.” Sound familiar? Lastly, she said “Wage growth has picked up substantially. Given a longer duration of wage contracts compared to the U.S. and a more centralized bargaining process, one could expect wage growth in the euro area to be more persistent.”

ECB tightening expectations have picked up. WIRP suggests a 50 bp hike March 16 is priced in. Looking further ahead, a 25 bp hike May 4 is priced in along with 35% odds of a larger 50 bp move. Another 25 bp hike June 15 is priced in, followed by one last 25 bp hike in Q3 that would result in a peak policy rate near 3.75%, up from 3.5% at the start of this week. These expectations are likely to drift lower if continued disinflation gives the doves the upper hand again. Villeroy also speaks today.

The U.K. reported firm January retail sales. Headline came in at 0.5% m/m vs. -0.3% expected and a revised -1.2% (was -1.0%) in December, while sales ex-auto fuel came in at 0.4% m/m vs. -0.2% expected and a revised -1.4% (was -1.1%) in December. Both y/y rates improved by around a percentage point from December to -5.1% and -5.3%, respectively. The Office of National Statistics said post-holiday discounting helped boost sales, noting that “After December’s steep fall, retail sales picked up slightly in January, although the general trend remains one of decline. Discounting helped boost sales for online retailers as well as jewelers, cosmetic stores and carpet and furnishing shops.” It’s hard to get excited about this tiny hiccup as the fundamental outlook for the economy remains very weak.

Bank of England Chief Economist Pill continues to sound dovish. Specifically, he said that “Continuing to raise rates at the pace and magnitude seen over the past year would eventually - and perhaps soon - imply that monetary policy had cumulatively been tightened too much.” Others at the BOE have also warned of the risks of overtightening. Pill also said that the labor market is showing signs of loosening, which implies that wage pressures may be easing. Lastly, Pill stressed that much of the impact of the past tightening by the BOE has yet to impact the economy. BOE tightening expectations have steadied. WIRP suggests a 25 bp hike March 23 is nearly priced in. After that, a final 25 bp hike is nearly priced in for Q2 with very low odds seen of a third hike and so the expected terminal rate remains near 4.5%. This is still well below the peak near 6.25% right after the disastrous mini-budget back in September.


Reserve Bank of Australia Governor Lowe testified before Parliament. Lowe stressed that “The RBA and many other central banks are managing two risks. One is the risk of not doing enough, which would result in high inflation persisting and then later proving very costly to get down. The other is the risk that we move too fast, or too far.” He repeated recent RBA forward guidance by noting that “The board expects that further increases will be needed over the months ahead to ensure that inflation returns to target and that this period of high inflation is only temporary.” He acknowledged that he wasn’t sure how much higher rates need to go, noting that will depend on how the global and domestic economic outlooks unfold. WIRP suggests a 25 bp hike at the next meeting March 7 is nearly 75% priced in, while the swaps market is pricing in a peak policy rate near 4.30% over the next 6 months followed by 6 months of steady rates and then an easing cycle over the subsequent 12 months.

New Zealand Finance Minister Grant Robertson acknowledge the likely impact of the Auckland floods due to Cyclone Gabrielle. He said it was not yet possible to quantify the likely economic cost but acknowledged that the initial effects will be on food production and prices, adding “The availability of that food and the cost of it is going be a real impact.” In terms of growth, Robertson said “We’ve obviously seen a softening in the economy that’s likely to be exacerbated to some extent.” Robertson noted that the rebuilding phase could help offset some of the recessionary impacts expected in 2H and that “I think we can get through this without the significant damage to the New Zealand economy.”

The floods will certainly complicate the RBNZ’s job. While the impact is obviously a temporary one, higher even inflation coupled with even slower growth is never a good situation. That said, market expectations have not changed much in recent weeks. RBNZ meets next Wednesday and WIRP suggests a 50 bp hike is about 75% priced in. Looking ahead, 25 bp hikes are priced in for April and May that would see the policy rate peak near 5.25%. However, the market is still pricing an easing cycle in Q4 and that seems very unlikely.

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