Dollar Claws Back Some Post-ECB Losses

October 29, 2021
  • As expected, a fiscal deal was announced by President Biden yesterday; September core PCE is the data highlight; October Chicago PMI will also be reported; we got our first look at Q3 GDP yesterday and it wasn’t pretty; weekly jobless claims are worth mentioning; Colombia is expected to hike rates 25 bp to 2.25%
  • ECB delivered a less dovish than expected hold; reports suggest the Governing Council advised Lagarde to emphasize current forward guidance but not to say that market expectations for ECB lift-off were wrong; peripheral spreads are widening out; eurozone reported October CPI and Q3 GDP data
  • Japan reported weak data; this wasn’t helpful for the ruling LDP ahead of Sunday’s general election; RBA appears to have abandoned its YCC; developments make next Tuesday’s RBA meeting all the more important

The dollar is clawing back some of its post-ECB losses. DXY is trading just above 93.50, which is back at the bottom of the trading range that has largely held since mid-October after trading as low as 93.28 yesterday. The euro is trading heavy near $1.1650 after being unable to break above $1.17, while sterling is trading flat near $1.38. USD/JPY is modestly higher near 113.75 after finding support yesterday near 113.25. We expect U.S. yields and the dollar to resume rising. Next week’s FOMC meeting and jobs report could prove to be the catalyst as both are expected to be dollar-supportive.


As expected, a fiscal deal was announced by President Biden yesterday. He said a framework for a $1.75 trln package had been reached but left it to his party’s lawmakers to hammer out the details. Our base case has always been that some sort of compromise would be reached, but the price tag has fallen dramatically from what we initially expected to be in the $2.5 trln area. House Democrats then released a rough draft of the legislation last night but negotiations are likely to be protracted. While the deal on the “human infrastructure” bill should pave the way for a quick vote on the $550 tradition infrastructure bill, the progressive wing of the Democrats is pushing back since many of its initiatives are the ones which are likely to be cut from the other package. Stay tuned.

September core PCE is the data highlight. The Fed’s preferred measure of inflation is expected to pick up a tick to 3.7% y/y. If so, this would be the highest since February 1991 and the sixth straight month above the 2% target. Personal income and spending will also be reported at the same time and are expected at -0.3% m/m and +0.6% m/m, respectively. Q3 Employment Cost Index and final October University of Michigan consumer sentiment will be reported.

U.S. yields are getting dragged higher along with the rest of the world. The 10-year yield is trading back near 1.61% after trading as low as 1.52% this week. Similarly, the 2-year yield is trading back near 0.52% after trading as low as 0.42% this week. With the Fed widely expected to begin removing accommodation at next week’s FOMC meeting, it seems to us that U.S. yields should continue their steady march higher and that should help the dollar.

October Chicago PMI will also be reported and is the second broad survey reading for the month. It is expected at 63.5 vs. 64.7 in September. Last week, Markit manufacturing PMI came in at 59.2 vs. 60.5 and 60.7 in September, but services PMI came in at 58.2 vs. 55.2 expected and 54.9 in September. As a result, the composite PMI rose to 57.3 from 55.0 in September to the highest level since July. Yesterday, Kansas City Fed survey came in at 31 vs. 20 expected and 22 in September.

We got our first look at Q3 GDP yesterday and it wasn’t pretty. Growth came in at 2.0% SAAR vs. 2.6% and down sharply from 6.7% in Q2. Of note, Bloomberg consensus sees growth picking up to 4.9% SAAR in Q4 before falling back a bit to 4.0% in Q1 and 3.6% in Q2. These are still enviable rates of growth, but of course there are downside risks to these forecasts as supply chain issues remain ongoing. Core PCE eased to 4.5% SAAR from 6.1% in Q2, but remains elevated.

Weekly jobless claims are worth mentioning. Continuing claims were for the BLS survey week containing the 12th of the month and they fell to 2.243 mln vs. 2.42 bln expected and 2.48 mln the previous week. Initial claims continued to fall to 281k vs. 288k expected and a revised 291k (was 290k) the previous week, which was the BLS survey week and clearly not a fluke. The claims data point to a solid jobs report next Friday, with consensus currently at 425k vs. 194k in September.

Colombia central bank is expected to hike rates 25 bp to 2.25%. However, about a third of the analysts polled by Bloomberg look for a 50 bp hike. The bank just started the tightening cycle September 30 with a 25 bp hike to 2.0%. The vote then was split 4-3, with the dissents in favor of a 50 bp hike. September CPI came in at 4.51% y/y vs. 4.44% in August. This was the highest since April 2017 and further above the 2-4% target range. As such, we cannot rule out a 50 bp hike today.


The European Central Bank delivered a less dovish than expected hold. Madame Lagarde had flagged this meeting as a mere placeholder, but it was anything but. All policy settings were left unchanged. The big surprise was that after stressing that inflation was still seen as transitory, Lagarde then said it was “not for me to say” if markets are getting ahead of themselves with regards to ECB tightening expectations. It actually IS for her to say that markets are getting ahead of themselves, that's what jawboning is all about.

Reports suggest the Governing Council advised Lagarde to emphasize current forward guidance but not to say that market expectations for ECB lift-off were wrong. As usual, the unnamed sources came out after the ECB decision was still being digested. Why shouldn’t Lagarde push back? The story goes that the GC was afraid that it would backfire, which really doesn’t make much sense to us. The fact she did not push harder saw the euro post its biggest one day gain since May 7, with swaps market now pricing in 16 bp of ECB tightening vs. 10 bp pre-meeting. That’s what backfiring looks like to us. This may not sound like a lot when compared to RBNZ (188 bp), BOC (116 bp), BOE (110 bp), and RBA (91 bp), but for the ECB, it really is a lot.

Peripheral spreads are widening out. Chalk this up to the Law of Unintended Consequences. If the ECB is to halt QE and then hike rates, then peripheral bonds are going to come under severe pressure. For instance, the 10-year Italy-Germany spread has blown out to 130 bp, the highest since last November and up from less than 100 bp just last month. Does this spell doom for the eurozone? No, but the periphery has benefited greatly from extremely low interest rates and a weak euro. Take those benefits away and widening budget deficits will come back into focus.

Eurozone reported October CPI and Q3 GDP data. Eurozone headline inflation picked up to 4.1% y/y vs. 3.7% expected and 3.4% in September, while core picked up to 2.1% y/y when it was expected to remain steady at 1.9%. After yesterday’s upside CPI misses from Germany and Spain, today’s eurozone reading wasn’t all that surprising. GDP grew 2.2% q/q vs. 2.1% expected, while Q2 was revised to 2.1% q/q from 2.2% previously. However, recent monthly data suggest a significant loss of momentum as we go into year-end. Bloomberg consensus sees Q4 growth of 1.0% q/q, easing to 0.9% in Q1 and 0.8% in Q2.


Japan reported weak data. September IP was expected to fall -2.7% m/m but instead fell twice that at -5.4% vs. -3.6% in August and was the third straight monthly contraction. October headline Tokyo inflation was expected to pick up a tick to 0.4% y/y but instead slowed two ticks to 0.1%, while core (ex-fresh food) was expected to pick up two ticks to 0.3% y/y but instead was steady at 0.1%. While the core reading was still the highest since July 2020, it does not bode well for the national core reading, which came in last week at 0.1% y/y for August. Elsewhere, September housing starts slowed to 4.3% vs. 7.9% expected and 7.5% in August. The only solid readings came from the labor market, with the September unemployment rate steady at 2.8% and the jobs-to applicant ratio rising two ticks to 1.16, the highest since May 2020.

The data aren’t helpful for the ruling LDP ahead of Sunday’s general election. Polls keep going back and forth as to whether the LDP will win an outright majority, which tells us that it will be a close race. Consensus sees the LDP and its coalition partner Komeito winning enough to stay in power, which suggests no change in policy. However, it does look like the LDP will lose quite a few seats and that will put Prime Minister Kishida in the hot seat, so to speak. A revolving door of leaders would not be a great outcome and so bears watching.

The Reserve Bank of Australia appears to have abandoned its YCC. With the yield on the targeted April 2024 government bond up nearly 25 bp to 0.72%, the RBA did not intervene to drive the yield back down to 0.10% like it did last week. Yields rose across the curve, with the 10-year up nearly 25 bp to 2.08%. What’s worse, the silence from the RBA is deafening. Running monetary policy requires predictability as well as communication. We are getting neither and that’s not good for RBA credibility going forward.

These developments make next Tuesday’s RBA meeting all the more important. The RBA now appears that the RBA will official abandon YCC and move its forward guidance for liftoff up significantly from 2024 currently. Swaps market now sees nearly 100 bp of tightening from the RBA over the next twelve months. This seems overly aggressive and so while the RBA is clearly shifting to hawkish mode, it is likely to push back on these market expectations.

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