Dollar Consolidates, Yen Shrugs Off BOJ Liftoff Reports

March 15, 2024

Win Thin

We got the big moves in U.S. rates and the dollar in the direction we wanted yesterday; there’s also been some more Fed repricing; Q1 growth remains solid; University of Michigan March consumer sentiment will be the highlight
BOE reported February inflation expectations; ECB policymakers continue to telegraph a June rate cut; Poland February CPI cooled
Rengo announced strong results of its spring negotiations; reports suggest the BOJ is poised to end its negative policy experiment next week; China’s credit growth slowed sharply in February; PBOC kept its key 1-year MLF rate steady at 2.5%; iron ore prices continue to slide

The dollar is consolidating yesterday’s gains. DXY is trading flat near 103.342 ahead of the weekend. DXY has only retraced about a third of its February-March drop and so we see scope for some catch-up with higher UST yields. The 200-day moving average near 103.697 is a near-term target. The euro is trading higher near $1.0890 while sterling is trading flat near $1.2755. USD/JPY is trading higher near 148.85 despite reports of likely BOJ liftoff next week and strong results from spring wage negotiations (see below). We embrace this dollar recovery and believe further gains are likely. The U.S. data continue to come in mostly firmer and despite Powell’s dovish comments last week, most Fed officials remain very cautious about easing too soon. We believe that the current market easing expectations for the Fed still need to adjust. When they do, the dollar should recover further. This week’s inflation and retail sales data sparked the start of this process.

AMERICAS

We got the big moves in U.S. rates and the dollar in the direction we wanted yesterday. However, we were wrong about the cause. We figured PPI would have little impact after CPI and that markets would focus more on retail sales, but it turned out to be the other way around. Lower claims data added to the upward pressure on yields. The U.S. 10-year yield is on track to test the February 23 high near 4.35%, while the 2-year yield is on track to test that day's high near 4.74%. Given how much yields have recovered, the dollar should be much higher. DXY has only retraced about a third of its February-March drop and so we see scope for some catch-up. The 200-day moving average near 103.697 is a near-term target.

There’s also been some more Fed repricing. There is now no chance that the Fed cuts rates next week. Looking ahead, the odds of a May cut are now close to 10%, while the odds of a June cut are around 65%. Furthermore, markets are basically back to matching the Fed's outlook for three cuts this year. We've noted before that it would take only two FOMC members to shift their 2024 Dot from 4.625% to 4.875% to get a similarly hawkish shift in the 2024 median. Looking ahead to 2025, it would only take three FOMC members to shift their 2025 Dot from 3.625% to 3.875% to get a similarly hawkish shift in the 2025 median. It's all going to boil down to whether the Fed really does engineer a soft landing. If so, 175 bp of easing in 2024 and 2025 seems too much.

February PPI ran hot. Headline came in at 1.6% y/y vs. 1.2% expected and a revised 1.0% (was 0.9%) in January, while core remained steady at 2.0% y/y vs. 1.9% expected. It’s becoming clear that disinflation is stalling out, with most measures of inflation flatlining or even picking up in recent months.

February retail sales ran cool. Headline came in at 0.6% m/m vs. 0.8% expected and a revised -1.1% (was -0.8%) in January, while ex-autos came in at 0.3% m/m vs. 0.5% expected and a revised -0.8% (was -0.6%) in January. The so-called control group used for GDP calculations came in flat m/m vs. 0.4% expected and a revised -0.3% (was -0.4%) in January. Looking at the y/y rates, headline sales came in at 1.5% vs. 0.0% in January, ex-autos came in at 1.5% vs. 0.6% in January, and control group came in at 2.2% vs. 2.3% in January. All are down from the heady 4-5% rates back in Q4 but those rates were unsustainable, as was Q4 GDP growth of 3.2% SAAR.

Q1 growth remains solid. The New York Fed’s Nowcast model is tracking Q1 growth at 2.1% SAAR and Q2 growth at 2.5% SAAR and will be updated today. Elsewhere, the Atlanta Fed’s GDPNow model is currently tracking Q1 growth at 2.3% SAAR after yesterday’s data and will be updated next Tuesday after the data. Bottom line: the U.S. economy is slowing in Q1 but it's not falling off a cliff.

The labor market remains tight. Initial claims came in at 209k vs. 218k expected and a revised 210k (was 217k) last week, while continuing claims came in at 1.811 mln vs. 1.905 mln expected and a revised 1.794 mln (was 1.906 mln) last week. The tightness in the labor market suggests that consumption will hold up, albeit not as strong as we saw in Q3 and Q4. Of note, next week’s initial claims reading will be for the BLS survey week containing the 12th of the month. If they remain low, we can expect another solid NFP number for March. There is no Bloomberg consensus yet, but its whisper number stands at 222k vs. 275k in February.

University of Michigan March consumer sentiment will be the highlight. Headline is expected to rise two ticks to 77.1, driven by an expected rise in current situation to 79.7 that offsets an expected drop in expectations to 75. 1-year inflation expectations are expected to pick up a tick to 3.1%, while 5- to 10-year expectations are expected to remain steady at 2.9%. The Fed won’t be happy to see expectations remain so sticky.

Regional Fed surveys for March start rolling out. Empire manufacturing survey kicks things off today and is expected at -7.0 vs. -2.4 in February. February IP will also be reported and is expected flat m/m vs. -0.1% in January.

EUROPE/MIDDLE EAST/AFRICA

Bank of England reported February inflation expectations. Its 1-year measure fell to 3.0% vs. 3.3% in January and is the lowest since August 2021. While the drop is welcome, expectations remain too high. The BOE will continue to monitor measures of short and longer-term inflation expectations to ensure they ease closer to the 2% target.

ECB policymakers continue to telegraph a June rate cut. Governing Council member Rehn noted that the ECB “will be able to gradually start taking its foot off the monetary-policy brake when the summer nears.” The market is pricing in around 10% odds of a cut April 11, rising to only 85% June 6 vs. fully priced in earlier this month. While some doves may push for an April cut, Lagarde and the hawks are in control and June seems most likely. Panetta, Vujcic, and Lane speak today.

Poland February CPI cooled. Headline came in at 2.8% y/y vs. 3.2% expected and a revised 3.7% (was 3.9%) in January. This was the lowest February March 2021 and back within the 1.5-3.5% target range. Next policy meeting is April 4, and no change is expected then. However, with disinflation continuing, the bank’s hawkish stance will become harder and harder to maintain. Indeed, the swaps market is pricing in 25 bp of easing over the next three months. This is still a much more hawkish outlook for rates than both Czech Republic and Hungary and so PLN continues to outperform CZK and HUF YTD.

ASIA

Rengo announced the results of its spring negotiations. Japan’s largest trade union federation announced agreements on total pay increases averaged 5.3% this year, up from 3.8% last year and higher than the 4.1% expected by Bloomberg consensus. Of note, base pay increases averaged 3.7% vs. 2.3% last year. The odds of a rate hike next week rose briefly to a high near 70% before settling back down to 55% currently. Looking ahead, an April hike is only 70% priced in, with expectations still centered on June for liftoff. Furthermore, we believe Japan’s improving inflation backdrop and soft economic activity suggest the BOJ is unlikely to normalize the policy rate by more than is currently priced in, which is 50-75 bp over the next three years. As such, USD/JPY will likely remain well supported.

Reports suggest the Bank of Japan is poised to end its negative policy experiment at next week’s meeting. if so, it's a risky move coming as the economy hit a soft patch. The report suggests that the view at the bank is strengthening that its 2% inflation target has been sustainably achieved. However, it added that the bank will most likely make a final decision after spring wage negotiation results are announced. USD/JPY is trading at a new high for this move near 148.85 after a quick dip to around 147.45 yesterday on this report. While JGB yields continue to rise, this potential hike has been so well-telegraphed that we wonder if the yen will really move all that much after liftoff.

China’s credit growth slowed sharply in February. New loans came in at CNY1.45 trln vs. CNY1.5 trln expected and CNY4.92 trln in January, while aggregate financing came in at CNY1.56 trln vs. CNY2.3 trln expected and CNY6.5 trln in January. In y/y terms, new loans rose only 9.7% and was the slowest in the series going back to 2003, while aggregate financing rose only 9% and is near a record low. It’s clear from the bond issuance plans announced at the NPC that policymakers will not (and cannot) be relying on debt-fueled fiscal stimulus to boost growth. As such, credit growth is likely to continue slowing.

PBOC kept its key 1-year MLF rate steady at 2.5%. However, it surprised markets by draining liquidity a net CNY94 bln via this facility. While the drain was small, it was the first time since November 2022. Monetary policy is reaching the limits of what it can do in a deflationary environment and so any further easing is likely to be modest. Bottom line: the 5% growth target for this year will be very difficult to meet.

Iron ore prices continue to slide. The price for a ton fell as low as $98.55 before recovering slightly but is still down 3.5% today, bringing the total drop from the January peak to nearly 30%. Weakness in the mainland China economy is the main driver and this is set to continue. Prices are the lowest since August 2023 and that month’s low near $91.90 is coming into view. After that is the May 2023 low near $81.95. This is a huge negative terms of trade shock for Australia and should weigh on AUD. Iron ore is now trading below where it was in December 2022, when China finally reopened.

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