Dollar Consolidates, Yen Sinks

June 08, 2022

U.S. yields are moving higher; Fed tightening expectations continue to adjust; the heavy slate of U.S. Treasury issuance continues; consumer credit continues to surge; reports suggest Michael Barr’s confirmation as Fed Vice Chair for supervision will be smooth sailing; fiscal concerns are rising after President Bolsonaro announced plans to cut fuel prices ahead of the October elections; Chile reports May CPI
Reports suggest the U.K. is pressing ahead with plans to unilaterally rewrite parts of the Brexit accord; ECB tightening expectations have picked up ahead of tomorrow’s decision; Germany reported weak April IP; Poland is expected to hike rates 75 bp to 6.0%
Japan reported final Q1 GDP data; Japan April current account data is worth discussing; India hiked taxes 50 bp to 4.90%, as expected; Thailand delivered a hawkish hold

The dollar is consolidating its recent gains. DXY is up modestly and trading near 102.40. The euro is trading back above $1.07 ahead of the ECB decision tomorrow. The weakening trend in the yen has reasserted itself as USD/JPY is up for the fourth straight day and traded at a new high for this cycle just above 134. We maintain our long-standing target of the January 2002 high near 135.15 but we need to start talking about the August 1998 high near 147.65. Sterling is underperforming today after failing to break above $1.26 as Brexit headlines are back (see below). We look for continued underperformance from ongoing political and economic risks that should push the EUR/GBP cross higher. We still view this recent move lower in the dollar as a correction within the longer-term dollar rally and are heartened by the recent bounce. That said, we acknowledge that further gains will likely be slow until the market pessimism on the U.S. economic outlook improves further.


U.S. yields are moving higher. The 10-year yield traded as high as 3.06% yesterday, up from last month’s low near 2.70% but still below the May 9 peak near 3.20%. It is currently near 3.01%. Elsewhere, the 2-year yield is trading near 2.75% today, up from last month’s low near 2.44% but still below the May 4 peak near 2.85%. The 2-year differential with Germany has risen to 203 bp after briefly touching 200 bp earlier this week, the lowest since the end of February, while the gap with Japan has risen back to 282 bp, just shy of the May 3 high near 283 bp. Much of this divergence hinges on the underlying relative monetary policy divergences as the ECB pivots more hawkish and the BOJ remains ultra-dovish. However, we believe the Fed will out-hawk them all and so the dollar uptrend should remain intact.

Fed tightening expectations continue to adjust. WIRP suggests 50 bp is fully priced in for June and July. A third 50 bp hike for September is now about 75% priced in vs. 35% at the start of last week. After that, two more 25 bp hikes in November and December are fully priced in and a third one next February is mostly priced in. However, the swaps market is now pricing in a terminal Fed Funds rate between 3.25-3.50% by mid-2023 vs. 3.25% at the start of this week. This would be followed by an easing cycle over the course of the subsequent 12 months but this would only happen if the U.S. were to fall into recession next year. While it is possible, it is not our base case.

The heavy slate of U.S. Treasury issuance continues. $33 bln of 10-year notes will be sold today, followed by $19 bln of 30-year bonds tomorrow. At the last auction, indirect bidders took 70.3% while the bid/cover ratio was 2.49. Yesterday’s $44 bln sale of 3-year notes saw weak demand, as indirect bidders took 51.5% vs. 62.0% previously and the bid/cover ratio was 2.45 vs. 2.59 previously. This saw the high yield rise to 2.927% vs. 2.809% previously.

Consumer credit continues to surge. Yesterday, April credit rose $38.1 bln vs. $35.0 bln expected and a revised $47.3 bln (was $52.4 bn) in March. On an annualized basis, it climbed 10.1%. This is noteworthy as it helps explain how consumption can remain strong even as real income is squeezed by high inflation. The other explanation of course (and it’s likely a bit of both) is that households are running down savings that were accumulated earlier in the pandemic. April wholesale trade sales and inventories will be reported today.

Reports suggest Michael Barr’s confirmation as Fed Vice Chair for supervision will be smooth sailing. Yesterday, three Republicans on the Senate Banking Committee (Toomey, Rounds, and Lummis) signaled they would support Barr at today’s nomination hearing, meaning he should easily pass the full Senate vote with bipartisan backing. No word yet on when the full Senate vote will be held but assuming Barr is confirmed, the FOMC Board of Governors would be fully staffed for the first time since the Trump administration.

Fiscal concerns are rising after President Bolsonaro announced plans to cut fuel prices ahead of the October elections. All federal taxes on gasoline and ethanol will be cut until year-end and Bolsonaro invited states to do the same for their taxes on diesel and natural gas while pledging to make up for lost revenue. The government did not provide any estimates of the potential fiscal impact. Some analysts estimate that the move could shave a 2-3 percentage points off of headline inflation. In turn, this would imply less need to tighten monetary policy further. The prospects for lower interest rates coupled with greater fiscal risks should help BRL continue to underperform near-term.

Chile reports May CPI. Headline is expected at 11.4% y/y vs. 10.5% in April. If so, it would be the highest since July 1994 and further above the 2-4% target range. Yesterday, the central bank hiked rates 75 bp to 9.0%, as expected. It said inflation risks remain elevated and acknowledged that further hikes were needed but of smaller size. Looking ahead, the swaps market is pricing in 75 bp of tightening over the next 3 months that would see the policy rate peak near 9.75%, followed by the start of an easing cycle in the subsequent 3 months and unchanged from the start of this week. Chile also reports May trade data Tuesday.


Reports suggest the U.K. is pressing ahead with plans to unilaterally rewrite parts of the Brexit accord. Johnson had pledged to “bash on” after what he called the “decisive” no confidence vote. His margin of victory was hardly decisive and a decision to double down on what has already turned out to be a disastrous decision to leave the EU is an incredibly risky move. That said, it is entirely consistent with Johnson’s style of leadership. According to press reports, the draft bill may be presented to the House of Commons as soon as tomorrow, though the timing is not set in stone. The EU has promised to respond to any unilateral changes in the Northern Ireland protocols and we see no reason why they wouldn’t follow through with retaliatory tariffs. A potential trade war with its largest trading partner would be yet another headwind for the U.K. economy that is already facing recession, and is another reason to remain negative on sterling.

ECB tightening expectations have picked up ahead of tomorrow’s decision. WIRP suggests liftoff July 21 remains fully priced in. However, markets are now pricing in a potential 50 bp move at either the September 8 or October 27 meetings, followed by a 25 bp hike December 15 that would take the policy rate to 0.75% by year-end, up from 0.5% previously. Looking ahead, the swaps market is still pricing in 225-250 bp of tightening over the next 24 months that would see the deposit rate peak between 1.75-2.00% vs. 1.50% at the start of last week.

Germany reported weak April IP. It rose 0.7% m/m vs. 1.2% expected and a revised -3.7% (was -3.9%) in March. As a result, the y/y rate came in at -2.2% vs. -2.4% expected and a revised -3.1% (was -3.5%) in March. Italy reported April retail sales flat m/m vs. 0.1% expected and a revised -0.6% (was -0.5%) in March. It’s clear from the monthly data that German activity was already slowing as we entered Q2 and is likely to get even worse. Elsewhere, final Q1 eurozone GDP data were reported. Growth was revised up to 0.6% q/q vs. 0.3% preliminary. However, the details were not so good as GFCF and government expenditure were both revised down sharply to 0.1% q/q and -0.3% q/q, respectively, while household consumption was revised up modestly to -0.7% q/q. A hawkish ECB message this week will most likely be undermined by deteriorating economic fundamentals.

National Bank of Poland is expected to hike rates 75 bp to 6.0%. A few of analysts look for 50 bp or 100 bp moves. The swaps market is pricing in another 125 bp of tightening over the next 12 months that would see the policy rate peak near 6.5%, but we see upside risks here as well. Minutes from the May 5 meeting will be released Friday. At that meeting, the bank delivered a dovish surprise with a 75 bp hike to 5.25% vs. 100 bp expected. Since then, May CPI inflation came in at 13.9% y/y in May, the highest since October 1997 and further above the 1.5-3.5% target range.


Japan reported final Q1 GDP data. The q/q was revised up to -0.1% vs. -0.3% expected and -0.2% preliminary, which boosted the SAAR to -0.5% vs. -1.1% expected and -1.0% preliminary. Consumption and inventories added to growth but this was offset in part by weakness in business spending. Bloomberg consensus sees growth rebounding to 4.5% SAAR in Q2, which may be too optimistic given weak household spending seen so far. Of note, the y/y rate of 0.4% was very disappointing given low base effects. Q2 will experience a high base effect and so the y/y rate may fall into negative territory. Given the risks to growth, we expect the Bank of Japan to maintain its ultra-loose policies for the foreseeable future.

Japan April current account data is worth discussing. The adjusted surplus came in at JPY512 bln vs. JPY399 bln expected and JPY1.56 trln in March. However, the investment flows will be of most interest. April data showed that Japan investors were net sellers of U.S. bonds for the sixth straight month and the -JPY2.4 trln sold nearly matched the -JPY3.1 trln sold in February, which was the most since April 2020. Japan investors were net buyers (JPY186 bln) of Australian bonds for the third straight month in April but were net sellers of Canadian bonds (-JPY172 bln) for the third straight month. They were small net buyers of Italian bonds (JPY13bln) in April after a month of net selling. Of note, April is the first month of FY22 and it will be interesting to see if these trends will be maintained throughout the fiscal year.

Reserve Bank of India hiked rates 50 bp to 4.90%, as expected. The bank just started the tightening cycle with a 50 bp intra-meeting hike May 4. At that time, Governor Das warned that persistent inflation pressures were becoming more acute. Today, he noted that “Inflation has steeply increased much beyond the upper tolerance level. The MPC, therefore, judged that further monetary policy measures are necessary to anchor the inflation expectations.” The RBI raised its inflation forecast FY22/23 6.7% vs. 5.7% previously. CPI rose 7.79% y/y in April, the highest since and May 2014 further above the 2-6% target range. The swaps market is pricing in 230 bp of tightening over the next 24 months that would see the repo rate peak near 7.25%, steady from the start of this week.

Bank of Thailand delivered a hawkish hold. It kept rates steady at 0.50%, as expected, but the vote was 4-3 with the dissents in favor of a 25 bp hike to 0.75%. The bank noted that “Headline inflation would increase and remain elevated for longer than previously estimated. The committee will assess the appropriate timing for a gradual policy normalization.” It raised its 202 inflation forecast to 6.2% vs. 4.9% in March and also raised its 2022 growth forecast a tick to 3.3%. Thailand reported May CPI Monday, with headline surging 7.10% y/y vs. 5.90% expected and 4.65% in April. This was the highest since July 2008 and further above the 1-3% target range. Assistant Governor Piti added “MPC wants to withdraw the accelerator as members don’t want the economy to recover strongly and put pressure on inflation next year. If that happens, we may need to use strong dose of medicine later, which is not good for the economy.” Looking ahead, the swaps market sees liftoff over the next 3 months, which implies a hike at the next meeting August 10. 250 bp of tightening is priced in over the next 24 months that would see the policy rate peak near 3.0%.

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