Dollar Consolidates as Fed Tapering Begins

November 15, 2021

As per the November 2-3 FOMC meeting, tapering begins this week; regional Fed manufacturing surveys for November will start rolling out
Geopolitical tensions remain high in Europe as a result of the Belarus border crisis; eurozone reported September trade data; Lagarde said today that a 2022 hike is “very unlikely”; Prime Minister Johnson and his Tory party continue to suffer from the recent scandals; Israel reports October CPI
Japan reported weak Q3 GDP data; BOJ Governor Kuroda hinted that its Covid funding program may be scaled back; China reported firm October retail sales and IP

The dollar is consolidating last week’s gains. DXY traded Friday at a new cycle high near 95.265 but is down modestly near 95.06 today. There really aren't any major chart points until the June 2020 high near 97.802. Similarly, the euro traded at a new low Friday near $1.1435 and is hovering around $1.1450. Here, the next major chart point is the June 2020 low near $1.1170. Sterling traded Friday at a new low near $1.3355. Despite the current bounce back above $1.34, we believe it remains on track to test the December 2020 low near $1.3135. USD/JPY continues to struggled to make a clean above 114 but if this pair can break above last month's high near 114.70, there really aren't any significant chart points until the December 2016 high near 118.65.

AMERICAS

As per the November 2-3 FOMC meeting, tapering begins this week. The New York Fed last week released an updated purchase schedule that will result in total purchases of $70 bln in USTS and $35 bln of MBS this month, $15 bln less than peak QE. How bonds trade this week will be very important in understanding the potential impact of tapering. The Fed plans to reduce its purchases every month by the same amount until June, when QE will have ended. While the Fed has reserved the right to change the speed of tapering, we believe the bar to any change is quite high. Fed Funds futures still see nearly two thirds odds of Q2 liftoff, which seems too soon, while Q3 liftoff is fully priced in. Strong data and rising inflation are likely to keep upward pressure on U.S. rates, which in turn should keep the dollar rally intact.

Regional Fed manufacturing surveys for November will start rolling out. Empire survey kicks things off today and is expected at 22.0 vs. 19.8 in October. Both Philly Fed and Kansas City Fed report Thursday and are expected at 24.0 and 30 vs. 23.8 and 31 in October, respectively. In between, October IP will be reported tomorrow and is expected to rise 0.8% m/m vs. -1.3% in September. Canada reports September manufacturing, sales (-3.1% m/m expected), wholesale trade sales (1.1% m/m expected), and October existing home sales today.

EUROPE/MIDDLE EAST/AFRICA

Geopolitical tensions remain high in Europe as a result of the Belarus border crisis. The EU approved new sanctions that allow it to target those involved in encouraging the flow of migrants through Belarus to its border with Poland. President Lukashenko has guided thousands of migrants from Iraq, Syria, Afghanistan, and other countries in what the EU has called a “hybrid attack.” Lukashenko has already threatened to block the flow of natural gas supplies from Russia to the EU. Of note, Poland has accused Russian President Putin of being behind the border crisis, but he has denied any involvement.

Eurozone reported September trade data. An adjusted surplus of EUR6.1 bln was reported, nearly half of the expected EUR11.5 bln and down from a revised EUR9.7 bln (was EUR11.1 bln0 in August. Exports fell -0.4% m/m, while imports rose 1.5% m/m. The usual culprits were at work here, with exports suffering from supply chain issues and imports boosted by higher energy prices. Policymakers should be concerned as the trade data point to both slower growth and higher inflation.

ECB President Lagarde said today that a 2022 hike is “very unlikely” but that “I don’t think I will venture in to 2023.” She added that inflation will move back below the 2% target over the medium-term. While she clearly wants to keep all options open, Lagarde is facing a delicate balancing act as many other central banks start to pare their accommodation. However, as we’ve seen since the last policy meeting October 28, ECB officials do not want to let market expectations get away from them. Swaps market suggests 10 bp of tightening over the next twelve months, about where it was ahead of that last meeting. Next ECB meeting December 16 should see some sort of extension of QE, as the risks of removing accommodation are rising significantly. Guindos also speaks today.

Prime Minister Johnson and his Tory party continue to suffer from the recent scandals. The latest Opinium poll published by the Observer show opposition Labour with 37% support, a percentage point higher than the ruling Conservatives. This is the first lead for Labour since January, with the same poll showing 9% support for the Liberal Democrats, 7% for the Greens, and 5% for the Scottish National Party. Another poll by Savanta ComRes published by the Daily Mail shows Labour with an even greater lead at 40% support, six percentage points above the Conservatives. Next general elections aren’t due until May 2024 and so the Tories have a lot of time to regain public confidence. Obviously, the pandemic and the related economic impact will be a key factor on top of any further sleaze scandals.

Israel reports October CPI. Inflation is expected to pick up a tick to 2.6% y/y. If so, it would be the highest since October 2011 but still within the 1-3% target range. Still, it seems the bank was right to call a halt to its QE at its last meeting, as it will then be in a better position to hike rates next year if needed. For now, the bank is likely to continue its FX intervention program to lean against shekel strength as USD/ILS again flirts with the 3.10 level. Next policy meeting is November 22 and no change is expected then. Q3 GDP will be reported tomorrow, with growth expected to slow to 3.8% annualized from 16.6% in Q2.

ASIA

Japan reported weak Q3 GDP data. The economy contracted -0.8% q/q vs. -0.2% expected and revised 0.4% (was 0.5%) growth in Q2. This means GDP has fallen in two of the three quarters in this calendar year and in five of the past eight quarters. Private consumption fell -1.1% q/q vs. -0.5% expected and 0.9% in Q2, while business spending fell -3.8% q/q vs. -0.6% expected and revised 2.2% (was 2.3%) in Q2, Inventories added 0.3% to growth, while net exports added 0.1%. Prime Minister Kishida is expected to unveil a fiscal package topping JPY40 trln sometime this week. If anything, the GDP data may push the size of the package higher.

Bank of Japan Governor Kuroda hinted that its Covid funding program may be scaled back. Kuroda noted that “Stress on corporate financing stemming from Covid-19 seems to have become limited to firms in industries facing subdued sales as well as small and medium-sized ones.” While this is a natural progression that most other central banks have embarked on, the BOJ is likely to take great pains to say that this is not an exit from its ultra-accommodative stance. Indeed, Kuroda said the bank would not remove any accommodation even if inflation were to rise to 1%, half of the 2% target. Of note, current BOJ forecasts see targeted core inflation at 1% by FY23. The funding program was introduced in March 2020, was renewed, and is set to expire at the end of March. Next policy meeting December 17 may be too soon to announce an end to this program. The January 18 meeting makes more sense, as a new Outlook Report with updated macro forecasts will be released then.

China reported firm October retail sales and IP. Sales rose 4.9% y/y vs. 3.7% expected and 4.4% in September, while IP rose 3.5% y/y vs. 3.0% expected and 3.1% in September. Despite this upside surprise, we believe the economy is still in a medium-term slowing trend as policymakers continue their efforts at restructuring and reform. While we expect another muddle through result, markets should be prepared for ongoing weakness in the economy as we move into 2022. Period virus outbreaks are also likely to disrupt the economy from time to time.

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