Dollar Consolidates as Risk Off Impulses Ease

May 16, 2022

U.S. yields are edging higher as risk off sentiment ebbs; Fed tightening expectations remain steady for now; regional Fed manufacturing surveys for May will start rolling out

The European Commission cut its growth forecasts for the eurozone; ECB tightening expectations remain subdued; BOE officials will take questions from the Treasury Select Committee; BOE tightening expectations have stalled

Japan reported April PPI and machine tool orders; HKD continues to trade at the weak end of its trading band; China reported weak April IP and retail sales data; new BOK Governor Rhee said he cannot rule a 50 bp rate move

The dollar is consolidating its recent gains. DXY is down modestly for the second straight day and is trading near 104.416, just below last week’s new cycle high near 105.005.  We continue to target the November 2002 high near 107.  The euro remains heavy just above $1.04 and we continue to target the January 2017 low near $1.0340.   If that level breaks, we have to start talking about parity and below.  USD/JPY is finding some traction above 129 and we continue to target the January 2002 high near 135.15 as risk sentiment improves and the BOJ sticks with its ultra-dovish stance.  Sterling traded last week at the lowest since May 2020 near $1.2155.  Despite the modest bounce, it remains heavy near $1.2250 and we continue to target that month’s low near $1.2075.  If that level breaks, then we would target the March 2020 low near $1.1410.


U.S. yields are edging higher as risk off sentiment ebbs.  The 10-year yield is trading near 2.93% after it ended the week near 2.92%, up from Thursday’s low near 2.81% but still below the cycle high near 3.20% from last Monday.  The 10-year breakeven inflation rate fell as low as 2.59% Thursday but recovered to currently trade near 2.74% so as a result, the real 10-year yield has steadied around 0.18% vs. the 0.34% cycle high last week.  Similarly, the 2-year UST yield is trading near 2.60% after it ended the week near 2.58%, up from Thursday’s low near 2.51% but still below the peak near 2.85% from May 4.  As risk off impulses ebb, U.S. yields should continue to rise.  With the dollar smile clearly in play, the greenback should continue to gain. 

Fed tightening expectations remain steady for now.  WIPR suggests 50 bp hikes in June, July, and September will be followed by 25 bp hike in November and December, which would see the Fed Funds rate peak near 3.0%.  The swaps market still sees a terminal Fed Funds rate near 3.0%, right where it started last week.  That said, last week’s CPI and PPI data suggest prices are likely to prove much sticker than anticipated.  Bloomberg consensus sees core PCE at 4.7% in 2022, 2.8% in 2023, and 2.2% in 2024.  This is similar to the Fed forecasts of 4.6%, 2.9%, and 2.2%, respectively.  Given recent readings, we see significant risks that core PCE overshoots these forecasts.  If this proves true, markets will have to reprice Fed tightening expectations to reflect rates staying higher for longer.  That would push US yields and the dollar higher.  Williams speaks today.  

Regional Fed manufacturing surveys for May will start rolling out.  Empire survey is expected at 15.0 vs. 24.6 in April.  The manufacturing sector continues to struggle with supply chain issues but we see underlying strength being maintained as we move towards H2.  March TIC data will also be reported.  Canada reports April housing starts, existing home sales, and March manufacturing  and wholesale trade sales.  


The European Commission cut its growth forecasts for the eurozone.  Its base case scenario sees GDP growth slowing this year and next to 2.7% and 2.3% from 4.0% and 2.7% forecast back in February, and sees inflation picking up this year and next to 6.1% and 2.7% from 3.5% and 1.7% forecast back in February.  Disruptions to Russian gas supply remain the key risk behind its so-called severe scenario, which would see GDP growth slowing to 0.2% this year.  These forecasts are an important preview of the updated ECB forecasts that will be released at the June 9 meeting, as its March forecasts were largely in line with the EC’s February forecasts.  Stay tuned. 

ECB tightening expectations remain subdued.   The end  of QE June 9 and liftoff July 21 remain fully priced in.  However, the swaps market is now pricing in only 140 bp of tightening over the next 12 months followed by another 45 bp of tightening priced in over the following 12 months that would see the deposit rate peak near 1.35% vs. 1.75% at the start of last week.  This repricing clearly reflects the worsening  economic outlook and is likely to continue weighing on the euro, which should break below the January 2017 low near $1.0340 and move towards parity.  Villeroy, Panetta, and Lane speak today.   

Bank of England’s Bailey, Ramsden, Haskel, and Saunders will all take questions today from the Treasury Select Committee.  Reports suggest they will face a rather hostile situation.  Chairman of the committee Stride has already set the tone in discussing the overheating labor market by saying “There, I think, the Bank of England, the MPC, has been rather slow off the mark, and I think that is going to lead to a requirement for a more aggressive monetary policy going forward than would otherwise have been the case had we nipped that in the bud.”  On the other hand, the bank can push back by saying its fears of premature tightening  were shared by many other central banks, including the Fed, and that the BOE hiked before most of them did. 

Bank of England tightening expectations have stalled.  WIRP suggests another 25 bp hike is priced in for the next meeting June 16.  Looking ahead, the swaps market is pricing in only 125 bp of total tightening over the next 12 months that would see the policy rate peak near 2.25%, down from 2.5% at the start of last week.  With the economy sliding into recession and BOE tightening expectations cooling as a result of its mixed messages, sterling should continue to weaken.  The May 2020 low near $1.2075 should soon be tested and a break below would set up a test of the March 2020 low near $1.1410.


Japan reported April PPI and machine tool orders.  PPI came in at 10.0% y/y bs. 9.4% expected and a revised 9.7% (was 9.5%) in March.   This was the highest since December 1980 but so far has not had as much impact on CPI as one might expect as firms so far have had little pricing power to pass the higher costs on to consumers.  National CPI will be reported Friday.  Headline is expected at 2.5% y/y vs. 1.2% in March, while core (ex-fresh food) is expected at 2.0% y/y vs. 0.8% in March.  To illustrate the outsized impact of oil prices, core ex-energy is expected at only 0.7% y/y vs. -0.7% in March.  The April Bank of Japan meeting showed that policymakers remain largely unconcerned about inflation, which it views as transitory.  We maintain our view that policy will be kept steady through the end of Governor Kuroda’s term next spring, leaving it up to his successor to change policy. 

HKD continues to trade at the weak end of its trading band.  Reports suggest HKMA spent around $750 mln to defend the peg today.  Given souring sentiment on EM and China, we expect HKD to remain at or near the 7.85 limit well into H2, which will require ongoing intervention.  While this will undoubtedly lead to tighter liquidity and slower growth in Hong Kong , the peg will hold.  Please see our recent Thoughts on the HKD Peg for an in-depth look.  

China reported weak April IP and retail sales data.  IP came in at -2.9%% y/y vs. 0.5% expected and 5.0% in March, while sales came in at -11.1% y/y vs. -6.6% expected and -3.5% in March.  Yet the PBOC kept its 1-year MLF rate steady at 2.85% despite this data on top of the weak new loan and aggregate financing data reported Friday.  Commercial banks will set their 1- and 5-year Loan Prime Rates Friday and will take their cue from the PBOC’s MLF decision and likely keep rates steady.  Overnight, the PBOC cut the mortgage rate for first-time buyers to as low as 4.4% vs. 4.6% previously.  The bank said the cut was aimed at supporting housing demand and will “promote the stable and healthy development of the property market.”  However, this is yet another example of a rather timid policy response. 

New Bank of Korea Governor Rhee Chang-yong said he cannot rule a 50 bp rate move.  However, he acknowledged that it would depend on how the inflation and growth data developed.  His remarks come ahead of the first policy meeting he will lead next Thursday, when the bank is expected to hike rates 25 bp.  Since it just hiked 25 bp April 13, we believe a 50 bp move is highly unlikely.  However, we commend Rhee for successfully keeping the bazooka in his pocket.  Looking ahead, the swaps market is now pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%. Interestingly, the government last week announced its largest-ever extra budget to help maintain growth.  The planned KRW59.4 trln ($46.3 bln) package must still be reviewed by parliament.  According to the Finance Ministry, the spending is meant to aid small businesses, pandemic workers, and households vulnerable to higher inflation.  

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