Dollar Continues to Gain as U.S. Shutdown Averted

September 30, 2021

U.S. government shutdown has been averted, at least until December 3; there is a busy slate of Fed speakers; some key September readings will start to emerge; weekly claims data will be very important; Mexico is expected to hike rates 25 bp to 4.75%; Colombia is expected to hike rates 25 bp to 2.0%.
Italy and France reported higher September CPI; U.K. Q2 GDP growth was revised higher to 5.5% q/q vs. 4.8% preliminary; short sterling strip is now pricing in three BOE hikes in 2022; Czech Republic is expected to hike rates 50 bp to 1.25%
Japan reported very weak August retail sales and IP; China’s September PMI figures were mixed, but somewhat concerning

The dollar continues to power higher. DXY is up for the fifth straight day, making new highs for this year near 94.50. The September 2020 high near 94.742 is the next target. After that, there are no major chart points until the June 2020 high near 97.802. EUR is trading at the lowest level since July 2020 near $1.1570 and is on track to test the lows from June and July 2020 just below $1.12. Elsewhere, USD/JPY is making new highs near 112.05 and is nearing the February 2020 high near 112.25 and then the April 2019 high near 112.40. As this pair moves higher, we have to start thinking about the October 2018 high near 114.55. Lastly, cable tested support near $1.34 but remains on track to test the December 2020 low near $1.3135. After that is the November 2020 low near $1.2855.

AMERICAS

A U.S. government shutdown has been averted, at least until December 3. The Senate will reportedly vote on a standalone continuing resolution that will keep the government funded until December 3. Majority Leader Schumer said a deal has been reached with Republican lawmakers now that the debt ceiling language was removed. This was widely expected as the Democrats had no choice after Republican Senators voted down the bundled bill twice, but the debt ceiling and infrastructure spending bills remain at an impasse. Of these two, the debt ceiling is the most pressing given the October 18 deadline that has been staked out by Treasury Secretary Yellen. Our base case is that the Democrats are eventually forced to pass the debt ceiling via budget reconciliation and will most likely be bundled together with the” human infrastructure bill.” Republicans have pledged not to support either initiative. The fact that the dollar continues to climb after a shutdown was averted supports our view that its recent gains are far more than just risk-off demand.

The recent price action in FX markets is worth reviewing. The speed of this dollar move is quite frankly very surprising. We are writing a piece (out later today) about the dollar price action during the last Fed tapering period back in 2013-2014, which points to further gains ahead for this current tapering period. As the saying goes, “History doesn't repeat itself, but it often rhymes.” Based on the previous experience, we believe that this period of dollar strength still has legs and so we will set out our medium-term outlook for the greenback in this longer piece.

The U.S. 10-year yield traded Tuesday at the highest level since June 17 near 1.57% before coming off. It remains on track to test the May high near 1.70% and then the March 30 high near 1.77%. The real 10-year yield is also higher and at -0.85% is the highest since July 1. A break above -0.82% is needed to set up a test of the March 19 high near -0.59%. If this rise in U.S. yields can be sustained, it is yet another dollar-positive factor to consider. Of note, the Fed Funds strip now has lift-off in Q4 2022 almost fully priced in.

There is a busy slate of Fed speakers. Williams, Bostic, Evans, Bullard, Daly, and Harker speak today, while Powell and Yellen appear before the House Financial Services Committee. Yesterday, both Harker and Daly came out in favor of tapering soon. Harker added that "I wouldn't expect any hikes to interest rates until late next year or early 2023."

Some key September readings will start to emerge. Chicago PMI is expected at 65.0 vs. 66.8 in August and should provide some hints for ISM manufacturing PMI will be reported tomorrow and is expected at 59.5 vs. 59.9 in August. Last week, preliminary September Markit PMI readings were reported. Manufacturing came in at 60.5 vs. 61.0 expected and 61.1 in August and services came in at 54.4 vs. 54.9 expected and 55.1 in August, which dragged the composite down to 54.5 vs. 55.4 in August. Q2 GDP revision (6.6% SAAR expected) will also be reported but this is old news as markets look ahead to Q3 and Q4.

Weekly claims data will be very important given the Fed’s focus on the November jobs report. Initial claims are expected at 330k vs. 351k the previous week, while continuing claims are expected at 2.805 mln vs. 2.845 mln the previous week. The readings last week were disappointingly high, with initial claims rising for the BLS survey week. Continuing claims are reported with a one-week lag and so this week’s reading will be for the BLS survey week. Current consensus for September NFP is 525k vs. 235k in August, with the unemployment rate expected to fall a couple of ticks to a new cycle low of 5.0%. We believe any reading in the 400-500k range would meet the Fed’s criteria to announce tapering in November.

Banco de Mexico is expected to hike rates 25 bp to 4.75%. CPI rose a higher than expected 5.87% y/y in mid-September, and it appears inflation is accelerating again after a couple months of decelerating. As such, the bank should burnish its credibility by delivering a third straight hike this week. Bloomberg consensus sees another 25 bp of tightening in Q4, followed by another 25 bp each in Q1 and Q2 that takes the policy rate to 5.5% by mid-2022. Another 25 bp hike is seen in Q1 2023.

Colombia central bank is expected to hike rates 25 bp to 2.0%. Rates have been on hold since the last 25 bp cut back in September 2020. CPI rose 4.44% y/y in August, the highest since April 2017 and above the 2-4% target range. With the economy recovering, it’s time to start a tightening cycle. Bloomberg consensus sees another 50 bp of tightening in Q4, followed by another 50 bp each in Q1, Q2, and Q3 that takes the policy rate to 4.0% at end-2022. Another 50 bp is seen in Q1 2023.

EUROPE/MIDDLE EAST/AFRICA

Italy and France reported higher September CPI. Italian EU Harmonized inflation came in at 3.0% y/y vs. 2.5% in August, while it came in at 2.7% y/y vs. 2.4% for France. Germany reports later today and is expected to pick up to 4.0% y/y vs. 3.4% in August. German state CPI data already reported today suggest some modest downside risks to the national number. Yesterday, Spain reported higher than expected September headline EU Harmonized inflation that came in at 4.0% y/y vs. 3.6% expected and 3.3% in August. The eurozone reading will be reported tomorrow, with headline inflation expected to pick up to 3.3% y/y from3.0% in August. Rising inflation will surely be keeping the ECB hawks up at night and will further their resolve to prevent extended monetary stimulus. That said, we believe Lagarde and the doves remain firmly in control.

U.K. Q2 GDP growth was revised higher to 5.5% q/q vs. 4.8% preliminary. Private consumption slowed a tick to 7.2% q/q, while government consumption was revised significantly higher to 8.1% q/q vs. 6.1% preliminary. GFCF was also revised higher to 0.8% q/q from -0.5% preliminary, driven by a 4.5% q/q gain in business investment vs. 2.4% preliminary. Yet this is all old news and Q3 and Q4 are shaping up to be much weaker quarters. Bloomberg consensus sees Q3 growth at 2.3% q/q, slowing to 1.5% in Q4 and 0.9% in Q1. Lastly, the Q2 current account deficit came in at -GBP8.6 bln vs. -GFP15.7 bln expected and a revised -GBP8.9 bln (as -GBP12.8 bln) in Q1.

The short sterling strip is now pricing in three BOE hikes in 2022. This despite the increasing risks to growth and the BOE’s insistence that the inflation spike is transitory. The fact that sterling is making new lows for the year despite heightened BOE tightening expectations tells us that the market sees a policy mistake. We concur. The U.K. should not be trying to out-Fed the Fed, as the two economies are in totally different situations. The U.S. is not facing an energy crisis, nor is it grappling with the fallout from a failed trade policy experiment. As such, the Fed has many more reasons to start removing accommodation than the BOE does.

Czech National Bank is expected to hike rates 50 bp to 1.25%. The bank has hiked by 25 bp in each of the past two meetings. At the last meeting August 5, the vote was split 4-3, with 1 dissent in favor of a 50 bp hike and 2 dissents in favor of no hike. However, several reportedly considered a 50 bp move. CPI rose 4.1% y/y in August, the highest since November 2008 and well above the 1-3% target range.

ASIA

Japan reported very weak August retail sales and IP. Sales fell -4.1% m/m vs. -1.7% expected and a revised 1.1% (was 1.0%) gain in July, while IP fell -3.2% m/m vs. -0.5% expected and -1.5% in July. The good news is that Q3 is almost over for Japan. For Q4, improving virus numbers and fiscal stimulus should put the economy on firmer footing. Bloomberg consensus sees GDP growth at 1.6% SAAR, though there are downside risks if August weakness carries over into September. Growth is then seen picking up to 3.8% in Q4.

China’s September PMI figures were mixed, but somewhat concerning. The non-manufacturing PMI came in well above expectations at 53.2, while the manufacturing PMI unexpectedly dipped into contractionary territory at 49.6. The composite came in right at 50.0 vs. 48.9 in August. Of note, this is the first contraction in the manufacturing PMI since the start of the pandemic, driven in large part by the well-known supply bottlenecks and energy crisis. As discussed, the government had planned on a rebalancing of the economy away from the export engine (dual-circulation system), which we imagined would also imply some rebalancing from manufacturing to services. However, we are concerned that this is happening faster than expected, and before domestic demand can take up the slack.

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