Dollar Enjoys A Technical Bounce Despite Lower U.S. Yields

November 29, 2023

Win Thin

U.S. yields continue to edge lower but the dollar is getting some traction; Chicago Fed financial conditions will be closely watched; Fed Beige Book report will be released; Banco de Mexico releases its quarterly inflation report
Eurozone November CPI readings have started rolling out; the dovish ECB and BOE narratives remains intact
BOJ officials remain dovish; Australia reported soft October CPI data; RBNZ kept rates steady at 5.5%, as expected; Thailand kept rates steady at 2.5%, as expected

The dollar is enjoying a modest technical bounce. DXY is trading higher near 102.87 after testing the key 62% retracement level from the July-October move near 102.546. Break below would set up a test of the July 14 low near 99.578. The euro is trading lower near $1.0980 as yesterday’s break above its retracement objective near $1.0960 may have been a false breakout. Sterling is trading lower near $1.2680 after testing its key retracement objective near $1.2720. Break above would set up a test of the July 14 high near $1.3140. USD/JPY is trading higher near 147.70, helped by some dovish BOJ comments (see below). With the dollar rally stalled, it will take some firm real sector data to challenge the current dovish Fed narrative. We stress that the U.S. economy continues to grow above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed will not be able to cut rates as soon and by as much as the markets think. That said, the dollar remains vulnerable until we see a shift in market expectations for the Fed and that may be a 2024 story.

AMERICAS

U.S. yields continue to edge lower. The 10-year yield traded as low as 4.25% today, down from the October peak near 5.02%, while the 30-year yield traded as low as 4.45% today, down from the October peak near 5.18%. The short end of the curve is participating, as the 2-year yield traded as low as 4.66% today, down from the October peak near 5.26%. Until we get some strong U.S. data to challenge this narrative, markets will be more than happy to continue running with this trend of low yields into year-end. Data this week are unlikely to provide much in the way of a challenge, as the PCE data are expected to show continued disinflation.

Despite lower yields, the dollar is getting some traction. However, this appears to be technical in nature. Both DXY and GBP were unable to break their key 62% retracement objective from the July-October moves and are in the midst of a correction. The euro led this move and broke its 62% retracement objective near $1.0960 yesterday but that may prove to be a false breakout. With the dovish Fed narrative picking up pace, yields are likely to edge lower and that will eventually take a toll on the dollar. We continue to look for near-term dollar weakness followed by a recovery in the coming weeks if and when the market reprices the Fed pivot.

The Chicago Fed's measure of financial conditions will be closely watched. The reading is for last week. The week before, conditions were the loosest since mid-February 2022 and will get even looser. The Fed made such a big deal about higher yields doing the heavy lifting but have said nothing at the 10-year sinks from the 5.02% peak in October to 4.25% today. Higher equities and the weaker dollar also add to looser financial conditions, as do tighter corporate spreads. These moves are getting out of control and the Fed is doing nothing to dissuade markets from continuing on this misguided path.

Fed Beige Book report will be released. The report was prepared for the upcoming December 12-13 FOMC meeting. Since the last meeting October31-November 1, we’ve gotten slightly softer jobs data and some downside inflation surprises. We expect the Beige Book to acknowledge these trends, which in turn should support another hold from the Fed next month. However, the Fed must keep the door open to another hike if needed. WIRP suggests very low odds of a cut in either December or January, but those odds rise to nearly 45% March 20 and fully priced in for May 1 vs. June 12 at the start of this week.

Even the Fed hawks have bought into the dovish narrative. Waller said “I am increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2%. I am encouraged by what we have learned in the past few weeks — something appears to be giving, and it’s the pace of the economy.” Hawk Mester speaks today, and it will be interesting to see if she has also succumbed to the dovish side.

We get a revision to Q3 GDP data. Growth is expected to be revised up a tick to 5.0% SAAR. However, this is old news as markets are already looking to Q4. The Atlanta Fed’s GDPNow model is tracking Q4 at 2.1% SAAR and the next update will come tomorrow after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q4 at 2.2% SAAR and the next update will come Friday. Despite the Fed’s tightening campaign, the economy continues to grow at or above trend at a time when below trend growth is needed to limit inflation. October wholesale and retail inventories and advance goods trade will also be reported today.

November Conference Board consumer confidence was mixed. Headline came in at 102.0 vs. 101.0 expected and a revised 99.1 (was 102.6) in October. Present situation fell to 138.2 vs. a revised 138.6 (was 143.1) in October, while expectations rose to 77.8 vs. a revised 72.7 (was 75.6) in October. Consumption held up as confidence dropped and so should recover as confidence rises. The early reads suggest Black Friday and Cyber Monday sales were strong.

Banco de Mexico releases its quarterly inflation report. At the last policy meeting November 9, the bank kept rates steady at 11.25% but said they would remain there “for some time” vs. “for an extended period” previously. We can't say the bank was dovish, perhaps just less hawkish. Next policy meeting is December 14, and no change is expected then. Swaps market is now pricing in some odds of a cut over the next three months vs. steady rates before the last decision. However, with only 50 bp of total easing seen over the next six months, the market views the bank as remaining very cautious.

EUROPE/MIDDLE EAST/AFRICA

Eurozone November CPI readings have started rolling out. Spain’s EU Harmonised inflation came in at 3.2% y/y vs. 3.6% expected and 3.5% in October. Spain is one of the few eurozone countries to report core inflation and it came in at 3.2% y/y vs. 3.7% expected and 3.5% in October. Germany reports later today, and its EU Harmonised inflation is expected at 2.5% y/y vs. 3.0% in October. German state data already reported today suggest some downside risks to the national reading. France and Italy report tomorrow. France’s EU Harmonised inflation is expected at 4.1% y/y vs. 4.5% in October, while Italy’s is expected at 1.1% y/y vs. 1.8% in October. Eurozone-wide CPI will also be reported tomorrow. Headline is expected at 2.7% y/y vs. 2.9% in October, while core is expected at 3.9% y/y vs. 4.2% in October. If so, headline would be the lowest since July 2021 and approaching the 2% target.

The dovish European Central Bank narrative remains intact. WIRP suggests very low odds of a cut either December 14 or January 25. After that, a cut is about 90% priced in for April 11 vs. 60% at the start of this week. Stournaras is the latest to push back against this market pricing, noting “The current numbers betting on April seem a bit optimistic.” He added that President Lagarde’s recent forward guidance suggests a cut is “in the beginning of the third quarter of next year, we might. That’s how I read it.”

Eurozone October retail sales data continue rolling out. Spain’s came in at 5.0% y/y vs. a revised 6.3% (was 6.5%) in September. Germany reports tomorrow and is expected at 0.4% m/m vs. -0.6% in September. Eurozone retail sales will be reported December 6 and Italy’s will be reported December 7.

The dovish Bank of England narrative remains intact. WIRP suggests no odds of a hike December 14, rising modestly to top out near 10% in Q1 vs. 25% at the start of this week. After that, a cut is about 70% priced in for June 20 vs. August 1 at the start of this week. Bailey and Hauser speak later today. Executive Director for Markets Hauser has been tapped to be the next RBA Deputy Governor and so this is likely to be one of his final appearances at the BOE.

ASIA

Bank of Japan officials remain dovish. Board member Adachi said “There seems to be emerging views that the bank is laying the groundwork for an exit, after October’s move to add flexibility to the BOJ’s yield curve control. But we need to continue with easing patiently, and we’re not at a phase to discuss an exit strategy, given the current economy and inflation.” He added that the bank will only be able to gauge the outlook for wages after the new fiscal year starts in April, presumably after the spring wage negotiations. Liftoff expectations continue to get pushed out. At the end of September, the market was pricing in liftoff in March; by early November, it was seen in April and now liftoff is seen in June. Weak economic data has been the main culprit here as markets debate under what conditions the BOJ will feel comfortable hiking. Governor Ueda also remains firmly in the dovish camp. Nakamura speaks tomorrow.

Australia reported soft October CPI data. Headline came in at 4.9% y/y vs. 5.2% expected and 5.6% in September. This was the first deceleration since July but remains well above the 2-3% target range. At the last meeting November 7, the RBA restarted the tightening cycle with a 25 bp hike to 4.35% and said “Whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks.” RBA tightening expectations have fallen after this week’s data. WIRP suggests no odds of a hike December 5, 20% odds February 6 vs. 35% at the start of this week, then rising modestly to top out near 30% in Q2 vs. 75% at the start of this week.

Reserve Bank of New Zealand kept rates steady at 5.5%, as expected. However, it was a hawkish hold as the bank discussed a rate hike before deciding on no change. Governor Orr said “We are confident we are restrictive with our monetary policy stance now and that provides us the ability to wait, to watch the data, but certainly highlight our willingness to move if we have to. We are showing an upward bias to the interest rate, but it’s not a probability.” That said, the new expected rate path shows an end-2024 policy rate of 5.7% vs. 5.5% previously, suggesting high odds of one last hike. In underscoring the higher for longer theme, the RBNZ now sees an end-2025 policy rate of 4.9% vs. 4.5% previously while the first cut is now forecast around Q2 2025 vs. Q1 previously. Despite the hawkish message, WIRP suggests 5% odds of a hike February 28. After that, it’s all about the rate cuts and the first one is still fully priced in for August 14.

Bank of Thailand kept rates steady at 2.5%, as expected. The bank said that he current level of rates was appropriate “for supporting long-term sustainable growth” and added that “The committee will take into account growth and inflation outlook as well as associated risks in deliberating monetary policy looking ahead.” Assistant Governor Piti said rates are likely to remain steady for a while. The ban cut its 2023 growth forecast to 2.4% vs. 2.8% previously and cut its 2024 forecast to 3.2% vs. 4.4% previously but stressed that “the broad trajectory of the economy is one of a continued recovery.” Headline inflation for 2023 and 2024 is forecast at 1.3% and 2.0%, respectively, and well within the 1-3% target range. The swaps market is pricing in steady rates over the next six months, with some odds of a rate cut over the subsequent six months.

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