Dollar Firm After Fed’s Hawkish Hold

June 13, 2024
  • FOMC delivered the expected hawkish hold; Chair Powell stayed on message; Dot Plots shifted more hawkish; May CPI data helped take UST yields lower; PPI will be today’s highlight; Mexico may take action to support the peso; Peru is expected to cut rates 25 bp to 5.5%
  • The internal ECB debate continues; eurozone data remain soft; South Africa political outlook is improving
  • Two-day BOJ meeting started today and ends tomorrow with an expected hold; Japan BSI Q2 business conditions survey was reported; Australia reported strong May jobs data; Taiwan kept rates steady at 2.0%, as expected

The dollar is firmer in the wake of the FOMC decision. With the Fed delivering a hawkish hold (see below), DXY is recouping its post-CPI losses and trading higher near 104.779. The euro is trading lower near $1.08, while sterling is trading lower near $1.2780. USD/JPY is edging higher to trade near 157.20 as the two-day BOJ meeting got under way (see below). MXN is stabilizing on reports of possible Banxico support measures (see below), while ZAR is outperforming on signs of an ANC-DA alliance (see below). Recent data support our view that the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. The Fed sees the same and delivered a hawkish hold yesterday. Overall, recent developments underscore the widening economic and monetary policy divergences that support the U.S. dollar and that should continue.

AMERICAS

Two-day FOMC meeting ended with the expected hawkish hold. The statement remained suitably cautious as the Fed noted “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.” However, it subtly signaled some improvement and noted that “In recent months, there has been modest further progress toward the Committee's 2% inflation objective.” This contrasts with the May 1 statement, which noted that “In recent months, there has been a lack of further progress toward the Committee's 2% inflation objective.”

While Chair Powell’s press conference came with the usual dovish risks, he stayed on message. Powell acknowledged that recent inflation has eased somewhat but added that the Fed needs to see more good data to bolster its confidence that inflation is moving towards target. He said he won’t be specific about how many good inflation prints the Fed wants to see before cutting. Powell was suitably vague and clearly doesn't want to be painted into a corner by today's CPI data. Lastly, Powell said wage gains are still running high and added that 2% inflation is likely to require slower wage growth. This was a clear reference to May jobs data, where AHE accelerated for the first time since January to a higher than expected 4.1% y/y.

The Dot Plots shifted more hawkish. The 2024 median moved from 4.625% to 5.125%, while the 2025 median moved from 3.875% to 4.125% and the 2026 median was unchanged at 3.125%. This was almost a wash as 25 bp of expected easing was moved from 2024 to 2025, while another 25 bp evaporated. Lastly, the median longer-term rate moved from 2.563% to 2.75%.

Updated macro forecasts were released. Growth forecasts were unchanged, while unemployment forecasts were nudged higher a tick in 2025 and 2026. PCE and core PCE forecasts were two ticks higher for both in 2024 and one tick higher for both in 2025. Williams speaks today. Goolsbee and Cook speak tomorrow.

After the decision, the market is fully pricing in a November cut. Other meetings before that need to be discussed, however. June CPI (July 11) and PCE (July 26) will come before the July 30-31 FOMC meeting. Another good month of inflation data then could put that meeting more in play, where the market currently sees less than 10% odds of a cut. It's more likely that the Fed waits for July CPI (August 14) and PCE (August 30) before deciding on a possible cut at the September 17-18 meeting, where the odds are now around 65%. As always, it will come down to the data and right now, the data say hold.

Meanwhile, financial conditions loosened for the seventh straight week through June 7. Conditions are the loosest since November 2021. Yes, November 2021. And with yields down and equities up this week, we may get an eighth straight week of looser conditions. We'd ask the Fed again, what's the hurry?

Ahead of the FOMC decision, May CPI data helped take UST yields lower. Headline came in a tick lower than expected at 3.3% y/y s. 3.4% in April, while core came in a ticker lower than expected at 3.4% y/y vs. 3.6% in April. Super core decelerated to 4.8% y/y from 4.9% in April, which was the highest since April 2023. Looking ahead, the Cleveland Fed’s inflation Nowcast model sees June headline at 3.15% y/y and core at 3.52% y/y.

PPI will be today’s highlight. Headline is expected at 2.5% y/y vs. 2.2% in April, while core is expected at 2.5% y/y vs. 2.4% in April. Keep an eye on PPI ex-trade, transportation, and warehousing. This measure goes into the calculation of PCE and rose to a cycle high 4.4% y/y in April and so there may be some upside risks to PPI. Weekly jobless claims will also be reported.

Mexico may take action to support the peso. Banco de Mexico Governor Rodriguez said, “We will be attentive to guarantee the proper operation of the financial markets,” adding that the bank could act if the peso shows “atypical behavior or extreme volatility.” Rodriguez blamed the peso volatility on external factors, and insisted policymakers aren’t trying to defend a specific level for the peso. We agree. Since the peg was broken back in 1994, Mexico moved to a freely floating peso. Since then, Banxico has typically been hands off with regards to the exchange rate but has used various programs to support the peso during times of great stress. For instance, it began spot dollar auctions during the financial crisis, but has also auctioned MXN NDFs as a way to maintain foreign reserves. Banxico has also directly intervened in the FX market, doing so back in January 2017. If the peso continues to weaken, some support measures are likely and would probably aim to restore a two-way market for MXN, much like recent BOJ intervention did, rather than defend a particular level.

Peru central bank is expected to cut rates 25 bp to 5.5%. At the last meeting May 9, the bank cut rates 25 bp to 5.75% and reiterated that future decisions will depend on incoming data. Since then, headline inflation has fallen further to 2.0% y/y, the lowest since December 2020 and hitting the 2% target. The central bank will also release its Inflation Report with updated macro forecasts.

EUROPE/MIDDLE EAST/AFRICA

The internal ECB debate continues. Vasle said “If the baseline scenario is realized and the data are favorable, then we can probably expect further rate cuts already this year, and then also next year.” Elsewhere, Muller said “As we saw in the initial euro area inflation estimate in May, the pace of inflation may temporarily accelerate again. We aren’t at the target yet. In order to achieve our goal, interest rates presumably still need to stay above average for some time.” The market still sees around 60% odds of a 25 bp cut September 12, followed by around 85% odds for another cut December 12. In our view, the ECB has room to deliver both those cuts. With the Fed delivering a hawkish hold this week, the monetary policy divergences will continue to widen.

Eurozone data remain soft. April IP came in at -0.1% m/m vs. 0.2% expected and a revised 0.5% (was 0.6%) in March, while the y/y came in at -3.0% vs. -2.0% expected and a revised -1.2% (was -1.0%) in March. Despite some improvement in the survey readings, there, Germany remains the weak link in the eurozone. When all is said and done, we believe the weak growth outlook was the primary reason for the ECB’s “hawkish cut.”

South Africa political outlook is improving. After more than two weeks of uncertainty, reports suggest the ANC and the Democratic Alliance have resolved key differences and will enter into an alliance that will allow President Ramaphosa to serve another term. Talks are set to continue but a deal seems likely and will allow the new parliament to vote on the president when it meets for the first time tomorrow. An ANC-DA alliance has always been the best outcome for markets and has led the rand to be the best performing EM currency over the past week. Since bottoming on June 6, ZAR has gained nearly 3.5% vs. USD. Contrast that with MXN, which has plunged nearly -10% since the June 2 elections.

ASIA

Two-day Bank of Japan meeting started today and ends tomorrow with an expected hold. All economists surveyed expect the BOJ to keep the policy rate target at 0 to 0.10%. The swaps market implies nearly 15% odds of a 10 bp hike this week, rising to over 70% odds in July. The BOJ will likely start or announce plans to begin reducing the amount of JGB purchases from the current roughly JPY6 trln per month pace. BOJ Governor Ueda noted recently that “it is appropriate for the Bank to reduce the amount of its JGB purchases as it proceeds with its exit from large-scale monetary easing.” Nevertheless, the bar for an aggressive BOJ tightening cycle is high because Japan underlying inflation is in a firm downtrend.

Japan BSI Q2 business conditions survey was reported. Large manufacturing came in at -1.0 vs. -6.7 in Q1, while large non-manufacturing came in at 1.1 vs. 3.2 in Q1. This led overall large industry to rise slightly 0.4 vs. 0.0 in Q1. Conditions for large companies have been trending lower in recent quarters. While the Q2 BSI suggests the economy is stabilizing, it does not point to a strong rebound this quarter.

Australia reported strong May jobs data. 39.7k jobs were added vs 30.0k expected and a revised 37.4k (was 38.5k) in April, while the unemployment fell a tick as expected to 4.0%. the mix was good, as 41.7k full-time jobs were offset by -2.1k part-time jobs. Overall, the labor market is easing very gradually, thereby curbing expectations the RBA will cut rates this year.

Taiwan central bank kept rates steady at 2.0%, as expected. However, the bank tightened liquidity by raising commercial bank reserve ratios 25 bp. After the May CPI data last week, central bank Governor Yang said “CPI, core CPI, important staples prices, and commonly purchased items prices are gradually falling.” While the bank does not have an explicit inflation target, Taiwan rates have likely peaked as price pressures ebb. However, the swaps market still sees some odds of one more hike over the next 12 months.  

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