Dollar Firm Ahead of FOMC Minutes

February 22, 2023
  • U.S. yields continue to rise; FOMC minutes will be closely watched; Fed tightening expectations remain elevated; preliminary S&P Global PMIs came in strong but housing sector data show continued weakness; Canada data came in soft yesterday
  • Germany reported a mixed February IFO business climate survey; ECB doves remain vocal; U.K. Chancellor Hunt is downplaying notions of a fiscal windfall; BOE tightening expectations have picked up
  • Two major Japanese car companies have agreed to large-sale wage hikes; Australia reported Q4 wage price index; RBNZ hiked rates 50 bp to 4.75%, as expected

The dollar continues to firm ahead of FOMC minutes. DXY is up for the second straight day and trading near 104.275. We look for a test of last week’s high near 104.667 and a break above that would set up a test of the January 6 high near 105.631. The euro is trading lower near $1.0625 and nearing a test of last week’s low near $1.0615. Break below that would set up a test of the January 6 low near $1.0485. Sterling trading lower near $1.2085 as recent moves above $1.21 have not been sustained. We would continue fade this bounce and look for cable to revisit last week’s low near $1.1915. Break below that would set up a test of the January 6 low near $1.1840. USD/JPY is trading just below 135 after making a new high for this move yesterday near 135.25. We look for a test of the December 20 high near 137.50, right before the BOJ shocked markets with its YCC tweak. To state the obvious, the recent U.S. data have come around to support our more hawkish view on the Fed, which in turn supports our call for a stronger dollar. Market sentiment is finally swinging back in the dollar’s favor and we remain hopeful that the data continue to encourage this shift.


U.S. yields continue to rise. The 2-year yield traded near 4.73% yesterday, the highest since November 8 and on track to test the November 4 cycle high near 4.80%. It is trading near 4.70% today. The 10-year yield traded near 3.97% today, the highest since November 10 and on track to test the November 8 high near 4.24%. After that, the next target is the October 21 cycle high near 4.34%. The move higher in yields coincides with renewed inflation concerns and a much-needed repricing of Fed tightening expectations. The dollar has recovered as a result and this process still has a ways to go, in our view.

FOMC minutes will be closely watched. That said, so much has changed since the February 1 decision that the minutes have likely become outdated. At that meeting, the Fed downshifted to 25 bp and said that ongoing rate hikes will be appropriate as inflation has eased somewhat but remains elevated. It added that it will consider the extent of future rate hikes, meaning that this downshift to 25 bp means the Fed is still trying to figure out how high it needs to go. The Fed said job gains have been robust and unemployment remains low, but added that recent data suggest modest growth in spending and production. Recall that in his press conference, Powell did not push back at all against the loosening of financial conditions. Nor did Powell push back against dovish market expectations of Fed policy. When asked about the divergence between the Fed view (Dot Plots) and the market view, Powell simply shrugged it off and said this was due to differences in the inflation forecasts. He said if inflation deviates from its forecasts and moves closer to market expectations, the Fed will adjust policy accordingly.

Since then, the exact opposite has happened. Inflation has come in higher than market forecasts, which were clearly too optimistic. This has led markets to significantly reprice Fed tightening expectations. We don’t know if Powell was prescient or simply lucky but market expectations have adjusted as they should. Chair Powell implied in his subsequent interview that the Fed did not have an advance look at the January jobs data when the decision was handed down, and so we suspect a fair amount of luck was involved. We also know from subsequent speeches that both Mester and Bullard were in favor of a 50 bp move before finally agreeing to a smaller 25 bp hike. Perhaps the minutes will show that these two were not the only ones favoring 50 bp. If so, it would be a hawkish surprise that would likely take rates and the dollar higher. Williams speaks later today after the minutes are released.

Fed tightening expectations remain elevated. WIRP suggests 25 bp hikes in March, May, and June are priced in that takes Fed Funds to 5.25-5.50%. Given how strong the data have been recently, we see growing risks of a fourth 25 bp hike that takes us up to 5.50-5.75%. Right now, there are only around 5% odds of that fourth hike in July but this should rise if the data continue to run hot. Strangely enough, an easing cycle is still expected to begin in Q4 but at much lower odds. Eventually, it should be totally priced out into 2024 in the next stage of Fed repricing.

Preliminary S&P Global PMIs came in strong. Manufacturing came in at 47.8 vs. 47.2 expected and 46.9 in January, services came in at 50.5 vs. 47.3 expected and 46.8 in January, and the composite PMI came in at 50.2 vs. 47.5 expected and 46.8 in January. This was the first reading above 50 for this composite since June. The Chicago PMI and ISM PMIs won’t be reported until next week but global PMI readings this week suggest potential for upside surprises. Philadelphia Fed non-manufacturing index came in at 3.2 vs. -6.5 in January and was the first positive reading since July and the highest since May. It also supports the big improvement in S&P Global services PMI.

Housing sector data show continued weakness. January existing home sales came in at -0.7% vs. at 2.0% expected and a revised -2.2% (was -1.5%) in December. As a result, the y/y rate worsened to -36.9% vs. -34.0% in December. New homes sales will be reported Friday and is expected at 0.7% m/m vs. 2.3% in December. With the 10-year yield rising, the average 30-year fixed rate mortgage has risen from 6.32% in early February to 6.96% currently. While still shy of the November peak near 7.35%, rising mortgage rates should put a further chill on the housing sector.

Canada data came in soft yesterday. Headline CPI came in at 5.9% y/y vs. 6.1% expected and 6.3% in December, while core common came in steady at 6.6% y/y. Other core measures fell, however, with core median coming in at 5.0% y/y vs. a revised 5.2% (was 5.0%) and core trim coming in at 5.1% y/y vs. 5.3% in December. December retail sales data were mixed. Headline came in as expected at 0.5% m/m vs. a revised flat (was -0.1%) in November, while ex-autos came in at -0.6% m/m vs. -0.1% expected and a revised -0.5% (was -0.6%) in November. Bank of Canada expectations did not change much after picking up sharply last week after the second straight blowout jobs report. If data continue to come in firm, the bank will find it harder and harder to justify its pause at 4.5%. No change is expected at the next meeting March 8 but the market is now pricing in another 25 bp hike that would see the peak policy rate near 4.75%.


Germany reported a mixed February IFO business climate survey. Headline came in at 91.1 vs. 91.2 expected and a revised 90.1 (was 90.2) in January. Current assessment came in at 93.9 vs. 95.0 expected and 94.1 in January, while expectations came in at 88.5 vs. 88.4 expected and 86.4 in January. March GfK consumer confidence will be reported Friday and is expected at -30.5 vs. -33.9 in February. While many of the survey indicators appear to have bottomed, we warn against getting too excited about the eurozone outlook as the hard data remain weak.

ECB doves remain vocal. Villeroy stressed that the ECB is “in no way” obliged to hike rates at every meeting between now and September given that the deposit rate is already in restrictive territory. He noted that “There’s been an excess of volatility on expectations for the terminal rate. In other words, markets have overreacted a little since Thursday.” Villeroy is clearly responding to the fact that ECB tightening expectations have picked up. WIRP suggests a 50 bp hike March 16 is nearly priced in. Looking further ahead, a 50 bp hike May 4 is nearly 45% priced. Another 25 bp hike June 15 is priced in, followed by one last 25 bp hike in Q3that would result in a peak policy rate near 3.75%, up from 3.5% at the start of last week. These expectations are likely to drift lower if continued disinflation gives the doves the upper hand again.

U.K. Chancellor Hunt is downplaying notions of a fiscal windfall. Specifically, he said that the fall in energy prices will lower the cost of its energy aid programs but this will be offset by a decline in tax revenues from oil and gas company profits. Some have been speculating that the recent unexpected improvement in the government’s fiscal position would allow Hunt to loosen fiscal policy in the FY2023 budget due next month, but his comments today would seem to downplay that. Still, with the Tories facing a likely election by late 2024, Hunt will be under some pressure from his own party to provide some fiscal relief.

BOE tightening expectations have picked up. WIRP suggests a 25 bp hike March 23 is nearly priced in. After that, a 25 bp hike May 11 is nearly 80% priced in while a final 25 bp hike in Q3 is also about 80% priced in and so the expected terminal rate has edged higher to 4.75% vs. 4.5% at the start of this week. This is still well below the peak near 6.25% right after the disastrous mini-budget back in September. However, rising rates will put upward pressure on debt servicing costs and so this may limit Hunt’s leeway next month.


Two major Japanese car companies have agreed to large-sale wage hikes. Toyota agreed to give the largest wage hikes in two decades, according to union officials. An agreement was reportedly reached in the first round of talks but the actual percentage increase was not announced. Elsewhere, Honda said it will raise wages by 5% and includes the biggest hike in base pay in nearly three decades. If other companies emulate these automakers, it may move the Bank of Japan one step closer to removing accommodation, as policymakers have stressed the need to see higher wages as well as higher inflation before tightening. January wage data won’t be reported until March 6 but the December data show some upward momentum in nominal wages was building in late 2022.

Expected BOJ liftoff is not imminent. Next BOJ policy meeting March 9-10 will be the last one under Governor Kuroda and while no change is expected, we simply cannot rule out one last surprise. WIRP suggests over 20% odds of liftoff April 28, rising to nearly 60% June 16 and 80% for July 28. That said, the actual tightening path is seen as very mild as the market is pricing in 25 bp of tightening over the next 12 months followed by only 30 bp more over the subsequent 24 months. That is why we expect the knee-jerk drop in USD/JPY after liftoff to be fairly limited.

Australia reported Q4 wage price index. It came in at 0.8% q/q vs. 1.0% expected and a revised 1.1% (was 1.0%) in Q4, while the y/y rate came in at 3.3% vs. 3.5% expected and a revised 3.2% (was 3.1%) in Q3. Wages accelerated to a new cycle high and should keep pressure on the RBA to continue tightening. WIRP suggests nearly 80% odds of a 25 bp hike at the next meeting March 7, while the swaps market is pricing in a peak policy rate near 4.35% over the next 12 months followed by an easing cycle over the subsequent 12 months, highlighting the “higher for longer” theme.

Reserve Bank of New Zealand hiked rates 50 bp to 4.75%, as expected. It signaled more hikes ahead as it noted that “While there are early signs of demand easing it continues to outpace supply, as reflected in strong domestic inflation. The Committee agreed that monetary conditions need to tighten further.” The recent floods will certainly complicate the RBNZ’s job but the bank said it’s too early to assess the monetary policy implications. Furthermore, the bank noted that the timing, size, and form of the fiscal response was yet to be determined, making it even harder to formulate monetary policy. Updated macro forecasts were little change, with the policy rates still seen peaking near 5.5% this year and staying there for much of next year. WIRP suggests a 50 bp hike is about 40% priced in for the next meeting April 5, while the odds of one final 25 bp hike July 12 top out near 65% that would see the policy rate peak near 5.5%.

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