Dollar Firm Ahead of Key U.S. Data

January 26, 2023
  • U.S. financial conditions continue to loosen; December Chicago Fed National Activity Index will be important; Q4 GDP data will also be of interest; regional Fed manufacturing surveys will continue to roll out; BOC hiked rates 25 bp to 4.5% but signaled a pause; Chile is expected to keep rates steady at 11.25%.
  • The ECB hawks appear to have locked in 50 bp hikes at the next two meetings; U.K. CBI January distributive trades survey was very weak; South Africa is expected to hike rates 50 bp to 7.5%
  • A major bond index is removing JGBs due to liquidity issues; the IMF said the BOJ should consider more flexibility in long-term yields; it clearly does not believe that the current YCC regime is sustainable as inflation tops 4%

The dollar is up modestly ahead of a huge U.S. data dump. DXY is trading higher near 101.77. After making a new cycle low last week near 101.528, DXY is on track to test the May low near 101.297. The euro traded at a marginal new cycle high today near $1.0930, just shy of the April high near $1.0935. Break above that would set up a test of the March high near $1.1185. Sterling is trading flat just below $1.24 and is likely to continue underperforming due to the negative fundamental backdrop. USD/JPY is trading higher near 129.85 as moves above 130 have been hard to sustain. Last week’s high near 131.60 remains out of reach for now. China is closed all week for the Lunar New Year holiday. While we believe that the current dollar weakness is overdone, we continue to respect the price action. Until a more hawkish Fed narrative emerges, the dollar is likely to remain vulnerable.


U.S. financial conditions continue to loosen. According to the Chicago Fed’s measure, financial conditions through last Friday were the loosest since March (since February for its adjusted measure) and are still falling. After 425 bp of tightening, this looseness is not something the Fed wants to see right now. If conditions continue to loosen, we expect the Fed to deliver a very hawkish message at next week’s FOMC meeting. This is especially true if the Fed downshifts again to 25 bp, which the markets will see as further signs of a pivot and pause. Of note, the dollar sold off yesterday in sympathy with CAD after the dovish BOC decision (see below) but we think it would be a mistake to infer anything about the Fed from yesterday's BOC forward guidance signaling a hold.

Fed tightening expectations continue to drift. WIRP suggests a 25 bp hike February 1 is fully priced in, with less than 5% odds of a larger 50 bp move. Another 25 bp hike March 22 is about 80% priced in, while one last 25 bp hike in Q2 is only about 20% priced in. We think these odds are too low. Furthermore, the swaps market continues to price in an easing cycle by year-end and we just don’t see that happening. Neither does the Fed, despite its message of “higher for longer.” Until this Fed narrative changes, however, the dollar is likely to remain under pressure.

December Chicago Fed National Activity Index will be important. Simply put, we need a good read on the current state of the economy. November was never released and so we assume both months will be reported at the same time. As things stand, October came in at -0.05 and was the first negative reading since June, while the 3-month moving average was 0.09. A zero reading means the economy is growing at around trend. Recall that when that 3-month average moves below -0.7, that signals imminent recession and we are still well above that threshold. This series has taken on greater significance now that the 3-month to 10-year curve has inverted deeply. The continued resilience in the economy is noteworthy and suggests the Fed still has a lot more work to do in getting to the desired sub-trend growth.

Q4 GDP data will also be of interest. Consensus sees 2.6% SAAR growth vs. 3.2% in Q3. Personal consumption is seen at 2.9% SAAR vs. 2.3% in Q3. Of note, the Atlanta Fed’s final estimate for Q4 came in at 3.5% SAAR. Its first estimate for Q1 will be released tomorrow, where Bloomberg consensus currently stands at 0.1% SAAR. It does appear that the U.S. economy lost some momentum as we moved into the new year, as evidenced by weakness in the retail sales and IP data reported last week.

Regional Fed manufacturing surveys will continue to roll out. Kansas City Fed manufacturing index is expected at -8 vs. -9 in December. So far, Empire survey came in at -32.9 vs. -11.2 in December, Philly Fed came in at -8.9 vs. -13.7 in December, and Richmond Fed came in at -11 vs. 1 in December. December wholesale and retail inventories, advance goods balance (-$88.1 bln expected), durable goods orders (2.5% m/m expected), weekly jobless claims, and new home sales (-4.4% m/m expected) will also be reported.

Bank of Canada hiked rates 25 bp to 4.5%, as expected. However, the forward guidance was very dovish as the bank said “If economic developments evolve broadly in line with the MPR outlook, Governing Council expects to hold the policy rate at its current level.” The bank said it wants to assess the impact of its past hikes, noting that it sees growing evidence that the hikes are slowing the economy. It also sees inflation falling to 3% by mid-year and to 2% in 2024. On the other hand, the bank said sticky services inflation is the biggest upside risk as the economy remains in excess demand and the labor market is still tight. Despite the bank’s pause, the swaps market is pricing in one more 25 bp rate hike in H1 followed by the start of an easing cycle in H2. Recent data have come in firm and so we do not think the tightening cycle is over by any stretch. Indeed, if the economy remains firm, we see risks of a peak policy rate that’s higher than the 4.75% that markets are pricing in now. Of note, Governor Macklem stressed that it’s still “far too early to be talking about cuts.” We concur.

Chile central bank is expected to keep rates steady at 11.25%. It has kept rates steady since the last 50 bp hike at the October 12 meeting. The economy is clearly slowing while inflation was 12.8% y/y in December, down from the 14.1% peak in August but still well above the 2-4% target range. At the last meeting December 6, the bank said “The Board will maintain the monetary policy rate at 11.25% until the state of the macroeconomy indicates that this process has been consolidated.” We think inflation needs to fall much further before the bank starts cutting. That is why we think market expectations for the start of an easing cycle in the next three months are too aggressive.


The ECB hawks appear to have locked in 50 bp hikes at the next two meetings. In a coordinated response to reports of a downshift at the March meeting, the hawks have come out in support of President Lagarde’s forward guidance from December, when she said that it was obvious to expect more 50 bp hikes “for a period of time.” ECB tightening expectations are little changed. WIRP suggests a 50 bp hike February 2 is fully priced in, followed by nearly 75% odds of another 50 bp hike March 16. A 25 bp hike May 4 is nearly priced in, while a last 25 bp hike in Q3 is about 60% priced in that would see the deposit rate peak near 3.5%. For now, the hawks have the upper hand. However, if inflation continues to slow, we think the expected peak rate is likely to move back down to 3.25% as it did last week and perhaps even down to 3.0%, which is where it stood back in mid-December. January CPI data for the eurozone will be reported next week.

The U.K. CBI January distributive trades survey was very weak. Total reported sales came in at -22 vs. -5 in December, while retailing reported sales came in at -23 vs. 11 in December. The survey bodes ill for retail sales as 2023 gets under way. Yet BOE tightening expectations remain steady. WIRP suggest nearly 80% odds of a 50 bp hike February 2, while a 25 bp hike March 23 is now priced in rather than 50 bp previously. After that, a final 25 bp hike is priced in that would see the bank rate peak near 4.5%. Former BOE Chief Economist Haldane hopes that BOE tightening will slow now that inflation appears to have peaked.

South African Reserve Bank is expected to hike rates 50 bp to 7.5%. However, nearly a quarter of the analysts polled by Bloomberg look for a smaller 25 bp move. At the last meeting November 24, the bank hiked rates 75 bp for the third straight time to 7.0%. The vote was 3-2, with the dissents in favor of a smaller 50 bp move. Its model saw the policy rate at 6.55% at end-2023 vs. 6.36% previously, at 6.71% at end-2024 vs. 6.76% previously, and 6.83% by end-2025 in a new forecast. Of note, the swaps market sees the policy rate peaking at 7.25% but much will depend on whether inflation continues to fall in 2023. Ahead of the decision, December PPI came in at 13.5% y/y vs. 13.9% expected and 15.0% in November.


A major bond index is removing JGBs due to liquidity issues. FTSE Russell said that JGBs maturing March 2032 and March 2024 are being removed from its World Government Bond Index. It added that JGBs maturing September 2032 and June 2032 will be removed next month. They are being removed because in order to be eligible for inclusion in the index, bonds must have a minimum outstanding amount of JPY500 bln ($3.8 bln) excluding central bank holdings. That minimum amount is lower (JPY450 bln) for tenors over 20 years. Of note, BOJ ownership of total JGBs outstanding hit 50% in September and is holding 100% of certain tranches.

In its annual Article IV consultation, the IMF said the Bank of Japan should consider more flexibility in long-term yields. This is due to rising inflation, which means the bank will likely need more room for maneuver. The agency said it is making the recommendations amid “exceptionally high uncertainty” regarding inflation risks that are tilted to the upside. It warned that “The policy challenge in the near term is to ensure that the 2% inflation target is reached durably, without overshooting significantly. More flexibility in long-term yields would help to avoid abrupt changes later. This would help better manage inflation risks and also help address the side-effects of prolonged easing.” The IMF said options include raising its 10-year yield target, widening the trading band for the yield, switching back to a quantitative target for bond-buying, and targeting a shorter-maturity yield instead. Lastly, it highlighted the challenges that the BOJ will face in any of these tweaks. Of note, any recommendations made in Article IV consultations are not binding but do provide a window into how the IMF views it various member policies.

The IMF clearly does not believe that the current YCC regime is sustainable as inflation tops 4%. We concur, and look for YCC to be abandoned at either the March or April meetings if price pressures continue rising. WIRP suggests 20% odds of liftoff at the next meeting March 9-10, rising to nearly 45% for the April 27-28 meeting and nearly priced in for the June 15-16 meeting. If markets resume testing the BOJ’s commitment to YCC, we still think it’s quite possible that it abandons YCC at the March meeting in order to set up liftoff at the April or June meetings. Tokyo CPI data for January are out tomorrow, with core expected to post another cycle high near 4.2% y/y. The BOJ is falling further and further behind the curve.

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