- Higher U.S. rates should continue to support the dollar; Treasury continues its coupon issuance with a $36 bln sale of 10-year notes; Canada is expected to keep policy on hold; Brazil is expected to hike rates 150 bp to 9.25%; headline inflation for Chile came in at 6.7% y/y in November
- Reports suggest imminent announcement of new Covid restrictions in the U.K.; Johnson and his party will continue to suffer a freefall in support; new German Chancellor Scholz was sworn in today; Poland is expected to hike rates 50 bp to 1.75%.
- BOJ may begin removing some pandemic emergency lending programs; Japan October current account data are worth discussing; India kept rates on hold at 4.0%, as expected
The dollar is consolidating its recent gains. After trading as high as 96.592 yesterday, DXY is currently trading near 96.30. The November cycle high near 96.938 remain in sight as 2-year rate differentials continue to move in its favor (see below). The euro is seeing a slight bounce and is currently trading near $1.1275, but we continue to look for a test of the November cycle low near $1.1185. Sterling is underperforming on reports of new U.K. Covid restrictions (see below), breaking below support near $1.32 to trade at the lowest level since December 2020 near $1.3165. With market sentiment improving, USD/JPY has stabilized near 113.65 but remains subject to bouts of risk-off selling. We believe the underlying trend for a stronger dollar remains intact.
Higher U.S. rates should continue to support the dollar. The 2-year yield traded at a new cycle high near 0.70% today, more than recouping last week’s drop. The 2-year differential with Germany has risen to the highest level since March 2020 near 141 bp, while the differential with Japan has also risen to the highest since March 2020 near 81 bp. These moves should widen further and lead to continued euro and yen weakness. Elsewhere, the 2-year U.K.-U.S. differential has fallen further in the dollar’s favor to -28 bp, the lowest since January and presaging further sterling losses.
U.S. Treasury continues its coupon issuance with a $36 bln sale of 10-year notes. At the previous auction, indirect bidders took a whopping 71.0% while the bid-cover ratio was 2.35. Yesterday, the $54 bln sale of 3-year notes was mixed. Indirect bidders took 52.2% vs. 57.6% at the previous auction, while the bid-cover ratio was 2.43 vs. 2.33 at the previous auction. Coupon issuance for the week concludes tomorrow with a $22 bln sale of 30-year bonds. October JOLTS job openings (10.5 mln expected) will be reported.
Bank of Canada is expected to keep policy on hold. Data have been coming in strong lately and so there is a chance that the BOC tweaks its forward guidance again. Offsetting that risk is the uncertainty regarding the impact of omicron. Our gut feeling is that the bank sticks with its current forward guidance that slack will be gone by Q2 but there are risks of a hawkish surprise. New macro forecasts won’t be released until the January meeting, which may provide a better opportunity for the BOC to tilt more hawkish. After last week’s monster jobs number, BOC liftoff expectations have risen. While the odds of a hike today are low, WIRP suggests there's a 3 in 4 chance for a January 26 hike, while March 2 is more than fully priced in followed by two more hikes in Q2. At the last meeting October 26, the bank changed its forward guidance and saw the output gap closing in Q2 22, moving up from H2 22 previously. The swaps market is now pricing in more than 125-150 bp of hikes over the next 12 months, which is very hard to reconcile with the current forward guidance. Yesterday, November Ivey PMI rose to 61.2 vs. 59.3 in October.
Brazil COPOM is expected to hike rates 150 bp to 9.25%. October retail sales will also be reported today and are expected at 0.7% m/m vs. -1.3% in September. November IPCA inflation will be reported Friday, with headline inflation expected at 10.90% y/y vs. 10.67% in October. If so, it would be the highest since November 2003 and further above the 2.25-5.25% target range. Of note, that range falls to 2-5% in 2022. Swaps market sees the policy rate peaking around 12.50% by mid-2022 but then falling to 12.0% by end-2022 and 10.25% by end-2023. The Senate approved a bill that eases fiscal rules for the government, which should allow President Bolsonaro to turn on the fiscal taps ahead of his reelection campaign. That will keep pressure on the central bank to offset with tighter monetary policy.
Headline inflation for Chile came in at 6.7% y/y in November, slightly above expectations. This is the highest level since December 2008 and further above the 2-4% target range. The central bank started the tightening cycle with a 25 bp hike in July and then followed up with a 75 bp hike in August and a 125 bp hike to 2.75% at the last meeting October 13. Minutes showed that hikes of 75 or 150 bp were viewed as “inadequate.” Next policy meeting is December 14 and another large hike of 100-125 bp is expected. Swaps market sees the policy rate at 4.5% in Q1 and peaking at 5.5% by end-2022 before falling in 2023..
Reports suggest imminent announcement of new Covid restrictions in the U.K. Officials stress that no decisions have been made yet. The curbs would be meant to prevent the spread of the omicron variant but would come at a particularly bad time for the economy and for Johnson’s government. Recent data suggest the U.K. economy was already softening before omicron, which has led markets to take back the aggressive BOE tightening expectations. WIRP suggests odds of a hike next Thursday have fallen below 1 in 4, while a February 3 hike is no longer fully priced in. BOE officials have also tiptoed away from the extremely hawkish tone taken in the autumn and all this has led sterling to trade at new lows for this move below $1.32. A clean break sets up a test of the December 2020 low near $1.3135 and then the mid-November 2020 low near $1.3105. After that is the November 2 low near $1.2855.
On the political side, Prime Minister Johnson and his party will continue to suffer a freefall in support. The latest scandal hurting Johnson were revelations that several members of his cabinet threw a Christmas party last December in defiance of existing lockdown rules. Before that, several Tory MPs were implicated in lobbying and ethics scandals. A return to lockdowns will just make things worse for Johnson’s government. Some polls show opposition Labour now leading the Tories in popular support, though we note that a lot can happen between now and the next elections planned for 2024.
New German Chancellor Scholz was sworn in today. The Merkel era draws to a close even as Germany struggles to cope with the pandemic. After serving as Merkel’s Vice Chancellor for the past four years, Scholz will not represent a significant departure from his predecessor’s centrist policies. However, he inherits a very complicated situation both domestically (high inflation, rising virus numbers) and internationally (Russia, energy supply). More importantly, Scholz is tasked with choosing the next Bundesbank chief. There is no doubt that the choice will be suitably hawkish. What needs to be recognized is that the Bundesbank is but one of many eurozone central banks and most of them are in the dovish camp. Guindos, Lagarde, and Schnabel speak today.
National Bank of Poland is expected to hike rates 50 bp to 1.75%. However, the market is split. Of the 32 analysts polled by Bloomberg, 2 see a 25 bp hike, 20 see 50 bp, and 10 see 75 bp. The central bank started the tightening cycle with a 40 bp hike in October then followed up with a 75 bp hike to 1.25% at the last meeting November 3. Minutes to that meeting will be released Friday. With CPI rising 7.7% y/y in November, the bank is clearly behind the curve and in need of a more aggressive tightening cycle. As such, we see risks of a hawkish surprise today. Finance Minister Koscinski warned that recent government measures to soften the impact of higher prices and help the poor may be inflationary. Planned tax cuts would help lower inflation, but increased social transfers will mean more cash in the economy, which will boost inflation. Swaps market sees only 100 bp of tightening over the next 12 months, which seems to understate the case.
The Bank of Japan may begin removing some pandemic emergency lending programs. Deputy Governor Amamiya noted that market conditions for issuing corporate bonds and commercial paper are “extremely favorable” and implies central bank support in those areas may no longer be needed. However, he added that uncertainty about the economic outlook remains high due to the emergence of the omicron variant. Those programs are set to expire in March. While they have already been extended once, it appears that the BOJ, like many others around the world, will start to remove some emergency measures as the recovery continues. That said, the policy meeting next week may be too soon given the still unknown impact of omicron and so we lean towards no end to the lending programs being announced then.
Japan October current account data are worth discussing. The adjusted surplus came in at JPY1.03 trln vs. JPY999 bln expected and JPY763 bln in September. However, the investment flows will be of most interest. October data showed that Japan investors were net buyers of U.S. bonds for the second straight month at JPY282 bln vs. JPY3.77 trln in September, which was the biggest monthly number since March 2020. Japan investors were also net buyers (JPY106 bln) of Australian bonds for the first time after five straight months of being net sellers. Japan investors were small net buyers of Canadian bonds (JPY7 bln) for the second straight month but were big net sellers of Italian bonds (-JPY370 bln), the biggest monthly drop since November 2011. Elsewhere, final Q3 GDP was revised to -0.9% q/q (-3.6% SAAR) from -0.8% (-3.0%) preliminary. Private consumption was revised to -1.3% q/q from -1.1% preliminary, which was partially offset by business spending revised to -2.3% q/q v from -3.8% preliminary. The contributions of inventories and net exports to growth were also revised lower.
The Reserve Bank of India kept the repo on hold at 4.0%, as expected. It was a unanimous vote. The bank will also use 14-day reverse repos to mop up some $100 bln worth of INR liquidity this year. Still, the bank’s near-term priority is on growth and should remain so for now. CPI rose 4.5% y/y in October, near the bottom of the bank’s 2-6% target range, and so signaling little need for an aggressive tightening cycle, especially considering the recent fuel tax cuts. Bloomberg consensus sees the first hike possibly in Q2, followed by another one by end-2022. The impact of the new variant is still unknow, but it skews the risk to the downside. Longer-dated local bond yields were a few basis points lower and the rupee little changed.