Dollar Firm as Fed Repricing Takes Hold

May 17, 2023
  • Some progress appears to have been made in debt ceiling talks yesterday; Fed officials are starting to hint at no pause; April retail sales data were mixed; Canada reported mixed April CPI data
  • ECB officials remain split; BOE Governor Bailey is starting to sound a little more hawkish
  • Japan reported firm Q1 GDP data; yuan weakness continues

The dollar is trading firm as Fed easing bets are pared back. DXY is trading higher for the second straight day near 103. It tested the early April high near 103.058 and a break above sets up a test of the late March high near 103.357 but we have our eyes set on the mid-March high near 105.103. The euro is trading at a new low for this move near $1.0820 and is nearing a test of the April 3 low near $1.0790. After that is the late March low near $1.0715 and a break below that would set up a test of the mid-March low near $1.0515. Sterling is trading slightly lower near $1.2455 after testing the May 2 low near $1.2435. Break below sets up a test of the April 21 low near $1.2365 and then the April 3 low near $1.2275. USD/JPY rally continues and is on track to test the May 2 high near 137.75. After that is the November 30 high just below 140. Banking sector concerns and dovish market pricing for Fed policy have been the two major negative headwinds on the dollar. While regional bank stocks remain vulnerable, recent data suggest low risks of systemic problems and so we believe the dollar has likely put in a near-term bottom. However, we need significant repricing of Fed policy in order to see the next big leg higher for the greenback. That process is finally picking up steam (see below) and is a big part of the dollar strength this week.


Some progress appears to have been made in debt ceiling talks yesterday. Reports suggest talks will now intensify as both sides seek some sort of a framework agreement for review when President Biden returns from his trip to Asia. The trip was shortened due to the time crunch that’s in place, with Australia and Papua New Guinea no longer on the itinerary. We don’t want to get too excited as the two sides reportedly remain far apart. However, we get the sense that there is a real effort to avert a debt ceiling catastrophe as the x-date of June 1 is fast approaching. Stay tuned.

Fed officials are starting to hint at no pause. Barkin said “I do want to learn more about what’s happening with all these lagged effects. But I also want to reduce inflation. And if more increases are what’s necessary to do that I’m comfortable doing that.” Mester said “At this point, based on the data I have so far, given how stubborn inflation has been, I can’t say that I’m at a level of the fed funds rate where it’s equally probable that the next move could be an increase or a decrease.” Bostic said “We haven’t gotten to the hard part yet. We are going to have to be super strong and detached.” As a result, Fed easing expectations are starting to cool off. Two cuts by year-end are now priced in, with odds of a third only around 33% vs. 50% yesterday and 100% at the start of this week. The start of the repricing has been a major factor behind this week’s dollar strength but we still have a long way to go until rate cuts are totally priced out this year.

April retail sales data were mixed. Headline came in weaker than expected at 0.4% m/m, ex-autos came in as expected at 0.4% m/m, and the so-called control group used for GDP calculations came in stronger than expected at 0.7% m/m. The Atlanta Fed’s GDPNow model is currently tracking 2.6% SAAR growth for Q2, down from 2.7% previously and up from the initial 1.7% reading and 1.1% in Q1. Next model update comes later today after the data. Bloomberg consensus currently sees Q2 at 0.1% SAAR and Q3 at -0.6% SAAR.

Housing market data will be reported. April building permits and housing starts are expected flat m/m and -1.4% m/m, respectively. Existing home sales will be reported tomorrow and expected at -3.2% m/m vs. -2.4% in March. Mortgage rates have been creeping higher and is likely to keep downward pressure on this sector.

Canada reported mixed April CPI data. Headline unexpectedly picked up a tick to 4.4% y/y. This was an eye-opener as it was the first acceleration since last June, when it peaked at 8.1% y/y. Core measures eased modestly but common core remains uncomfortably high at 5.7% y/y. While we don't think it changes the BOC's intent to pause, markets are no longer pricing in a cut by year-end and that is the correct read. Of note, WIRP suggests odds of a hike at the next meeting June 7 stand around 35% vs. 10% at the end of last week, rising to nearly 75% for September 6. More importantly, a rate cut by year-end has now been priced out.


ECB officials remain split. De Cos said “We are getting closer to the end in terms of monetary tightening.” Elsewhere, Rehn said “Rate decisions are always based on the latest data, how the core inflation will develop and, on the other hand, how effective the monetary policy is.” WIRP suggests a 25 bp hike is nearly priced in for June 15 and another one about 60% priced in for July 27. Those odds peak near 95% September 14 and so the market still does not believe the hawks that are pushing for three straight hikes. The split between the hawk and the doves clearly remains in place but it feels like the doves have taken control of the narrative, at least for now. Elderson, Centeno, and Guindos also speak today.

BOE Governor Bailey is starting to sound a little more hawkish. Specifically, he said “The easing of labor market tightness is happening at a slower pace than we expected in February, and the labor market remains very tight.” Bailey added that “While we expect CPI inflation to fall quite sharply as energy costs begin to ease, albeit at a somewhat slower pace than projected in February given the near-term outlook for food prices, the outlook for inflation further out is more uncertain and depends on the extent of persistence in wage and price setting.” A 25 bp hike is nearly 75% priced in for June 22 while the odds of another 25 bp hike top out around 55% priced in for September 21. Inflation remains stubbornly high and so the market now sees the terminal rate peaking between 4.75-5.0% vs. 4.75% before last week’s meeting. We see rising risks that the BOE will have to tighten more than what the market is pricing in now but it will all depend on the data. With ECB tightening expectations topping out, this would suggest another leg lower for the EUR/GBP cross.


Japan reported firm Q1 GDP data. Growth is expected at an annualized 1.6% vs. 0.8$% expected and a revised -0.1% (was 0.1%) in Q4, while the q/q rate came in at 0.4% vs. 0.2% expected and 0.0% in Q4. Private consumption came in at 0.6% q/q vs. 0.4% expected and a revised 0.2% (was 0.3%) in Q4, while business spending came in at 0.9% q/q vs. -0.3% expected and a revised -0.7% (was -0.5%) in Q4. Inventories added 0.1 percentage point to growth while next exports subtracted -0.3 percentage points. March data have come in a bit soft and so we believe Q1 ended with slowing momentum, which suggests downside risks to Q2. No wonder the Bank of Japan is staying cautious. Liftoff this year is no longer priced in.

Yuan weakness continues. USD/CNY traded above 7 for the first time since December 2 and is starting to fill the gap created then between 6.9911 and 7.017. When that gap is filled, the pair should continue moving higher. After that gap, the 7.0308 level comes into view, which is the 62% retracement objective of the late November-January drop. Break above that would set up a test of the November 28 high near 7.2408. Yuan weakness continues to be driven by disappointing data, which in turn has fed into heightened PBOC easing expectations.

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