Dollar Firm as Risk-Off Sentiment Creeps Higher

January 25, 2023
  • Data Down Under support our view that markets continue to underestimate central bank tightening; markets continue to fight the Fed despite what we see as a similar dynamic unfolding here in the U.S.; January survey readings came in better than expected yesterday; BOC is expected to hike rates 25 bp to 4.5%
  • Germany reported January IFO business climate; U.K. reported PPI data for both November and December
  • Japan’s Cabinet Office downgraded its monthly economic assessment in January; Australia December and Q4 CPI data ran hot; New Zealand reported Q4 CPI data; Thailand hiked rates 25 bp to 1.5%, as expected

The dollar is up modestly as a bit of risk off sentiment creeps back into the markets. Tech earnings continue to disappoint and so U.S. equity futures are in the red. DXY is trading higher just above 102. 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 is trading lower near $1.0860 after making a new cycle high Monday near $1.0925, 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 lower near $1.23 after PPI data showed continued disinflation. Sterling is likely to continue underperforming due to the negative fundamental backdrop. Key retracement objectives from this year’s rally come in near $1.2215, $1.2145, and $1.2075. USD/JPY is trading lower near 129.75 as last week’s high near 131.60 remains out of reach for now. China is closed all week for the Lunar New Year holiday. AUD is outperforming after higher than expected CPI data were reported (see below). 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.


Data Down Under support our view that markets continue to underestimate central bank tightening. Both Australia and New Zealand reported higher than expected Q4 CPI data (see below) despite aggressive monetary tightening over the past year. The RBNZ has tightened by 400 bp since it started in October 2021, while the RBA has tightened by 300 bp since it started in May 2022. Both economies remain robust, especially their labor markets. As such, both central banks will most likely have to go higher for longer. And it’s not just the Antipodeans, as Canada and the Scandies are seeing a similar dynamic. Does this all sound familiar?

Markets continue to fight the Fed despite what we see as a similar dynamic unfolding here in the U.S. Yes, inflation measures have eased but the labor market remains red hot. Consensus sees 175k for January NFP. While down from 223k in December, hiring remains firm. 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 35% 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. Market pricing should eventually come around to our view. Until this Fed narrative changes, however, the dollar is likely to remain vulnerable.

January survey readings came in better than expected yesterday. S&P Global reported preliminary January PMI readings. Manufacturing PMI came in at 46.8 vs. 46.0 expected and 46.2 in December, services PMI came in at 46.6 vs. 45.0 expected and 44.7 in December, and the composite PMI came in at 46.6 vs. 46.4 expected and 45.0 in December. This suggests some upward potential for ISM PMI readings out next week. Elsewhere, the Richmond Fed manufacturing index came in at -11 vs. -5 expected and 1 in December, while the Philly Fed non-manufacturing index came in at -6.5 vs. a revised -12.8 (was -17.1) in December. Kansas City Fed manufacturing index will be reported tomorrow and is expected at -7 vs. -9 in December, followed by its services index Friday. There are no major U.S. data releases today.

Bank of Canada is expected to hike rates 25 bp to 4.5%. A few analysts polled by Bloomberg see steady rates. Headline inflation continues to decelerate while core continues to accelerate, making the central bank’s decision a bit more difficult. The labor market remained red hot in December, as 100k jobs created (mostly full-time) helped push the unemployment rate down to 5.0%, just a tick above the cycle low from this past summer. WIRP suggests very low odds of a follow-up 25 bp hike after today. Recent data have come in firm and so we see risks of a peak policy rate that’s higher than the 4.5% that markets are pricing in. As such, we see risks of hawkish forward guidance today that keeps the door open for further tightening.


Germany reported January IFO business climate. Headline came in a tick lower than expected at 90.2 vs. 88.6 in December. Current assessment came in at 94.1 vs. 94.9 expected and 94.4 in December, while expectations came in at 86.4 vs. 85.3 expected and 83.2 in December. Last week, Chancellor Scholz said he’s sure that Germany will avoid recession this year, buoyed by improved sentiment readings and a warm winter so far. While the outlook has brightened somewhat, the IFO readings suggest that this is starting to top out and so upside economic risks are likely limited, at least for now.

ECB tightening expectations are little changed. WIRP suggests a 50 bp hike February 2 is almost fully priced in, followed by nearly 70% odds of another 50 bp hike March 16. A 25 bp hike May 4 is about 75% priced in, while a last 25 bp hike in Q3 is about 50% priced in that would see the deposit rate peak near 3.5%. 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. December M3 data will be reported Friday and is expected at 4.6% y/y vs. 4.8% in November.

The U.K. reported PPI data for both November and December. PPI input came in at 16.5% y/y vs. 18.0% in November, while PPI output came in at 14.7% y/y vs. 16.2% in November. Both measures continue to fall from their mid-2022 peaks, adding to the sense that CPI inflation will continue to fall in the coming months. Of note, significant declines were seen in the costs of imported food, chemicals, parts and equipment, and oil.

BOE tightening expectations have steadied. WIRP suggest over 75% 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 25 bp hike in Q2 or Q3 is around 75% priced in that would see the bank rate peak near 4.5%. Last week, Governor Bailey said inflation has peaked and will fall “quite rapidly” in late spring due to largely energy prices and the PPI data support his view. However, market expectations for an easing cycle in H2 are as misguided as ever.


Japan’s Cabinet Office downgraded its monthly economic assessment in January. This was the first time the government has cut the outlook in eleven months. The Cabinet Office said that parts of the economy are showing weakness, which resulted in downgraded views of trade and bankruptcies. However, it stressed that overall, the economy is picking up moderately. Of note, the most recent BOJ forecasts also cut growth forecasts, with slowing growth expected in both FY23 and FY24 from an estimated 1.9% in FY22. Inflation is running red hot but the downside risks to the economy are what is keeping the BOJ reluctant to tighten policy.

Australia December and Q4 CPI data ran hot. Headline inflation came in at 7.8% y/y in Q4 vs. 7.6% expected and 7.3% in Q3, while trimmed mean came in at 6.9% y/y vs. 6.5% expected and 6.1% in Q3. For December alone, headline came in at 8.4% y/y vs. 7.7% expected and 7.3% in November. All these inflation readings are new cycle highs. At the last policy meeting December 6, the Reserve Bank of Australia hiked rates 25 bp to 3.10%. The next policy meeting is February 7 and WIRP suggests over 75% odds of a 25 bp hike, while the swaps market is pricing in a peak policy rate near 3.80%, up from 3.55% at the start of this week. Given that inflation is still rising despite the 300 bp of tightening seen so far, we believe there are upside risks to the expected terminal rate. Updated macro forecasts will come at the February meeting. Q4 PPI will be reported Friday.

New Zealand reported Q4 CPI data. Headline inflation came in steady at 7.2% y/y vs. 7.1% expected, while the RBNZ’s preferred measure of core inflation came in at 5.8% y/y vs. 5.6% in Q3. Headline remains near the 7.3% peak in Q2 2022 and still well above the 1-3% target range. At the last policy meeting November 23, the RBNZ hiked rates 75 bp to 4.25% and signaled further tightening ahead. Updated forecasts were released and showed an upward shift in the expected rate path to 5.5% this year, up sharply from 4.1% previously. Next policy meeting is February 22 and a 50 bp hike is fully priced in, with nearly 40% odds of a larger 75 bp move. New forecasts will be released then. The swaps market is pricing in a peak policy rate between 5.25-5.5%, which is close to the bank’s expected rate path.

Bank of Thailand hiked rates 25 bp to 1.5%, as expected. The bank sounded hawkish, noting “There is a risk that core inflation would remain high for longer than expected owing to a potential increase in pass-through given elevated costs. Risks of rising demand-side inflationary pressures must be monitored.” We note that core inflation came in at 3.23% y/y in December, the highest since July 2008. Assistant Governor Piti later said “The economy is taking off so it’s still appropriate to raise the rate for a while. But how far we will go is the key task for the following meetings.” He added that currency fluctuations won’t influence monetary policy for now and that there’s no need for any extraordinary measure on the baht. The swaps market is pricing in a policy rate near 1.75% over the next 12 months, rising to near 2.25% over the subsequent 24 months. This rate path seems too gradual given the bank’s tone and so we look for some upward repricing in the coming weeks.

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