Dollar Firm as U.S. Rates Rise

December 07, 2021
  • U.S. rates should continue to support the dollar; Treasury begins its slug of coupon issuance for this week with a $54 bln sale of 3-year notes today; Canada reports October trade and November Ivey PMI
  • German data posted a rare upside surprise; the IMF said that the ECB should maintain its loose policy; BOE officials continue to hedge their bets; sterling has faded along with December liftoff expectations; talk of sanctions on Russian banks relating to potential military action in the Ukraine could prove a major headwind for Russian assets; South Africa’s Q3 GDP data disappointed
  • Japan reported soft October real cash earnings and household spending; RBA kept policy on hold, as expected; if the economy continues to recover, we believe the RBA will deliver another round of tapering in February; RBNZ officials remain hawkish; comments from Chinese policymakers continue to reinforce the shift towards accommodation and prioritizing near-term stability

The dollar remains supported by higher short-term rates. DXY is up for the second straight day and is trading near 96.35. A clean break above 96.40 is needed to set up a test of the November cycle high near 96.938. The euro remains heavy and is currently testing the $1.1250 level, with a break setting up a test of the November cycle low near $1.1185. Sterling is edging lower to trade around $1.3250 and is likely to again test support near $1.32. With market sentiment improving, USD/JPY is trading at the highest level since November 30 near 113.75. We believe the underlying trend for a stronger dollar remains intact as the Fed is moving closer and closer to liftoff sooner than markets previously thought.


U.S. rates should continue to support the dollar. The 2-year yield has risen to a new cycle high of 0.66% today, fully recouping last week’s drop. The 2-year differential with Germany has risen to 136 bp, just shy of the late November cycle high near 138 bp, while the differential with Japan has risen to 76 bp, matching the late November cycle high. These moves should continue and would lead to further euro and yen weakness. Elsewhere, the 2-year differential U.K.-U.S. has fallen further in the dollar’s favor to -18 bp, the lowest since June and presaging further sterling losses.

U.S. Treasury begins its slug of coupon issuance for this week with a $54 bln sale of 3-year notes today. At the previous auction, indirect bidders took 57.6% while the bid-cover ratio was 2.33. Issuance continues with a $36 bln sale of 10-year notes tomorrow and a $22 bln sale of 30-year bonds Thursday. Will demand remain strong with yields still at relatively depressed levels? Will foreign investors step up to the plate again? Stay tuned. Q3 nonfarm productivity and unit labor costs, October trade (-$66.8 bln expected), and consumer credit ($25.0 bln expected) will be reported today.

Canada reports October trade and November Ivey PMI. Data come ahead of the Bank of Canada decision tomorrow. After last week’s monster jobs number, BOC liftoff expectations have risen. While the odds of a hike this week are low at around 20%, WIRP suggests a January 26 hike is about 85% price in, while March 2 is more than fully priced in followed by two more hikes in Q2. The bank may again have to acknowledge risks of an earlier liftoff at tomorrow’s meeting. 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 nearly 125 bp of hikes over the next 12 months, which is very hard to reconcile with the current forward guidance.


German data posted a rare upside surprise. October IP rose 2.8% m/m vs. 1.0% expected and a revised -0.5% (was -1.1%) in September. After the -6.9% m/m in October that was reported yesterday, we know weakness in IP is coming and so it’s hard to get excited about today’s reading. Of note, the y/y WDA rate came in at -0.6% vs. -2.9% expected and a revised -0.4% (was -1.0%) in September. Elsewhere, December ZEW survey was mixed, however. Expectations component came in at 29.9 vs. 25.4 expected and in 31.7 November, while the current situation came in at -7.4 vs. 5.7 expected and 12.5 in November.

The IMF said that the ECB should maintain its loose policy. We concur. The agency wrote “With underlying inflation dynamics expected to remain weak over the medium term under the baseline, the ECB should look through transitory inflation pressures and maintain a highly accommodative monetary policy stance.” However, the IMF did acknowledge that risks to inflation are tilted to the upside and that “Upcoming wage negotiations, which are expected to be more frequent than in previous years after many contract renewals were put on hold during the pandemic, will need close monitoring. The ECB should also stand ready to scale down and then terminate asset purchases and TLTROs, followed by a gradual adjustment of policy rates, should high inflation prove to be more durable.”

Bank of England officials continue to hedge their bets. Yesterday, Broadbent said inflation is likely to climb above 5% in 2022, with risks coming from a tight labor market. He acknowledged that omicron is one of many factors to consider, noting an “extremely challenging period” for policymaking. That said, Broadbent declined to say if rate hikes are needed and added that he won’t decide until the meeting. This is a somewhat cautious view from Broadbent that is similar to Saunders’ from last week and suggests a hike next week is unlikely. Odds are about 1 in 4 but rise to nearly 100% for February 3.

Sterling has faded along with December liftoff expectations. Sterling remains heavy and is trading close to the cycle lows from last week near $1.32. A break below would set 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.

Talk of sanctions on Russian banks relating to potential military action in the Ukraine could prove a major headwind for Russian assets. So far, we haven’t seen much impact, with the MOEX index up 0.7% on the day and the ruble marginally stronger. One of the concerns here is that Russia would be cut off from SWIFT, which would probably lead to serious complications for its banking system, especially if coupled with action from European countries. In the medium-term, however, all this will only accelerate the decoupling of the two financial systems and Russia’s push to move away from the dollar as medium of trade and pricing commodities. It would be a very painful process and we are skeptical that the pain is worth any gains that Putin might get from any provocative actions in Ukraine.

South Africa’s Q3 GDP data disappointed. Growth decelerated to 2.9% y/y, well below the 3.8% expected. The -1.5% q/q rate was also weaker than expected and Aon top of this, the Q2 readings were revised slightly lower. We don’t need to repeat the innumerable structural headwinds facing the South African economy, only made more challenging by the new variant. The focus now turns to the government and whether Finance Minister Godongwana and President Ramaphosa can deliver much needed structural reforms within the backdrop of slowing growth and rising interest rates. Color us skeptical.


Japan reported soft October real cash earnings and household spending. Real earnings were expected at -0.5% y/y but instead fell -0.7% vs. -0.6% in September, while spending was expected at -0.5% y/y but instead fell -0.6% vs. -1.9% in September. The economy is showing signs of softness as we move into Q4 and so the big slug of fiscal stimulus that’s coming will be welcomed. For now, the Bank of Japan will remain on hold. Next policy meeting is December 16-17 and no change is expected. However, there is talk that the bank may extend its emergency credit lines until the impact of omicron is better known.

Reserve Bank of Australia kept policy on hold, as expected. Rates were kept steady at 0.10% and QE was maintained at the current weekly pace of AUD4 bln until the planned review at the next meeting February 1. The bank said it is prepared to be patient and won’t hike rates until inflation is sustainably within its target range. The bank said it was likely to take some time to meet the conditions for a rate hike, as inflation pressures are lower in Australia compared to other countries. However, the bank felt that omicron is unlikely to derail the recovery.

If the economy does continue to recover, we believe the RBA will deliver another round of tapering in February. Some are calling for an end to QE altogether then, but this would be too abrupt and would certainly feed into market expectations for liftoff coming sooner rather than later. The swaps market is still pricing in 75 bp of tightening over the next twelve months, which seems too aggressive to us. Updated forecasts will come in February and would have to show a significant upward revisions to the macro outlook from November to justify ending QE entirely then.

RBNZ officials remain hawkish. Assistant Governor Hawkesby said there are risks that the labor market gets tighter, adding that this would fan inflation. He said he was happy that monetary conditions are tightening. RBNZ has delivered two hikes so far and more are on the way. Next meeting isn't until February 23 but according to WIRP, another 25 bp hike is fully priced in, with some chance of 50 bp. 25 bp hikes are fully priced in for April 13, May 25, July 13, August 17, and November 23. That's a total of 150 bp over the next 12 months.

Comments from Chinese policymakers continue to reinforce the shift towards accommodation and prioritizing near-term stability. After yesterday’s 50 bp RRR cut, the PBOC cut the lending rate to SMEs by 25 bp, bring the 1-year rate to 2.0%. The RRR cut alone should unlock some RMB 1.2 trln ($188 bln) of liquidity into the system. We also expect more support for the housing sector as it represents an inordinate proportion of the country’s GDP and household savings. Elsewhere, November exports rose 22.0% y/y vs. 20.3% expected and 27.1% in October and imports rose 31.7% y/y vs. 21.5% expected and 20.6% in October. As a result, the surplus came in at $71.7 bln vs. $83.6 bln expected and $84.5 bln in October. Regional trade data have held up well despite the ongoing supply chain problems. Indeed, Taiwan reported November exports rose 30.2% y/y vs. 22.8% expected and 24.6% in October and imports rose 33.8% y/y vs. 24.5% expected and 37.2% in October.

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