Dollar Firm as U.S. Yields Push Higher

February 06, 2024

Win Thin

U.S. yields are rising from the double whammy of a hawkish Fed and strong data; Fed officials should continue to mirror Chair Powell’s cautious tone; January ISM services PMI ran hot; Fed’s SLOOS was released; Canada highlight will be January Ivey PMI
ECB reported December inflation expectations; eurozone December retail sales were reported; Germany reported some rare good economic data
Japan reported soft December cash earnings and household spending data; RBA delivered a hawkish hold; Governor Bullock leaned against expectations of an imminent dovish pivot; Australia reported Q4 real retail sales; Thai government continues to jawbone the BOT

The dollar rally continues as U.S. yields rise. DXY is trading higher for the third straight day near 104.500. Break above 104.632 is needed to set up a test of the November 1 high near 107.113. The euro is trading lower near $1.0740 and testing the December 8 low near $1.0725. Break below sets up a test of the November 1 low near $1.0515. Sterling is trading higher near $1.2555 but remains on track to test the December lows near $1.25. USD/JPY tested the January high near 148.80 but has since fallen back to trading flat near 148.70. When all is said and done, developments of the past week support our view that the Fed is unlikely to cut rates anytime soon. Recent data have mostly come in on the firm side and so we continue to believe that the current market easing expectations for the Fed still need to adjust significantly. These expectations have started to shift but more needs to be seen, even after the Fed’s hawkish hold and January jobs data.

AMERICAS

U.S. yields are rising from the double whammy of a hawkish Fed and strong U.S. data. The 2-year yield is trading near 4.45%, up from the 4.13% low from last week. Elsewhere, the 10-year yield is trading near 4.15%, up from the 3.81% low from last week, while the 30-year yield is trading near 4.34%, up from the 4.06% low from last week. Odds of a March cut have fallen close to 15% after being fully priced in at the start of 2024. A May cut is no longer seen as a sure thing either, with odds falling to around 75%. A total 125 bp of easing is still priced in for 2024, however. While the repricing process has begun, there is a long way to go.

Fed officials should continue to mirror Chair Powell’s cautious tone. Kashkari wrote in an online essay that “The current stance of monetary policy may not be as tight as we would have assumed.” He noted that “It is possible, at least during the post-pandemic recovery period, that the policy stance that represents neutral has increased. It gives the FOMC time to assess upcoming economic data before starting to lower the federal funds rate, with less risk that too-tight policy is going to derail the economic recovery.” Bostic didn’t comment on policy, but he did note that the Fed’s estimates for full employment have fallen. Going against the grain, noted dove Goolsbee wouldn’t rule out a cut in March and stressed that “We’ve had seven months of really quite good inflation reports, right around or even below the Fed’s target. So if we just keep getting more data like what we have gotten, I believe that we should well be on the path to normalization.” Mester, Kashkari, Collins, and Harker all speak today.

January ISM services PMI ran hot. Headline came in at 53.4 vs. 52.0 expected and 50.5 in December. This was the highest since September and the details were very strong as well. Employment rose to 50.5 vs. 43.8 in December while activity was steady at 55.8. Of note, prices paid rose to 64.0 vs. 56.7 in December. This was the highest since February 2022 and mirrors the rise in ISM manufacturing prices paid to 52.9, the highest since April 2022. Both support our concerns that inflation is likely to prove stickier than markets expect.

The Fed’s Senior Loan Officer Opinion Survey (SLOOS) was released. We note that the survey measures credit conditions for Q4 compared to the previous quarter. While 14.5% of the respondents said conditions had tightened for large and medium firms, that's down from a revised 35.6% (was 33.9%) in Q3 and so the pace of credit tightening seems to be slowing. A similar dynamic was seen for small firms and credit cards as well. Demand for credit remains weak but is picking up, as 25% of the respondents reported weaker loan demand from large and medium firms vs. 30.5% in Q3. Digging into the details, the survey showed that a significant net share of other banks (meaning other than large ones) reported tightening loan standards and weaker demand for all types of commercial real estate (CRE) loans. Moreover, a significant net share of banks reported weaker demand for loans secured by nonfarm nonresidential and multifamily residential properties, and a significant net share of banks reported weaker demand for construction and land development loans. Overall, we feel that the risk of a US commercial real estate-led banking crisis is low. As Fed Chair Jay Powell noted, while some smaller and regional banks have concentrated exposures in commercial property loans, the problem is “manageable”, and the Fed is doing a lot to manage it.

Canada highlight will be January Ivey PMI. Yesterday, January S&P Global services and composite PMIs came in firmer at 45.8 and 46.3, respectively. Both were up more than a full point from December. December building permits will also be reported today. Bank of Canada Governor Macklem gives a speech titled “The effectiveness and the limitations of monetary policy.”

Brazil central bank minutes will be released. At last week’s COPOM meeting, the bank cut rates 50 bp to 11.25% and said that pace would be maintained for the next several meetings. The swaps market is pricing in 175 bp of easing over the next 12 months that would see the policy rate bottom at 9.5%. January IPCA inflation will be reported Thursday, with headline expected at 4.42% y/y vs. 4.62% in December. If so, it would be the fourth straight deceleration to the lowest since July and within the new 1.5-4.5% target range for this year.

EUROPE/MIDDLE EAST/AFRICA

ECB reported December inflation expectations. Median 1-year inflation expectations fell to 3.2% from a revised 3.5% (was 3.2%) in November. This matches the February 2022 low. However, 3-year expectations increased slightly to 2.5% from a revised 2.4% (was 2.2%) in November. Both the 1- and 3-year measures had been falling steadily in recent months and this should continue. If so, this should give the ECB confidence to start the easing cycle. Odds of an April cut have fallen to around 65% after being fully priced in at the start of last week.

Eurozone December retail sales were reported. Sales came in a tick lower than expected at -1.1% m/m vs. a revised 0.3% (was -0.3%) in November, while the y/y rate came in as expected at -0.8% vs. a revised -0.4% (was -1.1%) in November. Household spending in December was sluggish across the major eurozone member countries. German and Spanish retail sales fell m/m by -1.6% and -0.7%, respectively, while French sales rose 0.9% m/m. Italy reports tomorrow.

Germany reported some rare good economic data. December factory orders jumped 8.9% m/m vs. -0.2% expected and a revised 0.0% (was 0.3%) in November. The y/y rate improved to 2.7% vs. -5.3% expected and a revised -4.7% (was-4.4%) in November and was the first positive reading since June. Yesterday, trade data came in very weak. IP will be reported tomorrow and is expected at -0.5% m/m vs. -0.7% in November.

ASIA

Japan reported soft December cash earnings and household spending data. Nominal earnings came in at 1.0% y/y vs. 1.4% expected and a revised 0.7% (was 0.2%) in November, while real earnings came in at -1.9% y/y vs. -1.5% expected and a revised -2.5% (was -3.0%) in November. Of note, scheduled cash earnings (less volatile than total cash earnings) rose 1.6% y/y vs. 1.0% in November and matching the May 2023 high. Household spending came in at -2.5% y/y vs. -2.0% expected and -2.9% in November. The Bank of Japan is closely monitoring whether a virtuous cycle between wages and prices will intensify before shifting away from loose policy settings. Wage growth in Japan remains subdued and suggests the BOJ is unlikely to rush into policy normalization.

Reserve Bank of Australia delivered a hawkish hold. It kept rates steady at 4.35%, as expected. However, the RBA did not rule out “a further increase in interest rates.” The Statement on Monetary Policy saw minor tweaks to the macroeconomic projections. The RBA made minor downward adjustments to their inflation forecasts, but they still expect both measures to return under 3% by Q4 2025. The RBA also cut their GDP growth projections across the forecast horizon, primarily reflecting a weaker near-term outlook for consumer spending and dwelling investments.

Governor Bullock leaned against expectations of an imminent dovish pivot in her press conference. Bullock noted that the “job is not done” on inflation, adding that “inflation has a four in front of it, which is too high.” She stressed that “We are not ruling in anything or out anything.” Despite her hawkish message, the market continues to price in 50 bp of rate cuts this year, with the first cut fully priced in August 6. Bullock testifies Friday.

Australia reported Q4 real retail sales. Sales came in at 0.3% q/q vs. 0.1% expected and a revised -0.1% (was 0.2%) in Q3. Household consumption growth is weak and consumer sentiment remains consistent with subdued retail sales activity.

The Thai government continues to jawbone the Bank of Thailand. None other than Prime Minister Thavisin called for a rate cut tomorrow, saying “there is still a lot of policy space” for the bank, adding “Why don’t we start doing it today?” Deputy Finance Minister Amornvivat piled on and said the administration would be “very thankful” if the BOT cut rates. While outright deflation makes a strong case for easing, this sort of interference should be troubling for investors. At the November meeting, the bank said that the current level of rates was appropriate “for supporting long-term sustainable growth” while Assistant Governor Piti said rates are likely to remain steady for a while. The swaps market is pricing in steady rates over the next three months followed by the start of an easing cycle over the subsequent three months with 25 bp of easing.

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