Dollar Firm as U.S. Yields Steady

December 05, 2023

Win Thin

U.S. yields may have bottomed, at least for now; the yield story has helped the dollar recover against the euro; November ISM services PMI will be the highlight; October JOLTS data will be closely watched; Canada reports November PMI readings
The ECB hawks have thrown in the towel; ECB reported steady October inflation expectations; final eurozone and U.K. November services and composite PMIs came in firm; November eurozone IP data started rolling out
Japan reported soft November Tokyo CPI; final Japan and Australia November services and composite PMIs were soft; RBA kept rates steady at 4.35%, as expected; Caixin reported firm November services and composite PMIs; Moody’s cut its outlook on China’s A1 rating from stable to negative

The dollar is getting some traction as U.S. yields rise. DXY is trading higher for the second straight day near 103.756. The euro is leading this move lower in the foreign currencies (see below) and is trading lower near $1.0820 while sterling is trading lower near $1.2620. USD/JPY remains heavy and is trading lower near 147. The pair remains on track to test the September 1 low near 144.45. AUD is the worst performing major after the RBA’s dovish hold (see below). At this point, it will likely take a string of firm U.S. data to truly challenge the current dovish Fed narrative. We continue to stress that the U.S. economy continues to grow at or above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed will not be able to cut rates as soon and by as much as the markets think. That said, the dollar remains vulnerable until we see a shift in market expectations for the Fed and that may be a 2024 story.

AMERICA

U.S. yields may have bottomed, at least for now. The 10-year yield traded as low as 4.20% Friday and is now trading near 4.25%, while the 30-year yield traded as low as 4.39% Friday and is now trading near that now. The 2-year yield has seen the biggest recovery, trading near 4.54% Friday but trading near 4.63% now. Yet Fed easing expectation remain in play. WIRP suggests no change this month but after that it’s all about the cuts. There are 15% odds of a cut January 31, rising to nearly 70% March 20 and fully priced in for May 1 vs. June 12 at the start of last week. Five cuts are fully priced in by end-2024. Needless to say, this isn’t happening.

The yield story has helped the dollar recover against the euro. Due in large part to falling eurozone inflation and dovish ECB comments (see below), the 2-year U.S. differential with Germany has risen to nearly 200 bp, the highest since early November. No wonder the euro has led this move lower in the foreign currencies. It peaked November 29 at around $1.1015 and then promptly sank as lower than expected eurozone CPI data started rolling out. It has now retraced over a third of its November rally and NOK has traded in a similar pattern. GBP also peaked November 29 but has only retraced about 25% of its November rally and SEK has traded in a similar pattern. JPY, CHF, and the dollar bloc all peaked yesterday and have some catching up to do. Of note, AUD is underperforming today after the RBA’s dovish hold (see below).

November ISM services PMI will be the highlight. Headline is expected at 52.3 vs. 51.8 in October. Keep an eye on employment and prices paid, which stood at 50.2 and 58.6 in October, respectively. Last week, ISM manufacturing PMI came in a weaker than expected at 46.7 but prices paid rose to 49.9, the highest since April. Now that supply chain issues have largely been resolved, we can only surmise that rising price pressures now are largely demand driven.

October JOLTS data will be closely watched. Job openings are expected at 9.300 mln vs. 9.553 mln in October. Quits, layoffs, and hires have all steadied in recent months but all three should also be watched for any changes that might signal a softer labor market. JOLTS data will be followed by ADP tomorrow (130k expected) and NFP Friday (189k expected).

Canada reports November PMI readings. S&P Global services and composite PMIs will be reported today, and Ivey PMI will be reported tomorrow. Bank of Canada also meets tomorrow and is expected to keep rates steady at 5.0%. At the last meeting October 25, the bank delivered a dovish hold and since then, the data have come in mostly softer. WIRP suggests nearly 25% odds of a rate cut January 24, then rising to 65% March 6 and fully priced in for April 10 vs. June 5 at the start of last week. Four cuts are priced in by the end of next October and this seems very unlikely.

EUROPE/MIDDLE EAST/AFRICA

The ECB hawks have thrown in the towel. Leading hawk Schnabel said “The November flash release was a very pleasant surprise. Most importantly, underlying inflation, which has proven more stubborn, is now also falling more quickly than we had expected. This is quite remarkable. All in all, inflation developments have been encouraging.” She added that “The most recent inflation number has made a further rate increase rather unlikely” but would not give any forward guidance about potential easing, stressing “We have to see what’s going to happen. We have been surprised many times in both directions. So, we should be careful in making statements about something that is going to happen in six months’ time.” WIRP suggests 5% odds of a cut December 14, rising to 15% January 25, 85% March 7 and fully priced in for April 11 vs. June 6 at the start of last week. A fifth cut by the end of next year is now fully priced in. October PPI was also reported cane came in a tick lower than expected at -9.4% y/y vs. -12.4% in September.

The ECB reported steady October inflation expectations. 1-year expectations remained steady at 4.0% vs. 3.8% expected while 3-year expectations remained steady at 2.5%. Both measures have been picking up in recent months. The ECB will not be happy with either of these measures settling in above its 2% target, but any hawkish comments are likely to be ignored as easing expectations have picked up.

Final eurozone November services and composite PMIs came in firm. Headline services rose to 48.7 vs. 48.2 preliminary, while the composite rose to 47.6 vs. 47.1 preliminary. Looking at the country breakdown, Germany rose to 47.8 vs. 47.1 preliminary and France rose to 44.6 vs. 44.5 preliminary. Italy and Spain reported for the first time and their composite PMIs came in at 48.1 and 49.8, respectively. Of note, this was the first reading for Spain below 50 since August and so the four biggest eurozone economies are in contractionary territory.

November eurozone IP data started rolling out. France came in at -0.3% m/m vs. 0.2% expected and a revised -0.6% (was -0.5%) in September, while Spain came in as expected at -0.5% m/m vs. 1.1% in September. Their WDA y/y rates came in at 1.8% and -1.5%, respectively. Italy and Germany report Thursday and are expected at -1.4% y/y and -3.0% y/y, respectively. Eurozone IP won’t be reported until December 13.

The U.K. reported firm final November services and composite PMIs. Services rose to 50.9 vs. 50.5 preliminary, while the composite rose to 50.7 vs. 50.1 preliminary. This was the highest composite reading since July, but we cannot see how it stays above 50 in the coming months given the building headwinds. Bank of England easing expectations continue to pick up. WIRP suggests no odds of a hike December 14, rising modestly to top out near 10% February 1. After that, rate cuts are priced in with the first one nearly 90% priced in for June 20 vs. fully priced in for September 19 at the start of last week.

ASIA

Japan reported soft November Tokyo CPI. Headline came in at 2.6% y/y vs. 3.0% expected and 3.2% in October, while core (ex-fresh food) came in at 2.3% y/y vs. 2.4% expected and 2.7% in October. Core ex-energy came in at 3.6% y/y vs. 3.7% expected and 3.8% in October. Core was the lowest since July 2022 and suggests that the national reading will also ease from 2.9% y/y in October. Bank of Japan liftoff expectations continue to get pushed out. At the end of September, the market was pricing in liftoff in March; by early November, it was seen in April and now liftoff is seen in June.

Final Japan November services and composite PMIs were soft. Services came in at 50.8 vs. 51.7 preliminary while the composite came in at 49.6 vs. 50.0 preliminary. This was the first reading below 50 since December 2022 and was the lowest since November 2022 and suggests that the soft patch in Q3 is extending into Q4.

Reserve Bank of Australia kept rates steady at 4.35%, as expected. Governor Bullock said “Higher interest rates are working to establish a more sustainable balance between aggregate supply and demand. Holding the cash rate steady at this meeting will allow time to assess the impact of the increases in interest rates on demand, inflation and the labor market.” She added that “The limited information received on the domestic economy since the November meeting has been broadly in line with expectations.” This was taken by the markets as rather dovish and so AUD has been sold after the decision. WIRP suggests only 5% odds of a hike February 6 vs. 20% at the start of the week, rising modestly to top out near 10% March 19 vs. 25% at the start of this week. The first rate cut is about 50% priced in for September, 70% for November, and fully priced in for December.

Final Australia November services and composite PMIs were soft. Services came in at 46.0 vs. 46.3 preliminary, while the composite came in at 46.2 vs. 46.4 preliminary. The composite reading was the lowest since August 2021, suggesting little positive impact from China.

Caixin reported firm November services and composite PMIs. Services came in at 51.5 vs. 50.5 expected and 50.4 in October, while the composite came in at 51.6 vs. 50.0 in October. This was the highest composite reading since August but does not line up with the official reading, which fell to 50.4 in November and was the lowest since December 2022. The Caixin reading tends to focus on smaller, export-oriented firms but this improvement does not really seem justified given the weak global outlook.

Moody’s cut its outlook on China’s A1 rating from stable to negative. It warned that government efforts to support the property sector will have a fiscal impact, noting “Considering the policy challenge posed by local government debt, the central government is focused on preventing financial instability. Still, maintaining financial market stability while avoiding moral hazard and containing fiscal costs of support is very challenging.” We have been expecting downward pressure on the sovereign rating after the PBOC finally acknowledged earlier this year that China’s debt to GDP ratio was approaching 300%. Moody’s last downgraded China’s sovereign rating in 2017 to A1 vs. Aa3 previously due to the rising debt load. The government pushed back on Moody’s decision, saying it was “disappointed” as the economy “will be highly resilient and has large potential.”

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