Dollar Flat Ahead of CPI and Beige Book

January 12, 2022

The Fed is sending a clear hawkish signal to the markets; Powell, Mester and George made similarly hawkish comments; Fed Beige Book report will be closely watched; U.S. CPI data will be the main focus
Eurozone reported firm November IP; U.K. Prime Minister Johnson continues to shed support; for now, sterling is shrugging off the political uncertainty
BOJ upgraded its assessment of every region for the first time since October 2013; Japan November current account data will be of interest; China reported some key December data

The dollar is trading flat ahead of CPI and Beige Book. DXY is trading below 96 again but is likely to find some support ahead of the November 30 low near 95.517. The euro continues to edge high but is likely to meet resistance near $1.14. GBP continues to outperform and is trading at new cycle highs near $1.3650. As a result, the EUR/GBP cross is making new lows for this move near .8324. USD/JPY continues to struggle but is seeing some support near the 115 level. We expect the dollar rally to resume but remain disappointed that the more hawkish Fed and higher U.S. yields have not yet translated into larger dollar gains.

AMERICAS

The Fed is sending a clear hawkish signal to the markets. Yesterday, Chair Powell made clear that the FOMC is pretty much united in the view that accommodation needs to be removed quickly this year. He said the balance sheet is “far above where it needs to be” and said runoff will likely commence later in 2022. Powell noted that the economy is close to full employment and so the Fed is trying to get policy to neutral, perhaps even tighten. While Powell did not commit to any timing for liftoff or how many hikes he sees this year, he pretty much kept to the Fed’s new script. While equity markets seemed to cheer Powell’s stance, we need to remember that he does not have magic wand to wave away inflation. Equity markets always seem to be priced for perfection and while we think the Fed is likely to succeed in reining in inflation, it will come at a cost to growth and earnings. The Goldilocks scenario is often just that: a fairy tale.

Ahead of Powell, Mester and George made similarly hawkish comments. Mester said she would support a hike in March if the data remain strong and acknowledged that she penciled in three hikes for this year in the December Dot Plots. Mester also favor letting the balance sheet run down faster than last time. Elsewhere, George said its time to move policy to a “more normal” posture and also favors running down the balance sheet earlier rather than later. Like Powell, George was not as explicit as the others in calling for a March hike, nor does she say how many hikes she sees this year. However, it seems pretty clear that she favors quick removal of accommodation. Both Mester and George are voters in 2022 and joins Bullard (voter), Barkin (non-voter), and Bostic (non-voter) in the hawkish camp. Odds of March liftoff are now nearly 90%, with a fourth hike over 50% priced in now.

The Fed Beige Book report will be closely watched. Given the Fed’s rather quickly executed hawkish tilt, we expect the Beige Book to highlight a tightening labor market and rising price pressures. The previous Beige Book for the December 14-15 meeting noted that nearly all Fed districts reported “robust” wage growth. That report also noted that increases in input cost were widespread across all industries, and that prices are rising at a moderate to robust pace. With the economy moving closer and closer to full employment, we expect this Beige Book to continue focusing on the labor market and wages. Kashkari speaks today.

U.S. CPI data will be the main focus. December headline inflation is expected at 7.0% y/y vs. 6.8% in November, while core (ex-food and energy) is expected at 5.4% y/y vs. 4.9% in November. Both would be new cycle highs. PPI will then be reported tomorrow. Headline is expected at 9.8% y/y vs. 9.6% in November, while core (ex-food and energy) is expected at 8.0% y/y vs. 7.7% in November. Here too, both would be cycle highs and should keep the Fed concerned enough to maintain its accelerated pace of removing accommodation. The December budget statement (-$5.0 bln expected) will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported firm November IP. IP jumped 2.3% m/m vs. 0.2% expected but this was due in large part to a huge downward revision in October to -1.3% from +1.1% previously. Italy (0.4% m/m expected) reports tomorrow. We can’t get too excited about this reading. While the eurozone manufacturing sector appears to be holding up, we know the services sector is softening and dragging the outlook down as we enter 2022.

U.K. Prime Minister Johnson continues to shed support. The latest YouGov survey found 56% said Johnson should resign, while the latest Savanta ComRes poll had that number even higher at 66%. Looking at just Tory voters, those numbers stood at 33% and 42%, respectively. We suspect those numbers will only get worse this spring as households face a significant jump in energy bills as well as payroll taxes. Both are being reviewed by policymakers as the popularity of the government sinks.

For now, sterling is shrugging off the political uncertainty. Instead, markets are focusing on BOE tightening as a key pillar of support for the currency. A hike is nearly 90% priced in for the February 3 meeting, followed by hikes at every other meeting this year that would take the policy rate up to 1.25% by year-end. Quantitative Tightening would also be triggered under this expected rate path. As we’ve seen here in the U.S., this is all supportive for the currency. This week’s price action suggests a test of the October 20 high near $1.3835 is coming up, though it must first break through the 200-day moving average near $1.3735 currently. Longer-term, we must ask whether the U.K. economy can survive such aggressive monetary and fiscal tightening. We believe the U.S. economy is in a much stronger position than the U.K. as the Fed goes into a tightening cycle.

ASIA

The Bank of Japan upgraded its assessment of every region for the first time since October 2013. In the report that is equivalent to the Fed’s Beige Book, the BOJ also revised up its assessment of consumer spending all nine regions for the first since it began issuing the report in 2005. Reports emerged last week that the bank will next week upgrade its long-held view that inflation risks are “skewed to the downside,” a phrase that has been used since October 2014. Today’s news would seem to confirm this. Officials stressed that any shift in the risk assessments aren’t meant to signal any move by the BOJ towards removing accommodation. Indeed, Governor Kuroda said that he expects underlying inflation to pick up only gradually over the long-term after moderate near-term gains caused by higher energy prices.

Japan November current account data will be of interest. An adjusted surplus of JPY1.37 trln was reported vs. JPY1.05 trln expected and JPY1.03 trln in October. However, the investment flows will be of most interest. November data showed that Japan investors were net sellers of U.S. bonds for the first time since August at -JPY459 bln. Japan investors were also net sellers (-JPY33 bln) of Australian bonds and resume the trend seen in six of the past seven months. Japan investors were net buyers of Canadian bonds (JPY166 bln) for the third straight month and also net buyers of Italian bonds (JPY161 bln), the biggest monthly increase since July.

China reported some key December data. CPI came in at 1.5% y/y vs. 1.7% expected and 2.3% in November, while PPI came in at 10.3% y/y vs. 11.3% expected and 12.9% in November. Price pressures continue to ease and so policymakers are likely to continue boosting the economy with further monetary and fiscal stimulus this year. December new loan and money data were also reported. Aggregate financing came in at CNY2.37 trln vs. CNY2.4 trln expected and CNY2.6 trln in November, while new loans came in at CNY1.1 trln vs. CNY1.25 trln expected CNY1.27 trln in November. These numbers should move higher in the coming months.

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