Dollar Gains as Fed Taper Talk Picks Up

June 02, 2021
  • Fed releases its Beige Book report for the upcoming June 15-16 FOMC meeting; add St. Louis Fed President Bullard to the list of Fed officials that are tilting more hawkish; yesterday’s survey data points to ongoing strength in U.S. economy; USD/CAD traded at a new low for this move just above 1.20 yesterday before recovering; Banco de Mexico releases its quarterly inflation report
  • BOE appears increasingly concerned about rising housing prices; Germany reported weak April retail sales; we got more details yesterday of ECB asset purchases for the week ending May 28; TRY fell to a new record low after President Erdogan explicitly called for lower interest rates
  • BOJ board member said the bank is ready to act if Fed tapering triggers any spikes in the yen; OPEC+ maintained its planned hike in its oil output; an Iran nuclear deal is taking longer than expected

The dollar is getting some traction as Fed tapering talk picks up. DXY is trading back above 90, while the euro is trading back below $1.22 and sterling is trading back near $1.41 after making a new high for this cycle near $1.4250 yesterday. The outside down day recorded points to further losses ahead. USD/JPY is trading back near110 and is likely to test last week’s high near 110.20, which was the highest level since April 6. While we believe the fundamental story favors the dollar, there is a lot of ground recover in the coming days. Until we see higher U.S. rates (both real and nominal), the greenback is likely to remain vulnerable to further bouts of selling. The 10-year yield remains stuck around 1.60% currently, while the breakeven inflation rate has edged higher to around 2.47%, pushing the real rate down to around -0.87%.

AMERICAS

The Fed releases its Beige Book report for the upcoming June 15-16 FOMC meeting. Since the last FOMC meeting April 27-28, the data have been mixed. Obviously, the April jobs miss was disappointing,. So was the April retail sales miss. Manufacturing surveys suggest a slight moderation of activity but are still strong overall. All in all, we expect the Beige Book to have an upbeat tone whilst warning of uneven pockets within the economy. It will most likely blame bottlenecks for any price pressures, suggesting the Fed sees inflation remaining transitory. May auto sales will be reported today and are expected to slow slightly to a still-high 17.4 annual rate vs. 18.51 mln in April.

Add St. Louis Fed President Bullard to the list of Fed officials that are tilting more hawkish. Yesterday, he said the labor market may be tighter than it looks and that he is “starting to advocate” for the Fed to look at other indicators, such as the unemployment to job opening ratio. Bullard added that the Fed is close to launching discussions about tapering its QE. For those keeping score at home, we know have Kaplan, Harker, Barkin, Clarida, Quarles, and now Bullard advocating for tapering discussions to start. Recall that in the March 16-17 Dot Plots, four FOMC members saw the first hike in 2022. The June 15-16 Dot Plots will be very interesting, and we suspect that more than four will see the first hike in 2022. Evans, Bostic, and Kaplan speak today.

Yesterday’s survey data points to ongoing strength in U.S. economy. They basically mirrored last week’s blockbuster Markit and Chicago PMI readings. ISM manufacturing PMI rose to 61.2 vs. 61.0 expected and 60.7 in April. New orders rose to 67.0 from 64.3 in April, new export orders rose to 55.4 from 54.9 in April, and prices paid fell to a still-high 88.0 from 89.6 in April. The only weak spot was employment, which fell to 50.9 from 55.1 in April. However, ISM noted that “companies and their supply chains continue to struggle to respond to strong demand due to the difficulty in hiring and retaining direct labor” and so it’s more about labor supply than labor demand. ISM services PMI will be reported Thursday and is expected to rise three ticks to 63.0. Elsewhere, Dallas Fed manufacturing survey came in at 34.9 vs. 36.3 expected and 37.3 in April. 

May jobs data Friday are coming into focus. Consensus currently sees 653k jobs added vs. 266k in April, with the unemployment expected to fall two ticks to 5.9%, a new cycle low. Both initial and continuing claims fell in the BLS survey week containing the 12th of the month, which suggests a solid May NFP number. Ahead of NFP, ADP reports private sector jobs data Thursday that is expected at +650k vs +742k in April. As one can see from last month, the ADP and NFP don’t always line up. However, most are looking for a snapback in NFP from the April miss.

USD/CAD traded at a new low for this move just above 1.20 yesterday before recovering. If it were to break below the May 2015 low near 1.1920, there's really not a lot in terms of chart points until the July 2014 low near 1.0620. That sort of move seems unlikely and would most likely require a broader dollar sell-off that sees the euro rise to its May 2014 high near $1.40 and DXY to fall to its May 2014 low near 78.906. We’re sure there are some dollar bears out there that aren't afraid to make this call but we just don't see the fundamental justification for another 12% move lower in the dollar. Canada reports April building permits today. Overall, the outlook for the Canadian economy remains strong. The Bank of Canada is on hold for now, with fiscal policy taking over this year in terms of stimulus.

Banco de Mexico releases its quarterly inflation report. Last week, minutes from the May 13 meeting showed that policymakers agreed on the need for cautious policy to make sure that inflation moves back to its 3% target. The vote to keep rates steady then was unanimous. Most saw the recent inflation spike as temporary but also saw greater upside inflation risks over the near term. This suggest steady policy for now, as one policymaker warned against any monetary tightening that could jeopardize the economic recovery and called for "an accommodative monetary policy stance for as long as necessary.” Next policy meeting is June 24 and rates are likely to be kept steady at 4.0%. Of note, Bloomberg consensus sees the policy rate at 4.0% until Q4, when the tightening cycle begins.

EUROPE/MIDDLE EAST/AFRICA

The Bank of England appears increasingly concerned about rising housing prices. Deputy Governor Cunliffe, in charge of financial stability, said that “What we’re seeing in the housing market at the moment is being driven mainly by the tax holiday. We’ve seen very fast rises in house prices and transactions before tax holidays in the past. There are some signs that people are making different housing choices that may affect the future.” This follows comments from Deputy Governor Ramsden, who warned that “There is a risk that demand gets ahead of supply and that will lead to a more generalized pick-up in inflationary pressure. That’s something we are absolutely going to guard against. We are looking carefully at the housing market and a raft of real-term indicators.” After the stronger than expected 10.9% y/y gain in housing prices for May reported yesterday, the U.K. today reported higher than expected mortgage approvals of 86.9k for April. Of note, the short sterling futures strip still sees solid odds of a hike in Q1 22 that rise further in Q2 until being fully priced in by Q3 22.

Germany reported weak April retail sales. Sales plunged -5.5% m/m, more than double the -2.5% drop expected and nearly reversing the 7.7% gain in March. Eurozone reports April retail sales Friday and are expected to fall -1.5% m/m vs. a 2.7% gain in March. There are clearly to this number after today’s big miss from Germany. Recent data also support the ECB’s caution about removing stimulus at this juncture. Today, ECB officials Villeroy, Weidmann, and Lagarde all speak.

We got more details yesterday of ECB asset purchases for the week ending May 28. Redemptions were a hefty EUR5.0 bln and so gross purchases were EUR25.0 bln vs. EUR23.7 bln for the week ending May 21. Recall that net purchases were EUR20.0 bln for the week ending May 28 vs. EUR21.7 bln for the week ending May 21. Both net and gross purchases have picked up noticeably over the last few weeks and the accelerated pace will be reviewed at the June 10 meeting. If yields continue to rise, then the current pace is likely to be extended into Q3, which would be a dovish sign. We expect ECB officials to continue sounding dovish this week ahead of next week’s meeting.

The Turkish lira fell to a new record low after President Erdogan explicitly called for lower interest rates. He said “I spoke with our central bank governor today. It’s an imperative that we lower interest rates. For that, we will reach July and August thereabouts so that rates can begin to fall.” He repeated his rather unorthodox view that “If we remove the burden of interest rates from investments and costs, then we will enter a calmer environment because it’s the interest rates that cause cost inflation.” Next central bank meetings are June 17, July 14, and August 12. In this environment, a cut at any of these meetings would invite further lira weakness. After trading as high as 8.80 after the comments, USD/TRY has fallen back to trade near 8.63 currently. Further losses appear likely until the monetary policy regime is unequivocally repaired.

ASIA

Bank of Japan board member Seiji Adachi said the bank is ready to act if Fed tapering triggers any spikes in the yen. He said “I can’t say whether they’ll taper or not. But if they do and the yen strengthens, there’s a chance we will discuss taking action.” This was a somewhat strange comment given that the yen is likely to weaken when the Fed tapers, not strengthen. Yet it underscores how sensitive policymakers are to any premature strengthening of the yen at a time when the domestic economy is reeling from the pandemic. Of note, the BOJ has not intervened in the FX market since 2011, when the country was reeling from a tsunami and the resulting Fukushima nuclear disaster. Back then, USD/JPY was trading below 80 and the pair went on to trade at a record low 75.35 in October of that year.

COMMODITIES AND ALTERNATIVE INVESTMENTS

As expected, OPEC+ maintained its planned hike in its oil output. The group will boost output by 841,000 bbl/day in July and follows hikes in May and June. After July, OPEC+ is scheduled to hold production steady until April 2022, according to the deal struck a year ago. Saudi Energy Minister Prince Abdulaziz bin Salman said “The demand picture has shown clear signs of improvement.” When asked if more output hikes are needed, he said “I will believe it when I see it.” Abdulaziz said he was sticking to the terms of that deal “verbatim.”

Meanwhile, an Iran nuclear deal is taking longer than expected. After various optimistic comments from both sides in recent weeks, Iran said that negotiators now expect to finalize a deal in August. There were hopes that a deal could be struck before Iran’s presidential elections June 18. As current President Rouhani’s term ends, there are concerns that he will be succeeded by a hardliner who will be less open to a nuclear deal. Bottom line is that Iranian oil is unlikely to return to global markets until the fall, meaning high oil prices are likely to remain in place through the summer.

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