Dollar Gains on Hawkish Fed, Sterling Pounded by Split BOE Decision

December 15, 2022

Win Thin

The two-day FOMC meeting ended with a 50 bp hike in the target range to 4.0-4.75%, as expected; as the dust settled, the market eventually focused on the entirety of Powell’s message, which was overwhelmingly hawkish; the Fed narrative finally seems to be moving our way; retail sales data will be the data highlight; we get the first survey readings for December; Mexico is expected to hike rates 50 bp to 10.5%
The ECB is expected to hike rates 50 bp to 2.5%; further details about QT are expected; BOE hiked rates 50 bp to 3.5%, as expected; SNB hiked rates 50 bp to 1.0%, as expected; Norges Bank hiked rates 25 bp to 2.75%, as expected
Japan reported soft November trade data; Australia reported firm November jobs report data; New Zealand reported firm Q3 GDP data; China reported weak November IP and retail sales data; Philippines hiked rates 50 bp to 5.5%, as expected; Taiwan hiked rates 12.5 bp to 1.75%, as expected

The dollar is getting traction as markets digest the FOMC decision. DXY is trading higher near 104.277 after two straight down days. The euro is trading lower near $1.06 ahead of the ECB decision (see below), while sterling is trading lower near $1.23 after the BOE hiked rates with a dovish 6-3 split (see below). USD/JPY is trading higher near 136.65. We continue to believe that the fundamental outlook still favors the dollar. The Fed narrative seems to be shifting our way and yesterday’s FOMC decision is key (see below).

AMERICAS

The two-day FOMC meeting ended with a 50 bp hike in the target range to 4.0-4.75%, as expected. It was a unanimous decision and the Fed noted that ongoing rate hikes are likely appropriate. The press conference was of course key. Chair Powell delivered the hawkish goods, noting that the Fed sees inflation risks to the upside and that a restrictive policy stance will likely be needed for some time. Powell said the labor market remains out of balance and that “we have more work to do.” He stressed that the Fed would need “substantially more evidence of lower inflation” and that the Fed isn’t at a sufficiently restrictive stance yet and still has “some ways to go.” Markets initially seized on Powell’s comment that the Fed is “getting close to sufficiently restrictive rates.” This was taken as a signal that the end of the tightening cycle was near and basically undercut the rest of his message.

As the dust settled, the market eventually focused on the entirety of Powell’s message, which was overwhelmingly hawkish. Looking ahead, WIRP suggests that a 25 bp hike February 1 is fully priced in, with around 30% odds of a larger 50 bp move. A 25 bp hike in March or May is priced in, with 20% odds of one last 25 bp hike in May or June. However, the swaps market is now pricing in a peak policy rate near 5.5%, up from 5.0% at the start of this week.

New forecasts were released. Updated macro forecasts moved closer to market consensus for higher inflation, slower growth, and higher unemployment. We also got a hawkish shift the December Dot Plots. 2023 was moved up to 5.125% from 4.625% in September, as we expected. For 2024, we expected a move up to 4.625% from 3.875% in September but only got 4.125% from the Fed, signaling 100 bp of easing. Similarly, 2025 came in at 3.125% vs. our expected 3.625% but up from 2.875% in September. This represents another 100 bp of easing in 2025 as well.

The Fed narrative finally seems to be moving our way. With both AHE and core PCE flat-lining near 5% for most of this year, we felt that a 5% Fed Funds rate would get inflation back to target, not when the labor market remains so firm and consumption is holding up. Strangely enough, the swaps market continues to price in an easing cycle in H2 2023. This seems highly unlikely and so the mispricing continues despite the strong message from the Fed yesterday.

Retail sales data will be the data highlight. Headline is expected at -0.2% m/m vs. 1.3% in October, while sales ex-autos are expected at 0.1% m/m vs. 1.3% in October. The so-called control group used for GDP calculations is expected at 0.1% m/m vs. 0.7% in October. For now, consumption continues to hold up. Of note, the Atlanta Fed’s GDPNow model is currently tracking 3.2% SAAR growth in Q4, down from the previous estimate of 3.4% SAAR. The next model update will come later today after the data.

We get the first survey readings for December. Regional Fed manufacturing surveys kick off with the Empire and Philly Fed surveys today. Empire is expected at -1.0 vs. 4.5 in November, while Philly Fed is expected at -10.0 vs. -19.4 in November. November IP will also be reported and is expected flat m/m vs. -0.1% in October. S&P Global then reports its preliminary PMI readings tomorrow. Manufacturing is expected at 47.8 vs. 47.7 in November, services is expected at 46.5 vs. 46.2 in November, and the composite is expected at 46.9 vs. 46.4 in November. Of note, the S&P Global readings have been weaker than ISM readings in recent months. Weekly jobless claims, October business inventories, and October TIC data will also be reported.

Banco de Mexico is expected to hike rates 50 bp to 10.5%. At the last policy meeting November 10, the bank hiked rates 75 bp to 10.0%. The vote was 4-1, with Deputy Governor Esquivel voting for a smaller 50 bp move. The bank said that the magnitude of future hikes will be decided the circumstances, suggesting greater data-dependence. Since then, headline inflation came in lower at 7.80% y/y in November, but core continues to accelerate to new highs. The swaps market is pricing in a policy rate peak near 10.75%.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank is expected to hike rates 50 bp to 2.5%. WIRP suggests a 50 bp hike is fully priced in, with only 20% odds of a larger 75 bp move. Elsewhere, the swaps market is still pricing in a peak policy rate near 3.0%, down from 3.5-3.75% after the October decision. New forecasts will be released. Of course, President Lagarde’s press conference will be key and she is likely to signal another hike at the next meeting February 2. That said, we stand by our call that the ECB will pivot and cut rates before the Fed does.

Further details about Quantitative Tightening are expected. The pace and timing are key. President Lagarde favors what she calls a “measured and predictable” approach, which suggests a strategy similar to the Fed that would set monthly ceiling for balance sheet runoff that increases over time. We do not think the ECB is contemplating outright bond sales as it could prove to be too disruptive. In terms of timing, QT starting at the March 16 meeting may prove to be the best bet as updated macro forecasts will be released then. The bank will also have a better idea of how the eurozone economy fared during the risky winter months, when energy prices could again prove disruptive. Ahead of that, the February 2 meeting would provide the ECB with an opportunity to fine tune its policy plans.

The Bank of England hiked rates 50 bp to 3.5%, as expected. However, the 6-3 vote was surprising in that Dhingra and Tenreyro voted to keep rates steady and Mann voted for a larger 75 bp move. Updated macro forecasts won’t come until the February 2 meeting. However, the bank underscored that the economy is in recession while inflation may have peaked. It forecast that the energy support plan will shave Q2 inflation by about 0.75 ppt. The bank added that inflation is likely to remain “very high” in the near-term but falling sharply from mid-2023. WIRP suggests a 50 bp hike February 2 is about 65% priced in, while the swaps market is now pricing in a peak policy rate near 4.5% vs. 4.5-4.75% at the start of this week and down sharply from 6.25% right after the mini-budget in late September.

The Swiss National Bank hiked rates 50 bp to 1.0%, as expected. Governor Jordan said “There is a danger that inflation could remain elevated in Switzerland in the medium term owing to second-round effects. The renewed tightening of our monetary policy is therefore necessary.” He added that “It was pretty clear that 50 bp is the right decision. If you look at our inflation forecasts over the medium term, inflation is still slightly above our 2% threshold.” The macro forecasts were little changed and suggest no urgency to tighten aggressively. Of note, the new 2023 growth forecast came in at 0.5%. The swaps market is pricing in a peak policy rate near 1.75%, up from 1.5% at the start of this week.

Norges Bank hiked rates 25 bp to 2.75%, as expected. The bank noted that the policy rate “will most likely be raised further in the first quarter of next year.” Governor Bache stressed that “The forecasts for the Norwegian economy are more uncertain than normal, but if the economy evolves as anticipated, the policy rate will be around 3% next year.” Updated macro forecasts and expected rate path were released. Of note, the expected rate path still sees the policy rate peaking near 3.0%, with gradual easing expected in H2 24. The swaps market finally caught up with Norges Bank and is now pricing in a peak policy rate near 3.25% vs. 2.5% at the start of this week. November CPI fell to 6.5% y/y from the 7.5% October peak. This is still well above the 2% target and so we believe that the bank’s expected rate path may move closer to the more hawkish market pricing.

ASIA

Japan reported soft November trade data. Exports came in 20.0% y/y vs. 19.7% expected and 25.3% in October, while imports came in at 30.3% y/y vs. 26.9% expected and 53.5% in October. Both continue the slowing trend and confirms other data that show the economy is slowing in Q4, which should keep the Bank of Japan on hold for now. Next policy meeting is December 19-20 and no change is expected then.

Australia reported firm November jobs report data. 64.0k jobs were added vs. 19.0k expected and a revised 43.1k (was 32.2k) in October. The mix was good as the total gain came from 34.2k full-time jobs and 29.8k part-time jobs. The unemployment rate was steady at 3.4%, as expected, as the participation rate rose a couple of ticks to 66.8%. WIRP now suggests 55% odds of a 25 bp hike February 7, up from 45% at the start of this week, while the swaps market is pricing in a peak policy rate near 3.90% vs. 3.65% at the start of this week.

New Zealand reported firm Q3 GDP data. Growth came in at 2.0% q/q vs. 0.9% expected and a revised 1.9% (was 1.7% in Q2), while the y/y rate came in at 6.4% vs. 5.5% expected and a revised 0.3% (was 0.4% in Q2). For now, the robust economy and ongoing price pressures should keep the RBNZ on its tightening path. WIRP suggests a 50 bp hike to 4.75% February 22 is fully priced in, with nearly 75% odds of a larger 75 bp move. The swaps market is pricing in a peak policy rate near 5.5% vs. 5.25-5.5% at the start of this week.

China reported weak November IP and retail sales data. IP came in at 2.2% y/y vs. 3.5% expected and 5.0% in October, while sales came in at -5.9% y/y vs. -4.0% expected and -0.5% in October. The economy continues to suffer from Covid Zero restrictions and even though the recent loosening is welcome, markets remain concerned that a likely spike in infections will reverse those moves. Elsewhere, PBOC sets its key 1-year MLF rate unchanged at 2.75%, as expected. We fully expect more stimulus measures early next year.

Philippine central bank hiked rates 50 bp to 5.5%, as expected. Governor Medalla signaled further tightening ahead, noting that “If I were betting my own money on whether it’s 25 or 50 bp. More likely, it could go either way, it depends on the data but it would be harder for me to bet that this is the last rate hike.” He added that the bank is no longer as concerned about matching the Fed’s moves. The swaps market is pricing in a peak policy rate near 6.0% vs. 5.5% at the start of this week, but this may move even higher if inflation continues to rise. CPI rose 8.0% y/y in November, the highest since November 2008 and well above the 2-4% target range.

Taiwan central bank hiked rates 12.5 bp to 1.75%, as expected. The bank cut its 2022 growth forecast to 2.91% vs. 3.51% previously and cut its 2023 growth forecast to 2.53% vs. 2.9% previously. It also cut its 2022 inflation forecast to 2.93% vs. 2.95% previously but left its 2023 inflation forecast unchanged at 1.88%. Governor Yang said weak exports was the main reason behind slower growth while noting that falling oil and commodity prices have helped lower import prices and inflation generally. He added “We will be careful of the risks of a slowing economy, but our key focus remains on stabilizing the cost of living.” The swaps market is pricing in the possibility of one more hike to 1.8725% next year but much will depend on the global economic outlook, especially China.

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