Dollar Gains on Strong U.S. Backdrop

December 10, 2024

Win Thin

NFIB small business optimism surged in November; growth remains solid; New York Fed November inflation expectations picked up; Brazil President Lula is in intensive care after emergency brain surgery; Brazil reports November IPCA inflation
The U.K. and EU will begin formal talks on a reset of their relationship next year; Italy reported soft October IP; Norway November CPI data ran hot
The yen continues to weaken; RBA delivered a dovish hold; China reported soft November trade data

The dollar is getting modest traction. DXY is trading modestly higher for the second straight day near 106.359 ahead of key US inflation data that may provide fresh clues to Fed policy. USD/JPY is trading higher near 151.65 on falling odds of a December BOJ hike (see below). Elsewhere, the euro is trading lower near $1.0535 and sterling is trading slightly higher near $1.2765. AUD is underperforming after the RBA delivered a dovish hold (see below). We look for the dollar rally to continue after this period of consolidation. While the U.S. election results have turbo-charged this dollar move, faithful readers will recall that we have been resolute in our belief that the strong U.S. fundamental story continues to favor higher UST yields and a higher dollar. Last week’s jobs report as well as other key data still to come over the next week or so should confirm our thesis. Market pricing for the Fed has already adjusted, which has given the dollar a huge lift.

AMERICAS

NFIB small business optimism surged in November. Headline came in at 101.7 vs. 95.3 expected and 93.7 in October. This was the highest since June 2021, and was led by a huge jump in the outlook for business conditions component. NFIB Chief Economist Dunkelberg noted that “The election results signal a major shift in economic policy, leading to a surge in optimism among small-business owners. Owners are particularly hopeful for tax and regulation policies that favor strong economic growth as well as relief from inflationary pressures.”

Growth remains solid. The Atlanta Fed GDPNow model still has Q4 growth at 3.3% SAAR and the next update will come next Tuesday after the data. Elsewhere, the New York Fed's Nowcast model is tracking Q4 growth at 1.9% SAAR while its initial estimate for Q1 growth came in at 2.4% SAAR. Both will be updated Friday.

New York Fed November inflation expectations picked up. 1-year expectations picked up a tick to 3.0%, 3-year picked up a tick to 2.6%, and 5-year picked up a tick to 2.9%. Expectations across the spectrum remain well above the 2% target and should keep the Fed in a cautious mood.

The strong U.S. backdrop suggests the Fed should be in no hurry to cut. The Fed still has to digest CPI, PPI, and retail sales before the December 18 FOMC decision. However, it’s clear from Fed comments last week that officials (ex-Goolsbee) are worried about sticky inflation and therefore preparing the markets for a pause. The market is pricing in nearly 90% odds of a cut this month. If the Fed does indeed cut, we are very confident that it will be a hawkish cut that sets up a pause in January and perhaps beyond (depending on the data).

Brazil President Lula is in intensive care after emergency brain surgery. The injury was sustained in an accident at home back in October. The surgery reportedly went well and Lula is recovering and being monitored. There will be a press conference later today for an update on his condition.

Brazil reports November IPCA inflation. Headline is expected at 4.85% y/y vs. 4.76% in October. If so, it would be the third straight month of acceleration to the highest since September 2023 and further above the 1.5-4.5% target range. COPOM then meets Wednesday and is expected to hike rates 75 bp to 12.0%. A few analysts polled by Bloomberg look for a smaller 50 bp hike. Looking ahead, the swaps market is pricing in 450 bp of total tightening over the next 12 months that would see the policy rate peak near 15.75%.

EUROPE/MIDDLE EAST/AFRICA

Yesterday, Chancellor of the Exchequer Reeves confirmed the U.K. and EU will begin formal talks on a reset of their relationship next year. Reeves said she’d be “more ambitious” in strengthening their economic relationship. While there is no plan for the U.K. to rejoin the single market, there is room for greater cooperation with the EU, namely in security and foreign policies. At the margin, this is sterling-positive. In addition, monetary policy divergences between the ECB and BOE still favor a lower EUR/GBP.

Italy reported soft October IP. It came in a tick weaker than expected at -3.6% y/y vs. a revised -3.9% (was -4.0%) in September. The soft data come ahead of the European Central Bank decision Thursday, when it is widely expected to cut rates 25 bp. Eurozone reports October IP Friday and is expected at -2.3% y/y vs. -2.8% in September.

Norway November CPI data ran hot. Headline came in a tick higher than expected at 2.4% y/y vs. 2.6% in October, while underlying CPI came in two ticks higher than expected at 3.0% y/y vs. 2.7% in October. Headline was the lowest since December 2020 and nearing the 2% target but underlying accelerated for the first time since October 2023. Inflation is tracking slightly below the Norges Bank’s forecast, but the bank emphasized at its November 6 meeting that “the policy rate would most likely be kept at 4.5% to the end of 2024.” The first 25 bp rate cut is fully priced in for March, which is in line with the Norges Bank’s policy guidance. Monetary policy divergences between Riksbank and Norges Bank suggests NOK/SEK can edge higher.

ASIA

The yen continues to weaken. USD/JPY trading at the highest since November 28 near 151.80 as BOJ rate hike expectations fade. Odds of a hike next week have fallen to 25% vs. 65% at the start of last week. Some are looking ahead to January for a hike but the market is not fully pricing it in until the May meeting. Until Fed/BOJ expectations shift dramatically, we think USD/JPY has firmly established a near-term range of 150-155.

Reserve Bank of Australia kept rates steady at 4.35%, as expected. However, the bank set the stage for a rate cut in February. First, the RBA scrapped its previous neutral policy guidance that “the Board is not ruling anything in or out.” Second, the RBA noted “the Board is gaining some confidence that inflation is moving sustainably towards target,” adding that “some of the upside risks to inflation appear to have eased.” Previously, the RBA warned of “the need to remain vigilant to upside risks to inflation.” Meanwhile, Governor Bullock was deliberately vague about future monetary policy adjustments. Bullock reiterated the Board did not explicitly discuss either cutting rates or raising rates and declined to lay out a scenario for a February rate cut. Regardless, AUD is vulnerable to more downside as market ramp up bets on a February rate cut. Odds of a move then have risen to nearly 65% vs. 50% before today’s RBA decision.

China reported soft November trade data. Exports came in at 6.7% y/y vs. 8.7% expected and 12.7% in October, while imports came in at -3.9% y/y vs. 0.9% expected and -2.3% in October. Weak imports are a symptom of soft domestic demand, which is disappointing in light of the stimulus measures taken so far.

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