Dollar Gets Some Traction Ahead of Core PCE Data

December 23, 2021
  • November core PCE is the key data point this week; weekly jobless claims will be of interest; Canada reports October GDP; BOC tightening expectations remain elevated; Mexico reported lower than expected mid-December CPI
  • Italy December consumer and manufacturing confidence readings came in mixed; 10-year Italy-Germany spread is the widest in over a year; Hungary hiked the 1-week deposit rate 20 bp to 3.80%
  • Australia is facing sharply higher virus numbers; the February 1 RBA meeting is very much in play as a result; reports suggest China will work to keep the yuan “basically stable,” as part of its policy support for its imports and exports

The dollar is getting some traction ahead of core PCE data. DXY is up modestly after three straight down days and is trading near 96.15. The 96 area continues to provide solid support. The euro continues to struggle above $1.13, while sterling is trading back above $1.34 as markets continue to gain confidence in another BOE hike in February. USD/JPY is trading at the highest level since November 26 near 114.40 as risk on sentiment solidifies its hold. We are likely in a consolidative period for now given the lack of any major new drivers. Looking ahead to an eventful January, we believe the underlying trend for a stronger dollar remains intact. U.S. rates are already moving back in the dollar’s favor and we expect that to continue.


November core PCE is the key data point this week. Consensus sees 4.5% y/y vs. 4.1% in October. If so, it would be the highest since March 1989 and further above the Fed’s 2% target. The Fed’s updated core PCE forecasts saw 2021 revised up to 4.4% from 3.7% and 2022 revised up to 2.7% from 2.3%. 2023 was revised up a tick to 2.3% while 2024 was kept steady at 2.1%. We note again that a terminal Fed Funds rate of 1.5% and core PCE at 2% would result in a negative real policy rate at the end of a tightening cycle, which is highly unlikely. Personal income and spending will be reported at the same time, with the former expected at 0.4% m/m and the latter at 0.6% m/m.

Weekly jobless claims will be of interest. That is because the initial claims data are for the BLS survey week containing the 12th of the month. Continuing claims are reported with a 1-week lag and so next week’s reading will be for the survey week. Initial claims are expected at 205k vs. 206k the previous week, while continuing claims are expected at 1.835 mln vs. 1.845 mln the previous week. Both readings would support the view that the labor market continues to heal. Current consensus for December NFP is 435k vs. 210k in November, while the unemployment rate is seen falling a tick to 4.1%. Of note, the Fed’s updated unemployment rate forecasts saw 2021 revised down to 4.3% from 4.8% and 2022 revised down to 3.5% from 3.8%. Both 2023 and 2024 were kept steady at 3.5%.November durable goods orders (2.0% m/m expected), new home sales (3.4% m/m expected), and final December University of Michigan consumer sentiment will also be reported.

Canada reports October GDP. It is expected at 0.8% m/m vs. 0.1% in September. While this is old news, the economic data have been coming in strong in November as well. While the Bank of Canada maintained its forward guidance at this month’s meeting, updated forecasts will come at the next meeting January 26. 2024 will be added to the forecast horizon and will be an important part of its forward guidance.

Bank of Canada tightening expectations remain elevated. WIRP suggests around 55% odds of a hike next month, which seems way too high. Looking ahead, a hike is almost fully priced in for the March 2 meeting. Five hikes in total are nearly fully priced in for 2022, which is consistent with swaps market pricing for an end-2022 rate of 1.5%. Another two hikes are priced in for 2023 that would take the policy rate up to 2.0%. Similar to the Fed, this would imply a real policy rate close to zero at the end of a tightening cycle, assuming inflation returns to target. Since this seems very unlikely, we think the risks are tilted toward a higher terminal policy rate than 2%.

Mexico reported lower than expected mid-December CPI. Headline inflation came in at 7.45% y/y vs. 7.70% expected and 7.05% in mid-November. It was still the highest since January 2001 and further above the 2-4% target range and so authorities must remain on high alert. Last week, Banco de Mexico delivered a hawkish surprise with a 50 bp hike to 5.50%. The vote was 4-1, with the dissent in favor of a smaller 25 bp move. Next policy meeting is February 10 and another 50 bp hike to 6.0% seems likely if price pressures remain high. Swaps market sees the policy rate peaking at 7.50% by end-2022 before falling slightly in 2023. This may understate Banxico’s need to tighten.


Italy December consumer and manufacturing confidence readings came in mixed. The former rose to 117.7 vs. 116.3 expected and 117.5 in November, while the latter fell to 115.2 vs. 115.3 expected and a revised 115.9 (was 116.0) in November. German readings earlier this week were broadly weaker, while the eurozone reading fell to -8.3 from -6.8 in November. The spread of omicron is already having an impact on the eurozone PMI readings and so we expect ongoing deterioration in the consumer surveys as well. Germany in particular is dangerously close to tipping into recession.

The 10-year Italy-Germany spread is the widest in over a year. This signals concern not just about Italy, but about the ECB’s plans to taper in 2022. Earlier this year, Madame Lagarde was forced to walk back her comment that the ECB was “not here to close spreads.” While that is not the primary aim of its QE policy, it is certainly a secondary one. ECB policymakers can’t be happy with the widening of peripheral spreads since September. At 138 bp currently, the 10-year Italy-Germany spread is the highest since November 2020 and compares to the 98 bp trough in September. In the early days of the pandemic, this spread jumped as high as 279 bp before falling after the ECB’s PEPP began. We do fear that the ECB tapered too much too quickly and may regret doing so in the coming months.

National Bank of Hungary hiked the 1-week deposit rate 20 bp to 3.80%. It was expected to hike 10 bp and was the sixth straight weakly increase to go along with six straight monthly hikes in the benchmark rate to 2.40% currently. Next policy meeting is January 25 and another hike in the benchmark rate is expected. Until then, the bank is likely to continue using its 1-week tenders to help tighten monetary conditions. Yesterday, policymakers announced that beginning in January, residential mortgage rates would be fixed for six months at the levels prevailing in October. Obviously, this was not good for local banks but Orban has his eyes on the spring elections and populist policy moves are to be expected. The move suggests the government is trying to limit the fallout as the central bank continues to hike rates to fight inflation. Orban knows that high inflation will erode his popular support but doesn't want the tightening cycle to hurt pocketbooks too much via higher floating rate mortgage payments.


Australia is facing sharply higher virus numbers. No lockdowns have been announced but the two most populous states are bringing back mask mandates. In New South Wales, there will also be limits on the number of guests in bars and restaurants starting December 27. While the early reports suggest omicron is less deadly, it is also much more infectious and can still overload healthcare systems around the world. Still, it’s early yet and so the Australian authorities are taking a prudent approach until more is known.

The February 1 RBA meeting is very much in play as a result. Many were getting more confident that the RBA would end QE altogether then, but if omicron disrupts the economy, then we lean toward a taper followed by another review at the May 3 meeting. Market pricing for RBA tightening remains elevated, with swaps market looking for 75 bp over the course of 2022. This strikes us as too aggressive, especially in light of the local spread of the omicron variant.

Reports suggest China will work to keep the yuan “basically stable,” as part of its policy support for its imports and exports. State-owned Xinhua News Agency cited a State Council meeting chaired by Premier Li as the source. Of note, policy support for trade will also include an accelerated export tax rebates process as well as greater support for smaller importers and exporters from China’s financial institutions. Of course, this codifies what markets already knew. That is, policymakers are now singularly focused on supporting the economy. We have already seen several rounds of monetary easing, as well as ongoing efforts by the PBOC to limit yuan strength. In that regard, we expect ongoing EM FX weakness to drag the yuan lower as well. Despite having an often heavy hand in the currency market, the PBOC has introduced a great role for market forces in determining the yuan exchange rate.

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