Dollar Gyrates as Fed Starts Talking About Talking About Tapering

May 20, 2021
  • FOMC minutes show that the Fed is now talking about talking about tapering; Kaplan is the only Fed speaker today; the Dot Plots for the June 15-16 FOMC meeting will take on more significance; Fed manufacturing surveys for May will continue to roll out; weekly jobless claims data will be closely watched
  • U.S.-Russia tensions have eased after the Biden administration held off on sanctions related to the Nord Stream 2 pipeline; tensions in the Middle East seem to be easing; South Africa is expected to keep rates steady at 3.5%
  • Japan reported firm April trade and March core machine orders data; Australia reported soft April jobs data; China appears to be getting increasingly concerned about inflation

The dollar got some modest traction after the FOMC minutes but has given up some of those gains already. DXY is modestly lower today and is testing the 90 area. Until we get a larger move in U.S. rates, DXY seems likely to eventually test the January 6 low near 89.209. The euro is back near $1.22 after trading down to $1.2160, while sterling is stabilizing after finding some support near $1.41. USD/JPY remain heavy and is back to testing 109 after a brief spell above. While we view the FOMC minutes as a potential game-changer (see below), we need to see stronger U.S. data and higher U.S. rates for the dollar rally to resume.

AMERICAS

FOMC minutes show that the Fed is now talking about talking about tapering. As our recent Fed piece here argues, the road to tapering will most likely begin with the minutes and the first step has now been taken. From the April 27-28 minutes: "A number of participants suggested that if the economy continued to make rapid progress toward the Committee's goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases." There is a clear shift from the March 16-17 minutes: "A number of participants highlighted the importance of the Committee clearly communicating its assessment of progress toward its longer-run goals well in advance of the time when it could be judged substantial enough to warrant a change in the pace of asset purchases. The timing of such communications would depend on the evolution of the economy and the pace of progress toward the Committee's goals." That said, the recent soft data suggest the Fed is no hurry to take the next step.

The U.S. 10-year yield has taken note and is trading higher near 1.66%. While short of last week's high near 1.70%, it's worth pointing out that the real 10-year yield has risen to -0.82%, the highest since April 30. This is because the 10-year breakeven inflation rate has actually fallen to 2.49%. All of these developments are dollar-positive, but we need larger moves higher in all these rates to really get the dollar rally back on track. To us, the drop in inflation breakeven rates means that the market is acknowledging that the Fed is moving a step closer to removing accommodation and that it better trusts the Fed not to allow runaway inflation. Of course, this sentiment can turn on a dime but that's the story for now, at least.

Kaplan is the only Fed speaker today. Of note, Kaplan remains the most hawkish at the Fed. Last Friday, he again stressed the need to talk about tapering sooner rather than later. We assume that he was one of the “number of participants” that brought up tapering at the FOMC meeting. The bigger question is which of the other Fed officials are now starting to line up with Kaplan. If we had to hazard a guess, one of them is very likely George. Recall that she dissented at every meeting in 2013 in favor of immediate tapering until December, when it was actually announced. Rosengren is the other likely candidate, as he has argued that the housing sector no longer needs support.

The Dot Plots for the June 15-16 FOMC meeting will take on more significance. Recall that the March Dot Plots still showed a median expectation of no rate hikes through 2023. However, there was a notable shift beneath the surface. 14 of 18 members saw no hikes through 2022 and 11 of 18 members saw no hikes through 2023. Back in the December Dot Plots, 16 of 17 members saw no hikes through 2022 and 12 of 17 members saw no hikes through 2023. Christopher Waller became the 18th member of the FOMC when he was confirmed back in January. The Fed Fund Futures strip implies a slightly shorter timeline for the first rate hike. There are significant odds of lift-off seen in Q4 2022 that rises to fully priced in by Q1 2023.

Fed manufacturing surveys for May will continue to roll out. Philly Fed survey is expected at 41.5 vs. 50.2 in April. Empire survey was reported Monday and came in at 24.3 vs. 23.9 expected and. 26.3 in April. Of note, preliminary May Markit PMI readings will be reported Friday. Manufacturing is expected at 60.1 vs. 60.5 in April, while services is expected at 64.4 vs. 64.7 in April. If so, this would pull the composite PMI down slightly from 63.5 in April. These are the first broad snapshots for May and have likely taken on more significance in light of the disappointing jobs and retail sales data for April.

Weekly jobless claims data will be closely watched. Initial claims are for the BLS survey week containing the 12th of the month and are expected at 450k vs. 473k the previous week. Continuing claims are reported with a one-week delay and are expected at 3.63 mln vs. 3.655 mln the previous week. The weekly data continue to show ongoing improvement in the labor market, but the April jobs data serves as a reminder that it’s not all moving in a straight line. April leading index (1.3% m/m expected) will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

U.S.-Russia tensions have eased after the Biden administration held off on sanctions related to the Nord Stream 2 pipeline. That announcement came ahead of a meeting between Secretary of State Blinken and Foreign Minister Lavrov on the sidelines of the Arctic Council summit in Iceland. Blinken said that the U.S. “sought a more stable and predictable relationship with Moscow” but also underscored President Biden’s “resolve to protect U.S. citizens and act firmly in defense of U.S. interests in response to actions by Russia that harm us or our allies.” Russia said that what it called constructive talks between these top diplomats were a "positive signal" for a potential summit between Presidents Biden and Putin, though no dates have been discussed yet. Elsewhere, Russia will test investor appetite by selling its longest euro-denominated bond, the first since U.S. sanctions were put on local currency debt about a month ago. Price guidance for the 15-year paper is reportedly around 2.875%. Russia is also offering a reopening of an existing EUR750 mln note due 2027, with guidance around 1.3675%.

Tensions in the Middle East seem to be easing. Israel and Hamas look set to reach an agreement to cease hostilities. Israeli Prime Minister Netanyahu has come under intense pressure from U.S. President Biden to end the conflict. Local wires suggest that the Israeli government is close to reaching its objectives, though there have been no official statements to confirm this. The shekel hasn’t done much during the conflict aside from a couple of days of sharp move and continues to broadly track the dollar.

South African Reserve Bank is expected to keep rates steady at 3.5%. At the last meeting March 25, the bank delivered a hawkish hold. There were no longer any dissents in favor of a rate cut and the bank's model forecasted two 25 bp hike this year, in Q2 and Q4. Yesterday, South Africa reported higher than expected inflation and weaker than expected retail sales, making the decision today even more difficult. Yet the country is on the brink of a devastating third wave as all provinces are seeing a significant surge in infections, moving President Ramaphosa closer to re-imposing lockdowns. When all is said and done, we think the central bank will be hard-pressed to deliver two rate hikes this year.

ASIA

Japan reported firm April trade and March core machine orders data. Exports rose 38.0% y/y vs. 30.8% expected and 16.1% in March, while imports rose 12.8% y/y vs. 9.0% expected and 5.8% in March. After lagging for much of the past year, Japan exports are finally catching up with Taiwan and Korea, which are both enjoying strong export performances. Base effects flattered the y/y numbers, but the gains were broad-based as exports to the U.S. rose 45.1% y/y, to the EU rose 39.6%, and to China rose 33.9%. Elsewhere, core machine orders rose 3.7% m/m vs. 5.0% expected and -8.5% in February. The strength in external demand comes at a good time, as domestic activity is taking a big hit from the lockdowns and the overall economy is likely to contract this quarter. The BOJ is on hold for now but we still expect another fiscal package over the summer as Suga’s popularity wanes ahead of October elections.

Australia reported soft April jobs data. There were -30.6k jobs lost vs. +20k expected and a revised 77.0k (was 70.7k) in March. Despite the drop, the unemployment rate fell to 5.5% from a revised 5.7% (was 5.6%) in March, as the participation rate fell to 66.0% from 66.3% in March. The breakdown wasn’t bad, as a 33.8k gain in full-time jobs was offset by a -64.4k drop in par-time jobs. However, the jobs data will be extra “noisy” for a couple of months as the wage subsidy program ended in March. We know the RBA is focused on the labor market for signs of wage and price pressures, but it’s a long way until we get near the bank’s 4% unemployment rate where wage inflation is likely to become more pronounced. Australia’s sovereign bond yields have been range bound since their big jump in February, with the 10-year at 1.77% and the 30-year at 2.68%.

China appears to be getting increasingly concerned about inflation. Reports have emerged in state media that the State Council said more efforts must be made to prevent rising commodity prices from being passed through to consumers. The State Council stressed that monetary policy should be kept steady, with the yuan kept stable at an appropriate equilibrium level. This suggests the PBOC will not tighten policy in response. Instead, officials pledged to boost domestic supply to ease prices, enact stronger oversight on spot and futures commodity markets, and crack down on speculation and hoarding. The warnings have helped push commodity prices broadly lower, with iron ore down 3% on the day and crude oil down nearly 2% on the day. Still, policymakers there face a delicate balancing act. Deleveraging and rebalancing will tend to slow growth while inflation saps the purchasing power of consumers. Too much of either poses risks of stagflation and potential social unrest. Stay tuned.

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