Dollar Limps into the Weekend Despite Higher U.S. Yields

October 22, 2021
  • Higher U.S. rates should continue to support the dollar; Markit preliminary October PMI readings will be reported; weekly jobless claims are worth a mention; Canada reports August retail sales; there was a big shake-up in Brazil’s economic team; Mexico reports mid-October CPI
  • Eurozone reported soft preliminary October PMI readings; U.K. reported weak September retail sales and firm preliminary October PMI readings; BOE Chief Economist Pill would not commit to imminent lift-off; Russia delivered a hawkish surprise by hiking rates 75 bp to 7.50%
  • Japan reported September national CPI; developed Asia reported firm October PMI readings; RBA defended its 0.10% bond yield target for the first time since February; Evergrande avoided default by making a dollar bond payment a day before the Saturday deadline

The dollar is softer despite rising U.S. rates. DXY has been unable to build on yesterday’s gains and is trading modestly lower around 93.60. USD/JPY feels heavy and is trading below 114 for the second straight day after trading earlier this week at a new cycle high near 114.70. Elsewhere, the euro found some support near $1.1620 and is modestly higher, while sterling is still having trouble staying above $1.38 area after meeting stiff resistance near $1.3835 all this week. With U.S. data remaining firm, the Fed is ready to taper and markets are fully pricing in Q3 22 Fed liftoff. As such, we believe the move higher in U.S. rates and the dollar will eventually pick up steam again.

AMERICAS

Higher U.S. rates should continue to support the dollar. The US 10-year yield traded as high as 1.70% yesterday, matching the May 13 high. While it has eased to 1.68% today, it seems likely to eventually test the March 30 high near 1.77%. The 2-year yield is trading today near 0.46%, the highest since March 2020, while the 5-year yield is trading near 1.23%, the highest since February 2020. With the U.S. data remaining firm and the Fed widely expected to announce tapering at the November 2-3 FOMC meeting, we believe the upward trajectory for U.S. rates and the dollar remains intact.

Markit preliminary October PMI readings will be reported. Manufacturing PMI is expected at 60.5 vs. 60.7 in September, while services PMI is expected at 55.2 vs. 54.9 in September. The composite PMI stood at 55.0 in September. Yesterday, Philly Fed manufacturing survey came in at 23.8 vs. 25.0 expected and 30.7 in September. The employment component rose to 30.7 vs. 26.3 in September and the prices paid component rose to 70.3 vs. 67.3 in September. The headline reading was a bit softer than expected but remains at historically high levels. The same goes for the Empire survey out last week. Supply chain issues continue to weigh on the manufacturing sector but the outlook is still solid.

Weekly jobless claims are worth a mention. Initial claims fell to 290k vs. 297k expected and a revised 296k (was 293k) previously. This reading is for the BLS survey week containing the 12th of the month. Continuing claims fell to 2.481 mln vs. 2.548 mln expected and a revised 2.603 mln (was 2.593 mln) previously. These are reported with a one-week lag and so next week’s reading will be key. Consensus for October NFP currently at 385k vs. 194k in September. That data will be out the Friday after the Wednesday FOMC decision but from what we can tell, there's a green light for tapering.

Canada reports August retail sales. Headline is expected to rise 2.0% m/m vs. -0.6% in August, while sales ex-autos are expected to rise 2.6% m/m vs. -1.0% in July. Earlier this week, September CPI came in higher than expected and recent data have boosted market expectations for BOC tightening. Swap market suggest over 75 bp of tightening has been priced in over the next twelve months, which is at odds with current forward guidance for H2 22 lift-off. Next policy meeting is October 27 and markets will be waiting to see if the BOC pushes back against these market expectations.

There was a big shake-up in Brazil’s economic team. Four top advisors to Economy Minister Guedes stepped down yesterday. All cited “personal reason” but they are all clearly protesting President Bolsonaro’s recent spending plans. Brazil assets are likely to come under pressure today as the resignations were announced after markets closed yesterday. Guedes remains in his post but has done little so far to push back against the massive spending planned, which would likely stoke inflation further and require even more monetary tightening. Next COPOM meeting is October 27. While a 100 bp hike to 7.25% has been widely flagged, the CDI market is pricing in a possible 150 bp move, up from 100 bp last week.

Mexico reports mid-October CPI. Headline is expected at 6.10% y/y vs. 5.87% in mid-September. If so, it would be the highest since April and further above the 2-4% target range. Banco de Mexico delivered its third straight 25 bp hike September 30 by a 4-1 vote and left the door open for further tightening. Minutes show several MPC members expecting further hikes, but dissenter Esquivel argued that rate hikes were “ineffective” and “inefficient.” Next policy meeting is November 11 and another 25 bp hike to 5.0% seems likely if price pressures continue to rise.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported soft preliminary October PMI readings. Manufacturing PMI came in at 58.5 vs. 57.1 expected and 58.6 in September, services PMI came in at 54.7 vs. 55.4 expected and 56.4 in September, and the composite PMI came in at 54.3 vs. 55.2 expected and 56.2 in September. The German and French composites fell to 52.0 and 54.7 from 55.5 and 55.3 in September, respectively. The drop in Germany’s readings are especially worrisome. For now, the ECB is likely to remain in dovish mode as the economic data continue to soften.

U.K. reported weak September retail sales and firm preliminary October PMI readings. Headline sales were expected to rise 0.6% m/m but instead fell -0.2% vs. a revised -0.6% (was -0.9%) in August, while sales ex-auto fuel were expected to rise 0.3% m/m but instead fell -0.6% vs. a revised -0.7% (was -1.2% in August). Manufacturing PMI came in at 57.7 vs. 56.0 expected and 57.1 in September, services PMI came in at 58.0 vs. 54.5 expected and 55.4 in September, and the composite PMI came in at 56.8 vs. 54.0 expected and 54.9 in September.

Bank of England Chief Economist Pill would not commit to imminent lift-off. He said that even though inflation may exceed 5% in the coming months, the decision whether or not to hike next month is “finely balanced.” Pill stressed that “We do not see, given the transitory nature of what we’re seeing in inflation in our base case, a need to go to a restrictive stance” but added that “Maybe there’s a bit too much excitement in the focus on rates right now.” His comments did not change market pricing for imminent rate hikes. The short sterling strip is fully pricing in Q4 lift-off, followed by another four hikes in 2022. WIRP suggests nearly 65% odds of a hike at the November 4 meeting, while the swaps market is pricing in 100 bp of tightening over the next twelve months.

Russia central bank delivered a hawkish surprise by hiking rates 75 bp to 7.50%. The market was split between 25-50 bp, with only one analyst looking for 75 bp. The bank said that more hikes are possible at the next meetings, and now sees the average policy rate between 7.25-8.25% in 2022 vs. 6-7% previously. It warned that inflation could deviate from the 4% target for longer than expected, though it sees end-2022 inflation between 4.0-4.5%. CPI rose 7.4% y/y in September, the highest since June 2016 and nearly double the 4% target. As such, we believe another hike is likely at the next meeting December 17.

ASIA

Japan reported September national CPI. Headline inflation came in as expected at 0.2% y/y vs. -0.4% in August, while core inflation (ex-fresh food) also came in as expected at 0.1% y/y vs. flat in July. Core inflation is positive for the first time since March 2020 but still well below the 2% target. Reports suggest the Bank of Japan will lower it inflation forecast for FY21 in its upcoming Outlook Report for the October 27-28 policy meeting. The forecast is likely to be cut to around 0% from 0.6% previously due to re-basing of the CPI. This would be seen as a very a dovish hold when it meets this month. FY24 will be added with the April 2022 Outlook Report and is likely to show inflation remaining well below the 2% target, which would mean no tightening until FY25 at the earliest.

Developed Asia reported firm October PMI readings. Japan manufacturing PMI came at 53.0 vs. 51.5 in September, services PMI came in at 50.7 vs. 47.8 in September, and the composite PMI came in at 50.7 vs. 47.9 in September. This was the first reading above 50 for the composite since April. Elsewhere, Australia manufacturing PMI came at 57.3 vs. 56.8 in September, services PMI came in at 52.0 vs. 45.5 in September, and the composite PMI came in at 52.2 vs. 46.0 in September. Here, this was the first reading above 50 for the composite since June. The improvements in both Japan and Australia were driven by the reopening of the economy.

 The RBA defended its 0.10% bond yield target for the first time since February. The yield on the targeted April 2024 government bond had been trading as high as 0.17% before the RBA intervened, and it is now trading back at the target. Like most other major central banks, market pricing for RBA tightening has intensified in recent weeks. According to Bloomberg, the swaps market is still pricing in nearly 50 bp of tightening over the next year after today’s RBA operation, which we believe was meant to underscore the RBA’s forward guidance that lift-off is not expected until 2024 “at the earliest.” Next policy meeting is November 1 and it will be very important whether the RBA continues to push back against market expectations for lift-off.

Evergrande avoided default by making a dollar bond payment a day before the Saturday deadline. The $83.5 mln payment was made just as the 30-day grace period was ending. Today’s move was certainly welcome but the 30-day grace period for the company’s next dollar bond payment ends October 29 and so markets are likely to remain jittery.

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