Dollar Marks Time Ahead of FOMC Decision

December 15, 2021
  • The two-day FOMC meeting ends with a decision this afternoon; if there were any doubts about a faster taper, yesterday’s November PPI readings have put those to rest; updated Dot Plots and macro forecasts are likely to support a more hawkish stance; data highlight is November retail sales; another debt ceiling crisis has been averted; Canada reports November CPI
  • U.K. reported higher than expected November CPI; reports suggest the upcoming ECB forecasts will show inflation remaining below the 2% target in both 2023 and 2024; South Africa November CPI came in right at expectations at 5.5% y/y
  • New Zealand expects to run a budget surplus by FY23/24, three years earlier than projected; Finance Minister Robertson also gave RBNZ Governor Orr a vote of confidence; China data was mixed

The dollar remains firm ahead of the FOMC decision. DXY is trading flat near 96.50 after two straight up days and is on track to test the late November high near 96.938. The euro is heavy and trading back below $1.13 while sterling is trading near $1.3250 after getting a boost from higher than expected CPI data (see below). USD/JPY remains stuck in narrow trading ranges just below 114. Markets are clearly marking time ahead of the many central bank decisions later this week. Looking ahead, we believe the underlying trend for a stronger dollar remains intact. However, there is some risk of a buy the rumor, sell the fact reaction initially.


The two-day FOMC meeting ends with a decision this afternoon. The Fed is widely expected to accelerate its pace of tapering a mere month after starting it. We expect the pace of tapering to be doubled to $30 bln per month ($20 bln UST and $10 bln MBS) and would allow QE to end by March. While the Fed has taken pains to try and decouple tapering from liftoff, the market is not having any of that. Q2 liftoff is now fully priced in, with follow-up hikes in Q3 and Q4 seen at around 90% odds.

If there were any doubts about a faster taper, yesterday’s November PPI readings have put those to rest. Headline rose 9.6% y/y vs. 9.2% expected and a revised 8.8% (was 8.6%) in October, while core (ex-food and energy) rose 7.7% y/y vs. 7.2% y/y and a revised 7.0% (was 6.8%) in October. Despite some relief after the CPI data, the PPI data point to upside risks going forward. We know US firms have been able to pass on higher costs pretty easily and so inflation is still likely to be rising as we move into 2022. This pretty much cements the faster tapering. While we believe that price pressures will abate next year, the Fed would be doing the prudent thing by tapering faster now so that it is well-positioned to hike rates next year as needed.

Updated Dot Plots and macro forecasts are likely to support a more hawkish stance. In the September Dots, the median saw one hike by end-2022 (0.375%). With several officials coming out in favor of faster tapering, it’s clear that there will be a hawkish shift in the 2022 dots. We can come up with any number of situations where the median for end-2022 shifts to two hikes from one currently, but think it is unlikely that the median will shift all the way to three hikes. In the September Dots, the median saw four hikes in total by end-2023 (1.125%). We do not think it would be hard to get a shift in this to five or six hikes (1.375-1.625%). In light of recent data, we expect core PCE forecasts to be revised higher and unemployment forecasts to be revised lower. We do not expect significant revisions to the growth forecasts.

We continue to take issue with swaps market pricing for a terminal Fed Funds rate of 1.5%. If inflation were to return to the 2% target, this would imply a negative real policy rate at the end of a Fed tightening cycle, which is something unheard of. If the labor market is as tight as we fear, it seems that the risks to the terminal rate are tilted to the upside. In the September Dots, the median saw a total of six hikes by end-2024 (1.875%) but this should also move higher. Elsewhere, the median saw the longer term rate at 2.5%. How can markets reconcile these Dots with a 1.5% terminal rate in 2023 and 2024? They can’t, and when markets realize this, that should give the dollar another leg higher.

Data highlight is November retail sales. Headline sales are expected at 0.8% m/m vs. 1.7% in October, while sales ex-autos are expected at 0.9% m/m vs. 1.7% in October. The so-called control group used for GDP calculations is expected at 0.7% m/m vs. 1.6% in October. Recall that this data series measures sales in nominal terms and so inflation will likely account for the lion’s share any gains. Since headline CPI rose 0.8% m/m in November, we see some upside risks to the sales data. Regional Fed manufacturing surveys for December also start rolling out. Empire survey kicks things off today and is expected at 25.0 vs. 30.9 in November. November import/export prices, October business inventories (1.1% m/m expected), and TIC data will also be reported.

Another debt ceiling crisis has been averted. Both the Senate and the House passed legislation that would raise the ceiling by $2.5 trln, which is intended to allow borrowing to continue until early 2023. Of note, the Senate last week agreed on a one-time deal that allowed the bill to pass with a simple majority and without having to resort to the cumbersome budget reconciliation process. The bill now goes to President Biden for signing. When al is said and done, we are heartened that both parties were able to get this done after much posturing and bullying from both sides. Democrats will now turn their attention to the Build Back Better package, which is likely to be delayed until early 2022.

Canada reports November CPI. Headline inflation is expected to remain steady at 4.7% y/y, while common core is expected to pick up a tick to 1.9% y/y. The Bank of Canada just delivered what we considered to be a dovish hold last week. The policy rate was kept at 0.25%, QE remained in its reinvestment stage, and forward guidance was left unchanged. Recall at the previous meeting October 27, the bank moved up its timetable for the output gap to close to Q2 from H2 previously. Of note, the BOC followed the Fed in dropping its reference to inflation as temporary, and also noted a strong job market and elevated inflation while warning that the omicron variant has “injected renewed uncertainty.” The next meeting January 26 will offer a better opportunity to signal a hawkish shift if needed, as 1) new macro forecasts will be released and 2) the potential impact of omicron will be better known. Swaps market is pricing in 125-150 bp of tightening over the next twelve months, which strikes us as a bit too aggressive.


The U.K. reported higher than expected November CPI. Headline inflation was expected at 4.8% y/y but instead accelerated almost a full percentage point to 5.1% from 4.2% in October. Core and CPIH inflation also accelerated to 4.0% y/y and 4.6% y/y, respectively. Headline is the highest since September 2011 and further above the 2% target, while core was the highest since July 1992. Data come just a day before the BOE decision. At the start of the week, odds for around 1 in 5 for liftoff tomorrow, but have since risen to nearly 1 in 3. Of note, liftoff February 3 is back to being fully priced in. We believe the downside risks will keep the BOE on hold for now, with the February outlook clearly dependent on the data and omicron.

Reports suggest the upcoming ECB forecasts will show inflation remaining below the 2% target in both 2023 and 2024. According to one ECB official, the inflation forecasts for those two years will be just under 2% but don’t account for potential upside risks, without being more specific. That will take the sting out of the 2022 forecast, which the official said is likely to be revised to above 2%. The 2024 forecast will be added for the first time and is an important part of the bank’s forward guidance. Taken at face value, one could argue that the quick return to sub-2% that’s forecast for both those years would imply no hikes until 2025.

South Africa’s November CPI came in right at expectations at 5.5% y/y. This is the highest since March 2017 and nearing the top of the 3-6% target range. The core reading was 3.3%, as expected and up a tick from October. Inflation for South Africa is still largely a fuel/transport story, with service inflation still at an acceptable 3.1% level. The result will be a gradual tightening cycle for the SARB after it began hiking at the last meeting November 18. The extent and timing of the next few moves will be largely dependent on the omicron outcome. Next policy meeting is January 27. Of note, the SARB’s model shows quarterly hikes in both 2022 and 2023, which seems too aggressive to us given the headwinds facing the economy.


New Zealand expects to run a budget surplus by FY23/24, three years earlier than projected. Finance Minister Robertson presented the upbeat outlook in his fiscal half-year fiscal and economic update. Expected borrowing for FY22/23 has been lowered by NZD10 bln to NZD20 bln, while the following three fiscal years have been cut by NZD7 bln to NZ$18 bln in each year. Faster growth and higher inflation will boost revenues and allow net debt to peak at 40.1% of GDP in 2023 vs. 48% previously forecast. With the RBNZ in the midst of a tightening cycle, it appears that New Zealand will be one of the first nations to return to some semblance of pre-pandemic normalcy in the coming years, and that massive support programs can eventually be wound down.

Finance Minister Robertson also gave RBNZ Governor Orr a vote of confidence. This comes amidst concerns that an exodus of senior RBNZ staff may threaten the stability of the central bank. The latest news is that Head of Supervision Wood and Head of Financial System Policy and Analysis Fiennes will leave over the coming months, while Chief Financial Officer Wolyncewicz will leave in May. This comes after Deputy Governor Bascand and Chief Economist Yuong Ha announced their departures earlier this year. Overall, 10 senior managers have either left in the last six months or plan to leave in coming months. Those 10 are a big chunk of the 26 total senior leadership roles. The RBNZ plans to boost that total to 36 when a new management structure is fully implemented in 2022. We too have confidence in Orr, but such a shakeup is unprecedented and comes at a time of great uncertainty.

China data was mixed. Industrial production data was in line with expectations, but retail sales came in well below. The latter came in at 3.9% y/y, almost a full percentage point below forecasts, suggesting that the impact of the latest virus wave is starting to impact consumers. IP rose 3.8% y/y, a small improvement from the previous 3.5% reading, largely supported by high-tech manufacturing. All around the data doesn’t change much; the PBOC will continue on its measured easing path while kicking the structural adjustment of the financial sector down the road. This is typical of China’s policymakers: push painful structural reforms until growth slows too much, at which time the focus pivots back to supporting the economy.

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