• U.S. yields are rising again; the two-day FOMC meeting starts today and is expected to end tomorrow with a 50 bp hike to 1.0%; the Fed is also likely to announce Quantitative Tightening; April ISM manufacturing PMI was softer across the board; Colombia central bank minutes will be released
  
• ECB tightening expectations remain subdued; eurozone reported March PPI and unemployment; Russia has avoided a technical default
  
• RBA surprised markets with a 25 bp hike to 0.35%; RBA tightening expectations jumped; updated forecasts will be released with the Statement of Monetary Policy Friday but some highlights were revealed; the rate hike comes at a bad time for the government; New Zealand introduced new fiscal rules; Korea reported April CPI data
  

The dollar has basically recouped its pre-weekend losses. DXY is back trading near 103.577 and should soon test last week’s cycle high near 103.928. We continue to target the November 2002 high near 107. The euro remains heavy after being unable to break above $1.06 Friday and is trading near $1.05 and should soon test last week’s cycle low near $1.0470. We still look for a test of the January 2017 low near $1.0340. After a period of consolidation, USD/JPY has resumed its march higher and is trading back above 130. We continue to look for a test of the 2002 high near 135.15. Sterling is trading heavy near $1.25 after being unable to break above $1.26 and should eventually test last week’s new cycle low near $1.2410. After that, we still target the June 2020 low near $1.2250 and then the May 2020 low near $1.2075. AUD is outperforming today after the RBA delivered a hawkish surprise (see below). Between lingering risk-off impulses and the recovery in U.S. yields, we believe the dollar uptrend remains intact.

AMERICAS

U.S. yields are rising again. The 10-year yield traded at a new high near 3.01% yesterday before easing to 2.96% currently. This in turn pushed the real 10-year yield up to 0.15% yesterday before easing to 0.13% currently. This is still the highest since March 2020 and signals that Fed policy is finally moving into a more restrictive stance. Elsewhere, the 2-year yield traded as high as 2.78% today, matching last week’s high near 2.78% before falling back to 2.75% currently. All these rates are expected to continue rising , which of course would be dollar-positive.

The two-day FOMC meeting starts today and is expected to end tomorrow with a 50 bp hike to 1.0%. There will be no new forecasts until the June 14-15 FOMC meeting, when another 50 bp hike is widely expected. Looking ahead, WIRP suggests three more 50 bp hikes in June, July, and September that would take the Fed Funds rate up to 2.25-2.50%. After that, two 25 bp hikes are priced in for November and December that would take the Fed Funds rate up to 2.75-3.0%. However, there is a greater than 50% chance of a final 25 bp hike in February that would take Fed Funds up to 3.0-3.25%. Of course, all of this market pricing is predicated on the data and whether the US economy can avoid recession.

The Fed is also likely to announce Quantitative Tightening. Recall that the minutes to March FOMC meeting set out a likely scenario for balance sheet runoff, with a $95 bln monthly cap seen as appropriate. This cap would be split $60 bln for USTs and $35 bln for MBS. Furthermore, the appropriate phase-in period for this cap was seen at three months or “modestly longer if market conditions warrant.” While the details may be tweaked, the pace of QT will be much faster this time around. Back in 2017, the phase-in period was 12 months and the final monthly caps were $30 bln for UST and $20 bln for MBS. The March minutes also showed that “the Committee was well placed to begin the process of reducing the size of the balance sheet as early as after the conclusion of its upcoming meeting in May.” If the Fed stays true to form, then a plan close to the one outlined here will be announced Wednesday and implemented on May 15.

April ISM manufacturing PMI was softer across the board. Headline reading of 55.4 was the lowest since September 2020 and is back to what one might call "normal" pre-pandemic levels. Prices paid fell to 84.6 from the 87.1 peak in March and perhaps bodes well for inflation data going forward. New orders component is expected at 54.1 vs. 53.8 in March, employment is expected at 55.0 vs. 56.3 in March, and prices pace is expected at 87.4 vs. 87.1 in March. Services PMI will be reported tomorrow and is expected at 58.5 vs. 58.3 in March. March factory orders (1.2% m/m expected), JOLTS job openings (11.2 mln expected), and April auto sales (14.1us mln annual pace expected) will be reported today.

Colombia central bank minutes will be released. The bank just delivered the expected 100 bp hike to 6.0% last week, but the vote was 4-3 with the dissents in favor of a larger 150 bp move. It sees inflation close to 7% by year end and also raised its growth forecast for this year to 5%. Next policy meeting is June 30 and another 100 bp is expected then, with risks of a 150 bp move. The swaps market is pricing in another 450 bp of tightening over the next 12 months that would see the policy rate peak near 10.5%. April CPI data will be reported Thursday. Headline inflation is expected at 8.80% y/y vs. 8.53% in March. If so, it would be the highest since July 2016 and further above eh 2-4% target range.

EUROPE/MIDDLE EAST/AFRICA

ECB tightening expectations remain subdued. WIRP suggests odds of liftoff June 9 are now around 25% vs. 30% at the start of this week and 40% at the start of last week, while liftoff July 21 remains fully priced in. The swaps market is now pricing in 150 bp of tightening over the next 12 months, with another 50 bp (vs. 75 bp) of tightening priced in over the following 12 months that would see the deposit rate peak near 1.5% vs. 1.75% at the start of last week. While this still seems too aggressive to us, at least markets are recognizing that 1) eurozone inflation may be close to peaking and 2) the risks to growth are mounting.

Eurozone reported March PPI and unemployment. PPI rose 36.8% y/y vs. 36.3% expected and a revised 31.5% (was 31.4%) in February, while the unemployment rate came in at the expected 6.8% vs. a revised 6.9% (was 6.8%) in February. Germany also reported unemployment at -13k vs. -15k expected and -18k in February, with the unemployment rate remaining steady at 5.0%. The PPI readings are worrisome as the acceleration implies further upside pressure on CPI in the coming months.

Russia has avoided a technical default. At least for now. Several investors reportedly confirmed that their custodian banks had received payments due on Russia’s external debt. The $650 mln in coupon and principal payments were blocked by sanctions in early April and the 30-day grace period ends tomorrow. Reports suggest that Russia was allowed to make these payments by tapping into its onshore foreign reserves. This suggests that the West is hoping to squeeze Russia further by making it run down those reserves after cutting of access to its offshore reserves after the Russian invasion of Ukraine. As always, the good news is that the drama surrounding potential Russian default has not had a significant impact on other EM debt spreads.

ASIA

Reserve Bank of Australia surprised markets with a 25 bp hike to 0.35%. Governor Lowe said “I expect that further increases in interest rates will be necessary over the months ahead. The board is not on a pre-set path and will be guided by the evidence and data.” Furthermore, the bank announced it would no longer reinvest any maturing proceeds of its balance sheet, effectively embarking on Quantitative Tightening. Of note, the RBA’s existing bond portfolio has little debt maturing over the next year and so QT will most likely bite in 2023. Lowe admitted that the bank's forward guidance that interest rates would not rise until at least 2024 was "embarrassing" and that it "should have done better.” He said an internal review of its forward guidance during the pandemic would be conducted and findings made later this year, adding that "Thankfully we were wrong. The economy has been much better."

RBA tightening expectations jumped. WIRP suggests another 25 bp hike at the June 7 meeting is fully priced in, with over 60% odds of a larger 50 bp move. The swaps market is now pricing in 350 bp of further tightening over the next 12 months followed by another 50 bp over the following 12 months that would see the policy rate peak near 4.35%, up from 3.5% at the start of this week and 3.25% at the start of last week. AUD jumped as high as .7150 after the hawkish surprise but is already back below the .7100 level. As we saw after the recent hawkish surprised from the Riksbank, the initial boost to the currency will eventually be overwhelmed by the more hawkish Fed outlook.

Updated forecasts will be released with the Statement of Monetary Policy Friday but some highlights were revealed. The central scenario forecast for 2022 headline inflation is around 6%, nearly double the 3.25% forecast in February. It is expected to moderate to around 3% by mid-2024, up from 2.75% in February. GDP growth is seen at 4.25% in 2022 and 2% for 2023, unchanged from the February forecasts. Lastly, unemployment is expected to fall to around 3.5% by early 2023 vs. 3.75% in February.

The rate hike comes at a bad time for the government. This was apparently the first rate hike during an election campaign in nearly 15 years. Yet to no do anything when inflation surged to 5.1% y/y in Q1 would itself have been seen as political and so we believe the RBA really had no choice but to hike now, especially as new macro forecasts can be used as justification. Most opinion polls suggest Prime Minister Morrison is facing a tough reelection battle ahead of the May 21 vote. Despite record low unemployment, households are focused more on the impact of rising inflation and blaming the incumbent Morrison. Rising rates will raise the costs of variable rate mortgages and so the post-RBA polls will be key.

New Zealand introduced new fiscal rules. Finance Minister Grant Robertson said the new rules would include a 0-2% of GDP target for the budget surplus, adding that he expects a return to surplus in FY24/25. Robertson stressed that this surplus target will be the primary rule controlling spending decisions. He also announced that New Zealand will adopt a new debt measure called General Government Debt, adding it is comparable across countries and includes assets like the Government Superannuation Fund as well as debt held by agencies such as Kainga Ora. The government will cap debt under the new measure at 30% of GDP vs. 50% under the old measure of net debt. While New Zealand has always managed enjoyed market confidence in its fiscal trajectory, these new rules are clearly meant to maintain it.

Korea reported April CPI data. Headline inflation came in at 4.8% y/y vs. 4.4% expected and 4.1% in March. This was the highest since October 2008 and further above the 2% target. Next Bank of Korea meeting is May 26. While rates are likely to be kept steady since the bank just hiked 25 bp to 1.5% at the April 14 meeting, we see some risks of a hawkish surprise. The swaps market is now pricing in 175 bp (vs. 150 bp at the start of the week) of tightening over the next 12 months followed by another 25 bp over the subsequent 12 months that would see the policy rate peak near 3.5% (vs. 3.0% at the start of the week).