Dollar Powers Ahead as Divergences Widen

October 23, 2024
  • The divergence theme remains intact; Fed Beige Book will be released; financial conditions remain loose; BOC is expected to cut rates 50 bp to 3.75%.
  • ECB officials remain dovish; BOE Governor Bailey speaks; South Africa reported September CPI data
  • Yen weakness continues; we expect official jawboning to pick up

The dollar is powering higher. DXY is trading at a new high for this move near 104.364 on the back of higher UST yields. It is on track to test the July 30 high near 104.799 but looking further ahead, clean break above 103.848 sets up a test of the June 26 high near 106.130. The yen is the worst performer, with USD/JPY is trading at a new high for this move near 152.80 and so we expect official jawboning to pick up (see below). The euro is trading at a new low for this move near $1.0780 as ECB officials tilt more dovish (see below) and is on track to test the June 26 low near $1.0665. Lastly, sterling is holding up relatively well but is still trading lower near $1.2975. We believe that recent U.S. data and Fed comments continue to support a very gradual easing cycle. Market easing expectations for the Fed have adjusted after the recent spate of strong U.S. data but are still too dovish. As the Fed repricing continues, the dollar should see another leg higher. In the meantime, the weaker growth outlook for the rest of the world highlights the ongoing divergences that favor the greenback (see below).

AMERICAS

The divergence theme remains intact. The dollar and U.S. Treasury yields continue to march higher, reflecting in large part the strong U.S. economy. Indeed, the IMF raised its U.S. growth projections to 2.8% (+0.2 ppt) for this year and 2.2% (+0.3 ppt) for next year. The IMF also sees the U.S. outpacing its international peers, as its eurozone growth forecasts were lowered to 0.8% (-0.1 ppt) for this year and 1.2% (-0.3 ppt) for next year. Its Japan growth forecast was slashed to 0.3% (-0.4 ppt) for this year and raised to 1.1% (+0.1 ppt) for next year, while Its U.K. growth forecast was raised to 1.1% (+0.4 ppt) for this year and kept unchanged at 1.5% for next year. When all is said and done, these economic divergences will feed into monetary policy divergences that should continue to favor the dollar.

The Fed Beige Book for the upcoming November 6-7 FOMC meeting will be released. The September Beige Book painted a mixed picture of labor market conditions and economic activity. “Five Districts saw slight or modest increases in overall headcounts, but a few Districts reported that firms reduced shifts and hours, left advertised positions unfilled, or reduced headcounts through attrition—though accounts of layoffs remained rare.” That Beige Book further noted that more Districts (9 vs. 5 previously) reported flat or declining economic activity than in the prior reporting period. However, “District contacts generally expected economic activity to remain stable or to improve somewhat in the coming months.” Given the recent data, we see risks that this Beige Book points to some modest improvements. Bowman and Barkin speak today.

Financial conditions remain loose. The Chicago Fed’s weekly measure has now loosened nine straight weeks through October 11 and are the loosest since mid-November 2021. Conditions through last Friday will be reported today.

Bank of Canada is expected to cut rates 50 bp to 3.75%. However, nearly a third of the 23 analysts polled by Bloomberg look for a smaller 25 bp move, while the swaps market sees 80% odds of a 50 bp rate cut. We expect the BOC to deliver a 50 bp cut and signal a faster return towards its nominal neutral interest rate estimate of 2.25-3.25%. Inflation in Canada is undershooting the BOC’s projection while business conditions and consumer sentiment remain subdued. New macro forecasts will be published in the Monetary Policy Report.

EUROPE/MIDDLE EAST/AFRICA

European Central Bank officials remain dovish. Yesterday, ECP President Lagarde declined to rule out larger rate cuts by noting that while the moves since June had been “sensible,” that didn't mean the ECB was bound to continue with quarter-point cuts. Similarly, Governing Council member Centeno said it was important for monetary policy to continue easing and left the door open for a 50 bp rate cut. Governing Council member Holzmann said that more rate cuts will follow, while Governing Council member Rehn warned that “the growth outlook has weakened quite clearly in the past few months, which could also increase disinflationary pressures.” Lagarde, Lane, Cipollone, Escriva, Knot, and Centeno speak today.

ECB easing expectations have responded to this dovish tilt. The swaps market sees nearly 45% odds of a 50 bp cut in December, up from 25% at the start of this week. Looking ahead, the market is back to pricing in 175 bp of tightening over the next 12 months that would see the policy rate bottom near 1.5% vs. 2.0% at the start of last week. Preliminary October PMIs tomorrow should confirm that the eurozone economy remains weak.

Bank of England Governor Bailey speaks. Yesterday, Bailey talked about challenges in financial stability and did not comment on monetary policy. Elsewhere, MPC member Greene reiterated that “rate-cutting should remain cautious, gradual” and noted that r* has crept up so “Rates will probably have to end up a bit higher than they were.” Greene added that U.K. growth above 1% would be inflationary. Interestingly, the IMF’s U.K. growth forecast for this year was raised to 1.1% (+0.4 ppt) and kept unchanged at 1.5% for next year. Breeden also speaks today.

South Africa reported September CPI data. Headline came in as expected at 3.8% y/y vs. 4.4% in August, while core remained steady as expected at 4.1% y/y. Headline is the lowest since March 2021 and nearing the bottom of the 3-6% target range. At the last policy meeting September 19, the South African Reserve Bank started the easing cycle with a 25 bp cut to 8.0%. The vote was unanimous and a limited easing cycle was flagged as the research department’s model saw the policy rate at 7.86% by end-2024, 7.17% by end-2025, and 7.09% by end-2026. The swaps market tends to agree as it sees the policy rate bottoming around 7.25% over the next 12 months.

ASIA

Yen weakness continues. USD/JPY has retraced nearly two thirds of the July-September drop and is trading near 152.70, the highest since the Bank of Japan’s hawkish surprise on July 31. The pair has broken above the 200-day moving average that came in near 151.40 today and is on track to test the July 30 high near 155.20. However, break of the 62% retracement objective of the July-September drop near 153.40 would set up a test of the July high near 162.

We expect official jawboning to pick up. However, we see little risk of BOJ intervention right now as the government has bigger fish to fry ahead of this weekend’s election. Until the Bank of Japan pivots to a more hawkish stance, officials can do very little to halt the yen’s slide. The market is not pricing in the next BOJ hike until the end of Q1 or early Q2, while only 30 bp of total tightening is priced in over the next 12 months. It’s worth noting that yen weakness is ongoing despite higher Japan yields, which suggests that most of this move in USD/JPY is being driven by the U.S. side of the equation.

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