Dollar Rangebound Ahead of Key Central Bank Meetings

December 14, 2021
  • The two-day FOMC meeting begins today and ends tomorrow with a decision; we continue to take issue with market pricing for a terminal Fed Funds rate of 1.5%; November PPI will be of interest; BOC added jobs to its mandate whilst renewing its 2% inflation target; Brazil central bank minutes will be released; Chile is expected to hike rates 125 bp to 4.0%
  • U.K. reported firm labor market data; FX intervention by the Turkish central bank is doing very little to halt the lira’s runaway depreciation; Hungary is expected to hike rates 40 bp to 2.5%
  • BOJ conducted a rare repo operation; Australia recorded the highest number of daily infections in more than two months; India November WPI surprised on the upside by a wide margin while CPI was slightly below expectations yesterday

The dollar remains rangebound ahead of the two-day FOMC meeting. DXY is trading just above 96 as it gave up earlier gains during the Asian session. The euro is trading back below $1.13 while sterling is trading near $1.3250 after testing support near $1.32. 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.

AMERICAS

The two-day FOMC meeting begins today and ends tomorrow with a decision. 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). If so, this would see QE end by March. While the Fed has taken pains to try and decouple tapering from liftoff, the market is not having any of that. Fed Funds futures have fully priced in liftoff in Q2, with follow-up hikes in Q3 and Q4 nearly fully priced in. Swaps market sees the Fed Funds rate peaking at 1.5% by end 2023.

We continue to take issue with 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, 1 policymaker saw a longer-term Fed Funds rates of 2.0%, 4 saw 2.25%, 1 saw 2.375%, 9 saw 2.5%, and 2 saw 3.0%. How can markets reconcile this with a 1.5% terminal rate? They can’t, and when markets realize this, that should give the dollar another leg higher.

November PPI will be of interest. Headline is expected at 9.2% y/y vs. 8.6% in October, while core (ex-food and energy) is expected at 7.2% y/y vs. 6.8% in October. Though markets breathed a sigh of relief after CPI came in as expected last week, the inflation trajectory remains worrisome. While we believe that price pressures will abate next year, the Fed is doing the prudent thing by tapering faster so that it is well-positioned to hike rates if needed.

Bank of Canada added jobs to its mandate whilst renewing its 2% inflation target. Full employment was seen as an implicit BOC target but now it is an explicit one, though the BOC made clear that "the primary objective of monetary policy is to maintain low, stable inflation over time.” So while it formalizes a policy already in place, the signal is nonetheless a dovish one as it gives the bank some wriggle room in terms of liftoff timing. In contrast, the ECB framework review allowed for higher than targeted inflation for an unspecified period of time but fell well short of introducing a second mandate for employment. Now, the BOC is taking a big step towards emulating the Fed, giving it the freedom to allow inflation to run a bit hot if the labor market is not where it should be.

Brazil central bank minutes will be released. Last week, it hiked rates 150 bp to 9.25%, as expected, and signaled another hike of the same magnitude at the next meeting February 2 and said “It is appropriate to advance the process of monetary tightening significantly into the restrictive territory” The bank releases its quarterly inflation report Thursday. IPCA inflation came in at 10.74% y/y in November vs. 10.67% in October, the highest since November 2003 and further above the 2.25-5.25% target range. That range falls to 2-5% in 2022. Swaps market is pricing in a peak policy rate of 12.25% by mid-2022, falling to 11.75% by end-2022 and then 9.50% by end-2023.

Chile central bank is expected to hike rates 125 bp to 4.0%. A handful of analysts look for either 100 or 150 bp moves. November CPI rose 6.7% y/y, the highest since December 2008 and further above the 2-4% target range. Swaps market is pricing in a peak policy rate around 5.75% by mid-2022 and remaining there at end-2022 before falling in 2023.

EUROPE/MIDDLE EAST/AFRICA

The U.K. reported firm labor market data. Unemployment fell a tick to 4.2% as expected in the three months ending in October, while the gain in employment was 149k vs. 225k expected. Job vacancies were a record high 1.22 mln. On the other hand, November jobless claims fell -49.8k vs. a revised -58.5k (was -14.9k) in October. The data so far suggest the end of the jobs furlough program in September has had little negative impact on the labor market. November CPI will be reported tomorrow. Headline inflation is expected at 4.8% y/y vs. 4.2% in October, while CPIH is expected at 4.4% y/y vs. 3.8% in October. If so, headline would be the highest since November 2011 and further above the 2% target.

Data come ahead of the Bank of England decision Thursday. Recent weakness in the data have led markets to recalibrate their BOE liftoff expectations. WIRP suggests a 1 in 5 chance of a hike this week, while a February 3 hike is no longer fully priced in. The data had been weakening even before this latest spike in virus numbers and the ongoing spread of the omicron variant. New macro forecasts were revealed at the November BOE meeting and won’t be updated until February 3. Given such heightened uncertainty, we think it makes perfect sense for the BOE to remain on hold this week. Swaps market is still pricing in 100 bp of tightening over the next twelve months, which strikes us as a bit too aggressive.

FX intervention by the Turkish central bank is doing very little to halt the lira’s runaway depreciation. This should surprise no one as the underlying monetary policy remains in place. Today marked the fourth intervention by the central bank, according to Bloomberg’s count. Investors know that the central bank doesn’t have enough ammunition to make any significant dent on dollar demand and so are just wasting dollars, in our view. Nothing short of a material turnaround in policy would make a difference here. We think the odds of this happening on Thursday are low but growing as the situation becomes more dire. We could see the bank refraining from easing as a face-saving way to provide a positive surprise. However, analysts believe that a rate hike shock of 10 percentage points or more is needed to stabilize the lira and that seems very unlikely. For now, USD/TRY is trading at 14.25, down 5.5% on the month and almost 50% on the year.

National Bank of Hungary is expected to hike rates 40 bp to 2.5%. However, the market is split. Of the 19 analysts polled by Bloomberg, 1 sees a 20 bp hike, 7 see 30 bp, 3 see 40 bp, 2 see 50 bp, 3 see 60 bp, 2 see 90 bp, and 1 sees 120 bp. The bank then holds its weekly 1-week repo tender Thursday and is expected to hike that rate 20 bp to 3.5%. November CPI rose 7.4% y/y, the highest since December 2007 and further above the 2-4% target range. As such, we see risks of hawkish surprises this week. Indeed, Deputy Governor Virag said last week that “We’re going to front-load as much of the interest-rate hikes as necessary.”

ASIA

The Bank of Japan conducted a rare repo operation. It offered to buy JPY2 trln yen ($17.6 bln) of JGBs under repurchase agreements after repo rates jumped to a two-year high. It was a one-day operation and was the first time since 2006 that the BOJ has conducted such a repo operation. The move is meant to cap the recent spike in repo rates due to year-end funding pressures and has no implications for monetary policy. The two-day BOJ meeting ends Friday and is the bank is widely expected to deliver a dovish hold.

Australia recorded the highest number of daily infections in more than two months. New South Wales and Victoria states are seeing significant spikes in the numbers as restrictions have been loosened. However, the high vaccination rate for now is preventing a related spike in hospitalizations and serious illness. Elsewhere, NAB business conditions index for November firmed to 12 vs. a revised 10 (was 11). This will be followed by Westpac consumer confidence index for December tomorrow.

Next RBA meeting is February 1. The bank is due to review its QE program then and if the economy remains in solid shape, we think it will announce another round of tapering. Some are calling for an end to QE then but we think that would be too abrupt and would fan market expectations for 2022 liftoff. As it is, swaps market is pricing in 75-100 bp of tightening over the next 12 months, which is at odds with RBA forward guidance for likely 2024 liftoff. If risks to the economy remain high, the RBA may have to push back a bit against market expectations at that February meeting.

India’s November WPI surprised on the upside by a wide margin, but CPI was slightly below expectations yesterday. The wholesale figure came in at 14.23% y/y, well above the 12% expected and the 12.54% last month. CPI at 4.91% y/y vs. 5.10% expected and 4.48% in October. One reason for the CPI miss comes from lower fuel taxes, but food prices accelerated to 2.6%. Perhaps most telling, core is at 5.2%, unchanged from the previous month but uncomfortably high. This means that the RBI will remain on the road to tighten in 2022 if external conditions and the pandemic outlook don’t deteriorate too much.

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