Dollar Rangebound as Markets Await Fresh Drivers

December 02, 2021
  • The clues are pointing to a strong jobs report tomorrow; Fed released its Beige Book report; Fed tightening expectations remain elevated; Fed officials remain hawkish
  • Brexit tensions may be easing a bit; eurozone reported surging October PPI; some ECB officials are in favor of delaying a decision on extending QE Turkey has a new Finance Minister
  • Japan life insurers cut their hedge ratios on dollar-denominated assets to a record low in Q3; Australia reported weak October trade data; Korea November CPI data came in considerably higher than expected

The dollar remains rangebound as markets await fresh drivers ahead of jobs data tomorrow. DXY is trading just below 96, still pretty much in the middle of this week’s trading range. The euro still feels heavy after being unable to break above $1.14 and is trading near $1.1330, while sterling remains stuck near $1.33. Even with market sentiment improving a bit, USD/JPY is still trading below 113, while EUR/CHF is trading just above 1.04 and hovering near this week’s low for this move near 1.039. Looking through the recent noise and distorted price action, we believe the underlying trend for a stronger dollar remains intact as the Fed moves sooner to liftoff than markets previously thought.

AMERICAS

The clues are pointing to a strong jobs report tomorrow. ADP private sector jobs came in at 534k vs. 525k expected while October was revised to 570k from 571k previously. Elsewhere, the employment component of ISM manufacturing PMI came in at 53.3 vs. 52.0 in October. This is the third straight month above 50 and the highest since April. For Friday, consensus sees 545k jobs added vs. 531k in October, with the unemployment rate see dropping a tick to 4.5%. Average hourly earnings are expected to pick up a tick to 5.0% y/y. Of note, the headline manufacturing PMI came in at 61.1 vs. 61.2 expected and 60.8 in October. Typically, the headline rarely spends much time above 60 but this is the third month in a row and nine of the past twelve months. ISM services PMI will be reported Friday after the jobs data, and is expected at 65.0 vs. 66.7 in October. Here, the employment component stood at 51.6 in October. Today, weekly initial jobless claims are expected at 240k vs. 199k last week, while continuing claims are expected at 2.002 mln vs. 2.049 mln last week. November Challenger job cuts will also be reported.

The Fed released its Beige Book report. While it has been superseded by Powell’s hawkish tilt, the report is still worth discussing. It noted that economic activity grew at a modest to moderate pace, with growth still being constrained by supply chain issues. More importantly, the report said that nearly all Fed districts reported robust wage growth. The Fed added that increases in input cost were widespread across all industries, and that prices are rising at a moderate to robust pace. We think the kicker here is that both wage and price increases are viewed as "robust" and so the Fed is clearly laying the groundwork not just for faster tapering, but for the rate hikes that will follow the end of QE. The omicron variant came too late to be considered in this report, which clearly poses some downside risks to the economy. That will become clear in the coming days but markets at this point are pricing in little downside risks from the variant.

Fed tightening expectations remain elevated. Fed Funds futures still suggest nearly 80% odds of Q2 liftoff, nearly double what it was at the start of the week. Q3 liftoff and a follow up hike in Q4 remain fully priced in, with some odds of a third hike next year. Ultimately, the monetary divergence story should lead the dollar rally to resume. It's worth noting that the major technical indicators (stochastics, MACD, RSI) all point to an overbought dollar. Failure to hold on to Tuesday's Powell-induced highs adds to the negative technical picture. So, while we are fundamentally bullish the dollar, we are in a period of consolidation and profit-taking ahead of tomorrow's jobs data. After that, all bets are off if we get a really strong number.

Fed officials remain hawkish. Yesterday, Cleveland Fed President Mester was in favor of faster tapering. She said “Making the taper faster is definitely buying insurance and optionality so that if inflation doesn’t move back down significantly next year we’re in a position to be able hike if we have to.” She noted that recent data “have come in supportive of that case, so I’m very open to considering a faster pace of tapering.” For those keeping score at home, Powell, Bostic, and Mester have now all come out in favor of faster tapering in recent days. Of course, Powell’s view carries the most weight and yet it also represents a consensus of some sort. While we have been downplaying the odds of a faster pace announced at the December 14-15 FOMC, the odds are getting higher. Jobs reports tomorrow may be a deciding factor. Bostic, Quarles, Daly, and Barkin speak today.

EUROPE/MIDDLE EAST/AFRICA

Brexit tensions may be easing a bit. Reports suggest a compromise on fishing rights is within reach, with the EU hailing the granting of a new batch of fishing licenses by the U.K. as progress towards a concrete long-term deal later this month. EU Fisheries Commissioner Sinkevicius noted that after 40 permanent licenses were granted to EU fishing boats, almost 95% of permits requested by the EU have been delivered since the beginning of this year. That said, many of the licenses are temporary ones and so a more permanent solution is needed. Elsewhere, tensions over the Northern Ireland protocol also seem to have eased. Talks continue and the U.K. has signaled its willingness to remain at the table rather than walk away as earlier threatened.

Eurozone reported surging October PPI. It was expected to rise 19.0% y/y but instead jumped 21.9% vs. a revised 16.1% (was 16.0%) in September. This is by far the highest on record , which suggests upside risks for CPI going forward. Unlike Japan, firms in the eurozone have some pricing power and have been able to pass on some of the higher costs seen during the pandemic. Eurozone CPI rose 4.9% y/y in November and further accelerations seems likely.

Reports suggest some ECB officials are in favor of delaying a decision on extending QE. Several policymakers feel uncertainty has risen due to omicron and that the decision should be delayed until the February 3 meeting. Rising price pressures will make for a lively debate at the December 16 ECB meeting but when all is said and done, we believe growing downside risks to the economy will allow Madame Lagarde and the doves to push through an extension of QE. Whether that happens this month or in February will have little impact longer-term, but as Macbeth so eloquently said, “If it were done when ’tis done, then ’twere well it were done quickly.” Why wait? As we noted earlier this week, the weekly pace of ECB asset purchases has picked up in recent weeks and that should set the table for more aggressive action ahead.

Turkey has a new Finance Minister. As usual, a complicated situation can always become more complicated in Turkey. After undermining the central bank’s credibility with a major reshuffle, President Erdogan has now sacked his Finance Minister and replaced him with loyalist Nureddin Nebati. Reports suggest Nebati is close to former Finance Minister and Erdogan’s son-in -law Berat Albayrak. It’s clear that Erdogan continues to clean house of anyone on the economic team that is not on board with his unorthodox call for lower interest rates. To makes matters worse, newswires are reporting growing protests over the government’s failed economic policies. The upshot here is that Erdogan dashed any hopes of policy U-turn. After yesterday’s brief respite following the surprise FX intervention, USD/TRY is up 1.4% and trading back above the 13.0 level. Further record highs are likely until some return of orthodoxy is seen.

ASIA

Japan life insurers cut their hedge ratios on dollar-denominated assets to a record low in Q3. According to Bloomberg data, nine of the largest life insurers together held $370.7 bln worth of dollar-denominated assets at the end of Q3. Of that total, 41.5% were covered by net short dollar positions via forwards, down from 42.1% in Q1 and the lowest in Bloomberg-compiled data going back to 2010. Of note, those insurers’ holdings of dollar assets increased 2.1% during Japan’s H1 FY21/22 through September. Part of it is the strong dollar trend, but part of it is the rising cost of hedging. According to Bloomberg, 3-month annualized hedging costs rose to around 55 bp last week, the highest since December. At 50 bp currently, the costs are up from the September low near 25 bp but remains far below the peak near 350 bp back in November 2018.

Australia reported weak October trade data. Exports were expected to fall -1% m/m but instead fell -3% vs. a revised -7% (was -6%) in September, while imports were expected to rise 2% m/m but instead fell -3% vs. a revised -3% (was -2%) in September. Iron ore prices continued to fall in November and so the export outlook remains weak as China continues to slow. A weaker AUD is the natural by-product of deteriorating terms of trade. Indeed, AUD remains under pressure as it nears a test of Tuesday’s cycle low near .7065 and a break below would set up a test of the November 2020 low near .6990.

Korea November CPI data came in considerably higher than expected. Headline rose 3.7% y/y vs. 3.1% expected and 3.2% in October, while core rose 2.3% y/y vs. 2.2% expected and 2.8%5 in October. The headline reading is the highest since December 2011 and nearly double the 2% target. Of course, most of the upside more came from higher energy prices and supply-side factors (especially food prices), but they also reflect one-off base effects from the impact the counter-cyclical fiscal measures last year. Despite the new variant, we think the BOK remains on the hiking path and move again early next year.

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