Dollar Recovers as U.S. Yields Rise

October 05, 2022
  • U.S. rates and the dollar have staged a bit of a recovery today as markets rethink the notion of a Fed pivot; Fed officials remain (what else?) hawkish; September ISM services PMI will be closely watched; September ADP private sector jobs estimate will also be of interest
  • ECB Executive Board member Fabio Panetta said he would not become Italy’s next Finance Minister; the eurozone reported soft final September services and composite PMI readings; U.K. officials are optimistic about striking a Brexit deal with the EU; Poland is expected to hike rates 25 bp to 7.0%
  • Japan reported firm final September services and composite PMI readings; RBNZ hiked rates 50 bp to 3.5%, as expected; OPEC+ meets in Vienna today for the first in-person gathering since March 2020

The dollar is getting some traction as U.S. yields rise. DXY is up for the first time after five straight down days and is trading near 110.845 after testing the 110 area yesterday. Sterling ran into strong resistance near $1.15 and is currently back trading near $1.1360. Similarly, the euro ran into strong resistance near $1.00 and is currently trading near $0.9920. USD/JPY continues to flirt with the 145 area but has yet to take another stab at Monday’s high near 145.30. This move higher in USD/JPY should continue as markets test the BOJ’s resolve. NZD is outperforming after the RBNZ delivered a 50 bp hike and hawkish forward guidance (see below). The combination of ongoing risk off impulses and eventual repricing of Fed tightening risks is likely to see the dollar recover after this recent correction. Much will depend on how the U.S. data come in.

AMERICAS

U.S. rates and the dollar have staged a bit of a recovery today as markets rethink the notion of a Fed pivot. A Fed pivot remains wishful thinking and nothing more. With inflation stubbornly high, the Fed isn't blinking anytime soon. The Fed is not the RBA, even though its 25 bp hike fed into market perceptions that central banks are getting less hawkish. The dovish surprise from the RBA was a "wag the dog" moment. To infer that the Fed or the ECB are somehow going to follow the RBA's lead is pure rubbish. Of note, WIRP now suggests nearly 80% odds of a 75 bp hike November 2. While this is up from 70% odds at the start of this week, we think 75 bp is a done deal. Looking ahead, the swaps market is starting to price in a peak policy rate between 4.5-4.75% vs. 4.5% at the start of the week.

During the summer period when markets last got carried away with the pivot theme, DXY weakened around 4% before recovering to make new highs. During this current episode, DXY also weakened about 4% before getting some traction today. Whether this bounce can be sustained will depend largely on how the upcoming data come in. We think it's dangerous to pile into risk assets ahead of key jobs market data this week and PPI, CPI, and retail sales data next week. Stay tuned.

Fed officials remain (what else?) hawkish. In his first public comments as Fed Governor, Jefferson said “We have acted boldly to address rising inflation, and we are committed to taking the further steps necessary. My colleagues and I are resolute that we will bring inflation back down to 2%.” He added that “Restoring price stability may take some time and will likely entail a period of below-trend growth.” Elsewhere, Daly warned that high inflation “will require that we follow through on our commitments to bring inflation down, which does mean further rate hikes and holding those restrictive policies in place until we are truly done with bringing inflation back to target.” She added that “I really see us being able to slow the economy, slow growth, slow the labor market. Yes, there will be an increase in unemployment, but I think the 4.5% range is the right range.” Kashkari and Bostic speak today.

September ISM services PMI will be closely watched. Headline is expected at 56.0 vs. 56.9 in August, which was the highest since April. The weaker than expected ISM manufacturing PMI Monday added to dollar weakness but we believe today’s services reading will provide a clearer picture of the U.S. economy. Keep an eye on the employment and prices paid components, which stood at 50.2 and 71.5 in August, respectively.

September ADP private sector jobs estimate will also be of interest. Consensus sees 200k vs. 132k in August but market are still trying to figure out whether ADP’s retooling of its model has made it any more accurate as a predictor of NFP. Of course, September jobs data Friday is of course the real data highlight. Consensus sees 263k vs. 315k inn August, with the unemployment rate steady at 3.7% and average hourly earnings falling two ticks to 5.0% y/y. August trade data will also be reported and the deficit is expected at -$67.9 bln vs. -$70.7 bln in July.

Ahead of NFP, other labor market data will be reported. Yesterday, August JOLTS job openings came in at 10.053 mln vs. 11.088 mln expected and a revised 11.170 mln (was 11.239 mln) in July. This supports the view that the labor market is cooling off but that there are still a lot of job openings out there. August Challenger job cuts and weekly jobless claims will be reported tomorrow. Initial claims are expected at 205k vs. 193k previously, while continuing claims are expected at 1.380 mln vs. 1.347 mln previously. The recent drop in the claims data point to continued resilience in the labor market.

EUROPE/MIDDLE EAST/AFRICA

ECB Executive Board member Fabio Panetta said he would not become Italy’s next Finance Minister. While he had not been officially offered the post, Panetta’s name had been bandied about in the Italian media as a potential candidate that would ease market concerns about the incoming right-wing coalition government led by Brothers of Italy. For now, markets are taking a wait and see approach to the situation but it’s a very delicate calm. Meloni inherits an economy that is already sliding into recession even as the ECB continues to hike rates. The swaps market is pricing in 200 bp of tightening over the next 12 months that would see the deposit rate peak near 2.75%. Spreads are likely to remain under upward pressure and it’s only a matter of time before markets test the ECB’s TPI.

The eurozone reported soft final September services and composite PMI readings. Both were revised down a tick from the preliminary to 48.8 and 48.1, respectively. Looking at the country breakdown, the German composite was revised down two ticks from the preliminary to 45.7, while the French composite was steady at 51.2. Italy and Spain reported for the first time and their composite PMIs both fell two full points from August to 47.6 and 48.4, respectively. Elsewhere, France reported August IP at 2.4% m/m vs. flat expected and -1.6% in July. The resilience in France is surprising but it should eventually follow the other major eurozone economies into recession.

U.K. officials are optimistic about striking a Brexit deal with the EU. Northern Ireland Secretary Heaton-Harris said that a negotiated settlement might be reached “in the next few weeks” as talks have restarted while Foreign Secretary Cleverly said that “the tone has improved.” The U.K. side reportedly believes that a deal on trade flows through Northern Ireland is achievable but warned that there are still many areas of disagreement. Reports suggest U.K. officials hope a deal can be reached before the end of October, which is also the deadline for the formation of Northern Ireland’s power-sharing government that would avoid fresh elections. Unionists have refused to participate in the government until the border checks between Northern Ireland and the U.K. are removed. While a Brexit deal would help Truss recover some standing, we caution that we are only hearing from U.K. officials; the EU may have another view of the situation.

U.K. final September services and composite PMI readings came in firmer. Services was revised up to 50.0 vs. 49.2 preliminary, which dragged the composite up to 49.1 vs. 48.4 preliminary. The economy is still sliding into recession. Market expectations for BOE tightening have eased in recent days. WIRP suggests a 100 bp hike November 3 is priced in vs. 150 bp last week, while the swaps market is pricing in a peak policy rate near 5.5% vs. the cycle high near 6.25% last week.

National Bank of Poland is expected to hike rates 25 bp to 7.0%. However, a few analysts polled by Bloomberg see no change. At the last policy meeting September 7, the bank hiked rates 25 bp to 6.75%. Before that meeting, Governor Glapinski said that he saw only one or two more 25 bp hikes in this cycle. Since then, September CPI came in much higher than expected at 17.2%, the highest since September 1996 and further above the 1.5-3.5% target range. The swaps market is pricing in 50 bp of tightening over the next 12 months that would see the policy rate peak near 7.25%. Here too, we see upside risks to the policy rate. Minutes from the September 7 meeting will be released Friday.

ASIA

Japan reported firm final September services and composite PMI readings. Services PMI was revised up to 52.2 vs. 51.9 preliminary, while the composite was revised up a tick to 51.0. This is the highest composite reading since June. However, the recent data overall have been mixed and thus supports the cautious stance being taken by policymakers and for now, the BOJ is on hold. Next policy meeting is October 27-28 and no change is expected then.

Reserve Bank of New Zealand hiked rates 50 bp to 3.5%, as expected. It noted that “The Committee agreed it remains appropriate to continue to tighten monetary conditions at pace to maintain price stability and contribute to maximum sustainable employment. Core consumer price inflation is too high and labor resources are scarce.” The bank acknowledged that it discussed a 75 bp move today before settling on 50 bp. This maintains the more hawkish tone established at the last meeting August 17. The bank also noted that “A lower New Zealand dollar, if sustained, poses further upside risk to inflation over the forecast horizon.” The RBNZ didn’t make any reference to its most recent forecasts from August. Updated forecasts will come at the next meeting November 23, where WIRP suggests another 50 bp hike is priced in. The swaps market is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 5.25%, which is well above the bank’s current expected rate path. We expect a hawkish shift in the rate path next month, though a 5.25% peak seems a bit aggressive right now.

COMMODITIES

OPEC+ meets in Vienna today for the first in-person gathering since March 2020. Reports suggest the group will consider an output cut in excess of 1 mln bbl/day. The group cut output by 100k bbl/day last month but this has done little to arrest the slide in oil prices, which last week fell to the lowest levels since January. Prices have since recovered on these reports of larger than anticipated output cuts.

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