Dollar Recovers from Month-End Rebalancing

May 02, 2022

Win Thin

U.S. yields are rising again; Fed tightening expectations remain elevated; April ISM manufacturing PMI will be the highlight
ECB tightening expectations remain subdued; eurozone reported mixed data
Japan reported some minor data overnight

The dollar is recouping its pre-weekend losses. We viewed Friday’s softness as stemming from profit-taking and month-end rebalancing. With that out of the way, the greenback firm as the new week gets under way. DXY is trading near 103.415 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 $1.0525 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 near 130 today. We continue to look for a test of the 2002 high near 135.15. Sterling has been 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. 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 near 2.95% today, the highest since April 22 and nearing the April 20 high near 2.98%. Similarly, the 2-year yield traded near 2.75% today, the highest since April 22 and nearing that day’s high near 2.78%. This uptrend is likely to continue as U.S. inflation rune hot and the Fed continues its aggressive tightening cycle (see below). Of note, the 2-year interest rate differentials are moving back in the dollar’s favor after a brief corrective phase last week. In particular, the spreads with Japan (276 bp) and the U.K. (112 bp) continue to make new cycle highs, while the spread with Germany (248 bp) is lagging a bit. All three should continue to rise.

Fed tightening expectations remain elevated. The Fed is expected to hike rates 50 bp to 1.0% Wednesday. There will be no new forecasts until the June 14-15 FOMC meeting, when another 50 bp hike is widely expected. Indeed, WIRP suggests nearly 50% odds of a 75 bp hike then. Looking further out, the swaps market is now pricing in 300 bp of tightening over the next 12 months that would see the Fed Funds rate peak near 3.5%. Because of the media blackout, there are no Fed speaker until Chair Powell’s post-decision press conference Wednesday afternoon.

April ISM manufacturing PMI will be the highlight. Headline is expected at 57.6 vs. 57.1 in March. Looking at the components, new orders 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 Wednesday and is expected at 58.5 vs. 58.3 in March. Of note, April Chicago PMI came in last week at 56.4 vs. 62.9 in March and so there are downside risks to the ISM readings. March construction spending (0.8% m/m expected) will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

ECB tightening expectations remain subdued. WIRP suggests odds of liftoff June 9 are now around 30% vs. 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 peaking and 2) the risks to growth are mounting.

Eurozone reported mixed data. Final April manufacturing PMI readings came in at 55.5 vs. 55.3 preliminary. Germany improved to 54.6 vs. 54.1 preliminary and France improved to 55.7 vs. 55.4 preliminary. Italy and Spain were reported for the first time and both fell more than expected from March to 54.5 and 53.3, respectively. Final services and composite PMI readings will be reported Wednesday. Germany also reported weak March retail sales. Sales came in at -0.1% m/m vs. 0.2% expected and 0.2% in February. This drove the y/y rate down to -5.4% y/y vs. 6.8% in February, the first contraction since October and the worst since last February. Recall that German GDP rose only 0.2% q/q in Q1 and so it seems momentum was lost as it moved into Q2.

ASIA

Japan reported some minor data overnight. Final April manufacturing PMI came in a tick higher than the preliminary at 53.5, while vehicle sales fell -15.0% y/y vs. -14.8% in March. Lastly, consumer confidence came in at 33.0 vs. 34.2 expected and 32.8 in March. This modest recovery was not enough to offset the sharp drop in confidence since the year began. Japan markets will be closed until Friday for the Golden Week holidays. While speculators may try to take advantage of thin markets to push USD/JPY higher, our understanding is that the Bank of Japan maintains staffing during the Golden Week to monitor markets. That said, we continue to downplay FX intervention risks for now.

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