Dollar Remains Firm as FOMC Meeting Begins

June 11, 2024

Win Thin

Two-day FOMC meeting begins today ends tomorrow with an expected hawkish hold; updated Dot Plots will be important; we look for a hawkish shift in the longer-term Fed Funds rate; the dollar tends to weaken on FOMC decision days; Brazil reports May IPCA inflation
ECB officials remain cautious; U.K. reported labor market data
Australia’s NAB May business survey was mixed; PBOC is allowing the yuan to weaken; BOK minutes suggest some policymakers are ready to ease

The dollar continues to gain as the FOMC meeting gets under way. DXY is trading higher for the third straight day near 105.253. Clean break above 105.536 sets up a test of the May 1 high near 106.490. The euro is leading this move lower in the foreign currencies and is trading lower near $1.0745. Clean break below $1.0750 sets up a test of the May 1 low near $1.0650. Sterling continues to hold up relatively better and trading higher near $1.2745 after mixed labor market data (see below). USD/JPY is edging higher to trade near 157.20 and clean break above 157 sets up a test of the April 29 high near 160.15. MXN continues to underperform on ongoing political uncertainty. Data last week support our view that the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. The Fed is widely expected to deliver a hawkish hold tomorrow (see below) even as central banks elsewhere are cutting rates. Recent developments underscore the widening economic and monetary policy divergences that support the U.S. dollar and that should continue this week.

AMERICAS

Two-day FOMC meeting begins today ends tomorrow with an expected hawkish hold. There is a lot for the Fed to consider but in the end, they will have no choice but to keep rates on hold for the foreseeable future. Since the May 1 decision, there has been little progress on getting inflation moving back towards the 2% target. In fact, some key inflation metrics such as super core PCE have actually picked up. Real sector data have been mixed but remain relative robust on the whole even as financial conditions remain loose. Markets have taken notice, with odds of a September cut basically a coin flip and odds of a November cut around 85%.

Updated Dot Plots will be important. It would take only one Fed policymaker to move from three cuts to two to raise the 2024 median by a similar magnitude from 4.625% to 4.875%. Getting an even bigger move will be a bit more difficult. By our calculations, it would take an additional five policymakers to shift from two cuts to one to raise the median 2024 Dot to 5.0%. Looking ahead, the median Dot for 2025 currently stands at 3.875%. This implies three cuts next year, which seems reasonable, but the 2025 median would have to shift higher along with 2024’s.

Looking even further ahead, we look for a hawkish shift in the longer-term Fed Funds rate. This is the Fed’s proxy for r* and it shifted up in March to 2.563% vs. 2.5% in December. We know the debate about r* continues to rage, not just here but in many other countries. Indeed, both BOC and RBNZ recently raised estimates of their r*. For the Fed’s longer-term rate, it would take only two Fed policymakers to move to 2.75% to get the same shift in the median to 2.75% and that’s what we look for.

Updated macro forecasts will also be released. Growth and unemployment forecasts may be adjusted to reflect recent softness in the data, while PCE and core PCE forecasts will likely be nudged higher for 2024 to reflect sticky inflation.
The dollar tends to weaken on FOMC decision days. It has done so four straight times, starting with the December meeting. The September and November 2023 FOMC meetings resulted in rare dollar gains. Before those two meetings, the dollar had weakened seven straight meetings and 11 of the past 12.

New York Fed inflation expectations remained high in May. 1-year expectations fell a tick to 3.2%, while 3-year expectations were steady at 2.8% and 5-year expectations rose two ticks to 3.0%. All three measures remain stuck above the 2% target and will be concerning to the Fed. Of note, University of Michigan consumer sentiment for May will be reported Friday. 1-year inflation expectations are expected to fall a tick to 3.2%, while 5- to 10-year expectations are expected to remain steady at 3.0%.

NFIB small business optimism for May is the only U.S. data today. Headline came in at 90.5 vs. 89.7 expected and actual in April. This was the second straight rise to the highest since December but still falls short of the mid-2023 peak near 91.9.

U.S. growth remains solid. Atlanta Fed's GDPNow model is now tracking Q2 growth at 3.1% SAAR, up from 2.6% previously. Next update comes June 18 after the data. NY Fed's Nowcast model is tracking Q2 growth at 1.9% SAAR vs. 1.8% previously. We also got its first estimate for Q3 at 2.0% SAAR. Both will be updated Friday.

Brazil reports May IPCA inflation. Headline is expected at 3.88% y/y vs. 3.69% in April. If so, it would be the first acceleration since September but would remain well within the 1.5-4.5% target range. Next COPOM meeting is June 19, and no change is expected as the easing cycle has likely ended. Indeed, the market is snow pricing in 25 bp of tightening over the next three months, which seems too aggressive.

EUROPE/MIDDLE EAST/AFRICA

ECB officials remain cautious. President Lagarde said "We've made the appropriate decision, but it doesn't mean interest rates are on a linear declining path. There might be periods where we hold rates again." Rehn said, “We are not pre-committing to any rate path.” Simkus said, “It’s too early to raise a victory flag.” Villeroy was more balanced, noting that “As regards our next rate cuts, I plead for a “pragmatic gradualism”, both on the timing, without haste nor procrastination.” Villeroy (again), Holzmann, Lane, Makhlouf, and Elderson speak later today. Despite the hawkish tone, the market still sees around 75% odds of a 25 bp cut September 12, followed by around 60% odds for another cut December 12. In our view, the ECB has room to deliver those cuts. With the Fed likely to deliver a hawkish hold this week, the monetary policy divergences will continue to widen.

U.K. reported labor market data. Average weekly earnings ex-bonuses came in a tick lower than expected and remained steady for the third straight month at 6.0% y/y, while total weekly earnings came in two ticks higher than expected at 5.9% y/y and remained steady from a revised (was 5.7%) reading for April. However, private sector wages slowed a tick to 5.8% y/y, the lowest since June 2022 but still tracking higher than the BOE’s Q2 projection of 5.1% y/y. Elsewhere, the unemployment rate unexpectedly rose a tick to 4.4% in the three-month period to April and was the highest since September 2021. That said, the labor market remains historically tight as the unemployment rate is around the BOE’s medium-term equilibrium level of around 4.5%. While a November cut remains fully priced in, the odds of a September cut have risen to 70%.

ASIA

Australia’s NAB May business survey was mixed. Business confidence dropped to a six-month low of -3 vs. 1 in April, while business conditions fell a point to 6, just below the long-run average. However, the employment sub-component improved while price growth measures rose. In our view, this is enough to keep the RBA cautious from easing too early. As a result, AUD can edge higher versus CAD because of the monetary policy divergences as BOC is already easing.

PBOC is allowing the yuan to weaken. USD/CNY traded at the highest since November after the PBOC fix came in at the weakest since mid-January. For now, we think the PBOC just allows the yuan to weaken along with the rest of EM, as any big moves in the currency will just encourage more capital flight and weaken the yuan even more. USD/CNY should eventually retest the September high near 7.35. After that, there are no real chart points until you get to the old peg at 8.28, which seems too far away right now.

Bank of Korea minutes suggest some policymakers are ready to ease. At the May 23 meeting, one board member said, “In terms of inflation, it appears that necessary conditions for easing the restrictiveness of policy are gradually being met, given the lagging effects of monetary policy.” However, minutes showed that most other board member remained cautious and wanted to monitor inflation trends further before pivoting policy. Of note, Governor Rhee said after the May decision that “Uncertainties over the timing of a rate cut have grown. If there is confidence that inflation stabilizes, the task of normalizing the rate level would need to be started.” Next meeting is July 11, and no change is expected then. The swaps market still sees steady rates over the next six months, followed by 25 bp of easing over the subsequent six months.

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