Dollar Remains Under Modest Pressure

January 23, 2023
  • There are no Fed speakers this week due to the media embargo ahead of the January 31-February 1 FOMC meeting; the U.S. yield curve remains deeply inverted
  • German officials are getting a bit too optimistic; the U.K. is still facing tight power markets as cold weather hits; Fitch cut the outlook for Hungary’s sovereign rating to negative to stable
  • Minutes from the BOJ’s December meeting contained a surprise; BOJ tightening expectations have steadied; New Zealand has a new Prime Minister

The dollar remains under modest pressure. DXY is trading lower for the fourth straight day just below 102. After making a new cycle low last week near 101.528, DXY is on track to test the May low near 101.297. The euro is trading flat near $1.0880 after making a new cycle high today near $1.0925, just shy of the April high near $1.0935. Break above that would set up a test of the March high near $1.1185. Sterling is trading lower near $1.2350 after making a new cycle high today near $1.2450 and just above the December high near $1.2445. Clean break above that would set up a test of the May high near $1.2665. USD/JPY is trading higher and back above 130 as last week’s high near 131.60 comes back into focus. China is closed all week for the Lunar New Year holiday. While we believe that the current dollar weakness is overdone, we continue to respect the price action. Until a more hawkish Fed narrative emerges, the dollar is likely to remain under pressure.


There are no Fed speakers this week due to the media embargo ahead of the January 31-February 1 FOMC meeting. During this quiet period, the markets typically go with the trend in place and right, that trend is for a less hawkish Fed. As measured by the Chicago Fed, U.S. financial conditions are the loosest since last April (since last February for the adjusted series) and if conditions get even looser by February 1, we believe Powell and his colleagues will once again try to deliver a wake-up call for the markets..

Fed tightening expectations are too dovish. WIRP suggests a 25 bp hike February 1 is fully priced in, with less than 5% odds of a larger 50 bp move. Another 25 bp hike March 22 is about 80% priced in, while one last 25 bp hike in Q2 is only 30% priced in. We think these odds are too low. Furthermore, the swaps market continues to price in an easing cycle by year-end and we just don’t see that happening. But until this Fed narrative changes, however, the dollar is likely to remain under pressure. Today, only December leading index will be reported and is expected at -0.7% m/m vs. -1.0% in November.

The U.S. yield curve remains deeply inverted. As such, we are puzzled by the growing market confidence that the Fed can achieve a soft landing. For December, the New York Fed’s model showed nearly 50% odds of a recession in the next twelve months. Those odds have likely risen in January. While we have long been very bullish on the U.S. economic outlook and remain so, it’s impossible for us to see how a recession is avoided. The same goes for Europe, where officials there are increasingly tempting fate by predicting that recession will be avoided (see below). Within the global spectrum, we continue to believe that the U.S. outperforms. Period. And by no means can we yet deny the old adage that “when America sneezes, the world catches a cold.”


German officials are getting a bit too optimistic. Bundesbank President Nagel predicted that “We will get inflation under control in such a manner that what many fear does not occur, namely that is does not come to a recession in the euro area.” Last week, Chancellor Scholz said that Germany would avoid recession. We think it’s awfully early to declare victory, especially since core inflation continues to accelerate. Yes, some sentiment indicators have improved in recent months but the bulk of the ECB’s 250 bp of tightening so far hasn’t really been felt yet due to the lags in monetary policy. With another 150 bp of tightening expected this year, it’s hard to see how the eurozone doesn’t avoid recession. The warmer than normal weather has helped, as has news of China reopening, but we don’t think that’s enough to stave off recession. Of note, Spain will be the first to report Q4 GDP data this Friday.

ECB tightening expectations are little changed. WIRP suggests a 50 bp hike February 2 is almost fully priced in, followed by nearly 75% odds of another 50 bp hike March 16. A 25 bp hike May 4 is about 85% priced in, while a last 25 bp hike in Q3 is about 80% priced in that would see the deposit rate peak near 3.5%. If inflation continues to slow, we think the expected peak rate is likely to move back down to 3.25% as it did last week and perhaps even down to 3.0%, which is where it stood back in mid-December. December M3 data will be reported Friday and is expected at 4.6% y/y vs. 4.8% in November.

The U.K. is still facing tight power markets as cold weather hits. National Grid has asked some U.K. households to cut energy use today and is likely to extend that request to tomorrow due to a drop in wind power coupled with freezing temperatures across the nation. Grid official said “Our forecasts show electricity supply margins are expected to be tighter than normal on Monday evening. These are precautionary measures to maintain the buffer of spare capacity.” Of note, this emergency measure to reduce electricity demand was previously in test mode but has now gone live. So far this winter, Europe has been fortunate to experience warmer than normal weather and so the economic outlook has improved.

BOE tightening expectations remain steady. WIRP suggest nearly 85% odds of a 50 bp hike February 2, while a 25 bp hike March 23 is now priced in rather than 50 bp previously. After that, a 25 bp hike in June is priced in that would see the bank rate peak near 4.5%. Last week, Governor Bailey said inflation had peaked and will fall “quite rapidly” in late spring due to largely energy prices.

Fitch cut the outlook for Hungary’s sovereign rating to negative to stable. The rating remains at BBB, which matches S&P and Moody’s. The agency noted “A tougher international environment, including higher global interest rates, volatile energy prices and weakening demand from key trading partners is exposing vulnerabilities stemming from a policy mix that is influenced by political considerations.” It added that “Fitch sees a high probability of delays in the disbursement of EU funds. Although the direct impact of a delay in disbursements on medium-term growth and external finances would be modest, in Fitch’s opinion it would raise further questions over policy credibility, highlight governance challenges and potentially hurt investor sentiment.” Of note, S&P cut Hungary’s outlook to negative back in August. HUF is the worst EM performer today against both USD and HUF. Of note, the 50- and 200- day moving averages for EUR/HUF are about to cross to the downside, suggesting the pair will likely continue moving lower after today’s hiccup.


Minutes from the Bank of Japan’s December meeting contained a surprise. Apparently, government representatives requested an urgent time out and so the meeting was adjourned from 1051 AM to 1128 AM local time. The meeting then concluded at 1154 AM with the surprise tweak to Yield Curve Control. This was the first adjournment since the June 2021 meeting. Press reports suggest that the adjournment led to an unscheduled discussion between government and BOJ officials and came as a complete surprise to the government. However, the minutes show that representatives from the Ministry of Finance and the Cabinet Office eventually signed off on the move and accepted the bank’s explanation that it was aimed at enhancing the sustainability of monetary stimulus. Most importantly, board members were aware of the risks that the widening of the YCC trading band could be misinterpreted by the markets and discussed the need to clearly communicate that the move wasn’t a step toward normalizing policy. Markets did test the 0.5% upper limit for the 10-year yield but this has since ebbed after the bank stood pat at the January 17-18 meeting.

BOJ tightening expectations have steadied. WIRP suggests only 5% odds of liftoff at the next meeting March 9-10, rising to nearly 55% for the April 27-28 meeting and nearly priced in for the June 15-16 meeting. If markets resume testing the BOJ’s commitment to YCC, we still think it’s quite possible that it abandons YCC at the March meeting in order to set up liftoff at the April or June meetings.

New Zealand has a new Prime Minister. Over the weekend, the Labour Party selected Chris Hipkins to replace Jacinda Ardern, who stepped down last week. Hipkins pledged that “As prime minister, I will lead a team that’s focused and working hard to fix the big issues that so many families and businesses are facing.” In a signal of a likely policy shift, he added “Over the coming week, cabinet will be making decisions on reining in some programs and projects that aren’t essential right now. We will be focused on middle and low-income New Zealanders.” Of note, Hipkins named Carmel Sepuloni as Deputy Prime Minister. She replaces Grant Robertson, who is expected to remain Minister of Finance. Hipkins faces an uphill battle to win a third Labour term as the opposition National Party and its ally ACT Party area ahead in the polls. Ardern has called the election for October 14, giving Hipkins around nine months to claw back popular support for Labour. Stay tuned.

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