Dollar Remains Under Pressure as U.S. Yields Fall

October 04, 2022

Win Thin

Yields and the dollar have fallen as soft U.S. data has renewed the notion of a potential pivot; softer real sector data will not deter the Fed from hiking rates further; indeed, Fed officials remain hawkish; September ISM manufacturing came in weaker than expected
The Truss tax plan may be dead in the water; market expectations for BOE tightening have eased in recent days; eurozone reported August PPI
September Tokyo CPI data point to a higher national reading; RBA hiked rates 25 bp to 2.60% vs. 50 bp expected

The dollar remains soft on lower U.S. yields. DXY is down for the fifth straight day and trading at the lowest level since September 22 near 111.114. Sterling traded as high as $1.1430 today and charts point to a test of the September 13 high near $1.1740. However, we see limited upside as the bulk of the fiscal plan remains intact, at least for now (see below). The euro is riding sterling’s coattails and traded as high as $0.9905 today. Break above $0.9945 would set up a deeper recovery to the September 12 high near $1.02. USD/JPY continues to flirt with the 145 area but has yet to trade above yesterday’s high near 145.30. This move higher in USD/JPY should continue as markets test the BOJ’s resolve. AUD is underperforming after the RBA delivered a dovish surprise (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 current correction.

AMERICAS

Yields and the dollar have fallen as soft U.S. data has renewed the notion of a potential pivot. This has been reflected in market pricing, with U.S. yields falling across the board. The 2-year yield traded as low as 3.99% today and compares to the September 26 peak near 4.35%, while the 10-year yield traded as low as 3.56% today and compares to the September 28 peak near 4.02%. The pendulum of sentiment is always swinging and right now, it is swinging against the dollar and higher yields. At some point, it will swing back the other way as the U.S. economy remains resilient and inflation remains persistent.

We must stress that softer real sector data will not deter the Fed from hiking rates further. Inflation remains stubbornly high and there is no question that the Fed will accept a recession if that is what is needed to get inflation back to target. WIRP suggests less than 70% odds of a 75 bp hike November 2 but we believe it’s a done deal. Elsewhere, the swaps market is now pricing in a peak policy rate of 4.5% vs. 4.75% last week. This too should adjust if inflation remains persistently high.

Indeed, Fed officials remain hawkish. Williams said “Tighter monetary policy has begun to cool demand and reduce inflationary pressures, but our job is not yet done.” He added that policy “is not yet in a restrictive place for growth” and that “My view is we still have a significant ways to go.” Elsewhere, Bostic said that shifts in global supply chains are adding to price pressures and noted “Such a fundamental shift in global sourcing strategies would almost certainly put upward pressure on prices. Obviously, elevated inflation today is the most pressing issue facing monetary policymakers. And by creating long-term upward price pressure, then secular shifts in supply chain management could present additional challenges for monetary policymakers during a period of already elevated inflation.”

Barkin acknowledged that the strong dollar has potential spillover effects on the global economy but stressed that the Fed is ultimately focused on the U.S. economy. Specifically, he said “The thing you worry about is what collateral damage could there be to international economies and in particular their financial systems. There are a lot of countries in the world that have chosen to borrow in dollars and so these get more expensive. You could worry about the risk of financial contagion….But in the end, our mandate is to help operate the U.S. economy. So you worry about it most in terms of does it affect the US economy.” This is the major reason why we believe the bar is very high for any coordinated G7 effort to weaken the dollar. If the U.S. is not on board, it won’t work. Logan, Williams, Mester, Jefferson, and Daly speak today.

We get some minor data today. JOLTS job openings are expected at 11.088 mln vs 11.239 mln in July. The labor market is no longer red hot but it remains firm nonetheless. We get September ADP private sector jobs data tomorrow as the lead-in to NFP Friday. Consensus for ADP is 200k and for NFP is 265k, up from 250k at the start of this week. August factory orders will also be reported today and are expected flat m/m vs. -1.0% in July.

September ISM manufacturing came in weaker than expected. Headline came in at 50.9 vs. 52.0 expected and vs. 52.8 in August, the lowest since May 2020. Employment came in at 48.7 vs. 53.0 expected and 54.2 in August while new orders came in at 47.1 vs. 50.5 expected and 51.3 in August. Of note, supplier deliveries fell to 52.4 vs. 55.1 in August, the lowest since December 2019, while backlog of orders fell to 50.9 vs. 53.0 in August, the lowest since June 2020. The lower these two numbers are, the lower the strains in the supply chains. This is obviously a good sign for inflation going forward, as is the prices paid component falling to 51.7, also the lowest since June 2020. ISM services PMI will be reported tomorrow, with headline expected at 56.0 vs. 56.9 in August.

EUROPE/MIDDLE EAST/AFRICA

The Truss tax plan may be dead in the water. Even though she and Chancellor Kwarteng have committed to pushing through the rest of their agenda, reports suggests they have spent (misspent?) all of their political capital. Unnamed Tory Cabinet members say that Truss will struggle to pass anything of significance as she has damaged relations with her party because she failed to take the basic steps needed to line up support within her party, including debate within the Cabinet. Of note, Kwarteng will reportedly bring forward the announcement of the fiscal plan that was originally due November 23, though no new date has been set yet. It will also include forecasts from the Office for Budget Responsibility which the government has so far bypassed.

Market expectations for BOE tightening have eased in recent days after the U-turn on the top tax rate. WIRP now 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 5.25% vs. the cycle high near 6.25% last week. Treasury Select Committee Chairman Stride noted “Provided the OBR forecast and new fiscal targets are credible then bringing these forward should calm markets more quickly and reduce the upward pressure on interest rates to the benefit of millions of people up and down the country.” He added that releasing the details before the next BOE meeting “should help to reassure our rate setters that they can go with a smaller base rate increase than would otherwise be the case.”

The eurozone reported August PPI. It came in a tick higher than expected at 43.3% y/y vs. a revised 38.0% (was 37.9%) in July. After some relief in May and June, PPI inflation has resumed climbing to new record highs and points to continued upward pressure to CPI. However, ECB tightening expectations have fallen in recent days. WIRP suggests nearly 70% odds of a 75 bp hike October 27, while the swaps market is pricing in a peak policy rate near 2.5%, down from 3.25% last week.

ASIA

September Tokyo CPI data point to a higher national reading. Headline fell a tick as expected to 2.8% y/y, while core (ex-fresh food) picked up two ticks as expected to 2.8% y/y. Core is the highest since June 2014. Of note, core ex-energy picked up three ticks to 1.7% y/y. We know that high inflation is causing some concern amongst the ruling LDP, as evidenced by reports of yet another fiscal package in the works. We also know from various BOJ comments that the bank really wants to see a sustained rise in wages before it will contemplate an exit from stimulus, so the earnings data has taken on just as much importance as the CPI data. For now, the BOJ is on hold. Next policy meeting is October 27-28 and no change is expected then. However, we expect the market to continue testing its commitment to YCC and to defending the yen.

Reserve Bank of Australia hiked rates 25 bp to 2.60% vs. 50 bp expected. However, there was a split between the analyst community and the market as WIRP suggested only 60% odds of a 50 bp hike. Governor Lowe stated that “The cash rate has been increased substantially in a short period of time. Reflecting this, the Board decided to increase the cash rate by 25 bp this month as it assesses the outlook for inflation and economic growth in Australia.” While the RBI said it expects to hike rates further, it’s clear that the RBA is nearing the end of the tightening cycle. WIRP suggests less than 75% odds of a 25 bp hike at the next meeting November 1, while the swaps market sees the policy rate peaking near 4.05%. Since updated macro forecasts were released at the August 2 meeting, we won’t see the next update until the November 1 meeting.

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