Dollar Roars Back Ahead of BOE Decision

November 04, 2021
  • The FOMC announced tapering will begin this month, as widely expected; despite the pushback, the market is still pricing in 50% odds for liftoff in Q2; Treasury announced its first reduction in its quarterly refunding in more than five years; U.S. data continue to surprise to the upside; minutes from the last Brazilian Central Bank (BCB) meeting read on the hawkish side
  • BOE is expected to keep rates steady at 0.10%; eurozone reported a slew of data; Norges Bank kept rates steady at 0.25%, as expected; Poland delivered hawkish surprise yesterday with a 75 bp hike to 1.25%; Czech National Bank is expected to hike rates 75 bp to 2.25%
  • BOJ Governor Kuroda and Prime Minister Kishida held their first regular meeting; oil prices are down for the third consecutive session, this time on favorable Iran headlines

The dollar is breaking higher ahead of the BOE decision due out shortly. DXY has recouped all of its post-FOMC losses and is trading near 94.30. The euro has resumed its slide and is approaching the cycle low near $1.1525 from October as the post-ECB euphoria wears off, while sterling is heavy and testing the $1.36 ahead of the BOE decision. USD/JPY is trading just below 114. As we suspected, there was so much priced in for the Fed that we did get a bout of profit-taking after the decision. Yet now that the dust has settled, the dollar should continue rising.

AMERICAS

The FOMC announced tapering will begin this month, as widely expected. The path for tapering will be as it was already flagged by the Fed, which will reduce asset purchases by $15 bln per month ($10 bln UST and $5 bln MBS) starting this month. If this pace is maintained, QE will effectively end by mid-June. However, the Fed said it is prepared to adjust the pace of tapering as warranted. On a dovish note, the Fed continues to push the transitory inflation theme, though Chair Powell admitted that the supply constraints are lasting longer than expected and could persist well into next year. He predicted that inflation would move down in Q2 or Q3.

 Despite the pushback, the market is still pricing in 50% odds for liftoff in Q2. Q3 liftoff is still fully priced in, as is another hike in Q4. This is much more aggressive than what the Fed itself anticipates, at least in the Dot Plots. Of note, Powell stressed that the focus of the meeting was tapering, not hiking rates. We suspect the Fed will continue pushing back against such aggressive tightening expectations, but so far, the market isn’t listening. Next forecasts and Dot Plots will come at the December 14-15 meeting.

Speaking of tapering, the U.S. Treasury announced its first reduction in its quarterly refunding in more than five years. Treasury announced it will sell $120 bln of long-term securities next week, down $6 bln from the record levels seen in the past three quarterly refundings. It said that after “modest reductions” over the three months through January, “additional issuance-size changes will be announced quarterly in subsequent refunding statements.” The deepest cuts will reportedly be in 7- and 20-year USTs, which saw the biggest increases in issuance during the pandemic. The exception will be TIPS, which won’t see any cuts to issuance amounts.

The U.S. data continue to surprise to the upside. Yesterday, ADP reported 571k private sector jobs were added in October. Consensus was 400k, while September was revised to 523k from 568k previously. October ISM services PMI came in at 66.7 vs. 62.0 expected and 61.9 in September, which was the highest since the series began in 1997. The employment component fell to 51.6 vs. 53.0 in September, while price paid rose to 82.9 vs. 77.5 in September. All signs continue to point to a good NFP Friday. Consensus is 450k but we suspect it will creep up after this latest round of data. Prices paid is of course a concern but the bottom line is that the US economy remains strong as we move through Q4.

Weekly jobless claims today are expected to continue falling to new pandemic lows. Initial claims are expected at 275k vs. 281k the previous week, while continuing claims are expected at 2.15 mln vs. 2.243 mln the previous week. October Challenger job cuts, Q3 Unit Labor Costs (7.0% SAAR expected), and September trade (-$80.2 bln expected) will also be reported. Canada also reports September trade data (CAD1.6 bln expected).

The minutes from the last Brazilian Central Bank (BCB) meeting read on the hawkish side. Markets were disappointed that the bank “only” delivered a 150 bp hike to 7.75%, but it seems ready to continue the cycle until inflation is in check, and we think they will do just that. Beyond the data, the BCB will also have to account for the high-risk of fiscal slippage, the upcoming elections, and the recent weakness in BRL. All in all, the bank is making all the right moves, in our view, starting with frontloading the cycle and gently leaning against FX weakness though moderate intervention when necessary. Next COPOM meeting is December 8 and the CDI market is pricing in a 200 bp hike then.

EUROPE/MIDDLE EAST/AFRICA

Bank of England is expected to keep rates steady at 0.10%. However, the market is split as nearly half the analysts polled by Bloomberg expect the BOE to start the tightening cycle with a 15 bp hike to 0.25%. WIRP suggests it’s about 50-50 and so the market truly is split. Conviction has wavered in recent days, as a hike was pretty much fully priced in last month. That said, a hike at the December 16 meeting is fully priced in now and so it seems like it’s just a matter of timing for the markets. Of note, the swaps market is pricing 125 bp of tightening over the next twelve months. New macro forecasts will be released today and should give some clues about the likely timing and length of the tightening cycle.

Eurozone reported a slew of data. Final October services and composite PMI readings came out and both headline readings fell a tick from the preliminary to 54.6 and 54.2, respectively. German and French composite PMIs were unchanged from the preliminary at 52.0 and 54.7, respectively. Italy and Spain composite PMIs were reported for the first time and came in at 54.2 and 56.2, down significantly from 56.6 and 57.0 in September, respectively. Eurozone September PPI was also reported and jumped 16.0% y/y vs. 15.4% expected and 13.4% in August. Germany reported September factory orders. They were expected to rise 1.8% m/m but instead rose 1.3% vs. a revised -8.8% (was -7.7%) in August. German IP will be reported tomorrow and is expected to rise 1.0% m/m vs. -4.0% in August. France also reports IP tomorrow and is expected flat m/m vs. 1.0% in August.

Norges Bank kept rates steady at 0.25%, as expected. The bank started the tightening cycle September 23 with a 25 bp hike to 0.25%. The bank said then that the next hike was “most likely” in December, and this was confirmed today. A new rate path will be released at that meeting and should be much steeper than the one from September, as Governor Olsen has suggested that the bank could hike rates 25 bp per quarter. Of note, the swaps market is pricing 100 bp of tightening over the next twelve months, which is consistent with Olsen’s forward guidance.

Poland central bank delivered hawkish surprise yesterday with 75 bp hike to 1.25%. Consensus saw a 25 bp hike. Despite having invoked the ECB’s “whatever it takes” meme when speaking about containing inflation, the communication was more balanced. The bank giving no assurance that this is the start of a protracted rate cycle. Still, this is clearly not over yet. Inflation is expected to peak around 7-8%, well above the 1.5-3.5% target range. Swaps market is pricing in 250 bp of further tightening over the next twelve months.

Czech National Bank is expected to hike rates 75 bp to 2.25%. However, the market is split as nearly half the analysts polled by Bloomberg see a smaller 50 bp hike to 2.0%. The bank started the tightening cycle with a 25 bp hike to 0.75% in August, then followed up with a larger than expected 75 bp hike to 1.5% in September by a 5-2 vote. Governor Rusnok said then that the rate hike debate is now about pace and magnitude, suggesting there is still quite a bit of tightening ahead. CPI rose 4.9% y/y in September, the highest since October 2008 and further above the 1-3% target range. As such, we see some risks of a hawkish surprise today.

ASIA

Bank of Japan Governor Kuroda and Prime Minister Kishida held their first regular meeting. Of note, the two reaffirmed the BOJ’s commitment to meeting its 2% target for core inflation. Kuroda said “We discussed the economic and financial situation domestically and abroad, and I’ve explained the BOJ’s stance on monetary policy.” Kuroda reportedly shared details of his meeting with government ministers earlier this week, when it was announced that both would adhere to the 2013 joint statement that set out the 2% target. It seems the BOJ is trying hard to burnish its dovish credentials even as other central banks are forced to tilt more hawkish. For now, it’s working, as the swaps market sees only 2 bp of potential tightening over the next twelve months. Admittedly, Japan is unique in that it is one of the only countries in the world that is still experiencing low inflation.

COMMODITIES

Oil prices are down for the third consecutive session, this time on favorable Iran headlines. Bloomberg reports that Iran will resume talks about its nuclear program this month. This will be the seventh round, with Europe and Russia acting as intermediaries between the U.S. and Iran. An agreement – which is nowhere near assured – would mean the end of sanctions against Iranian oil, hence another source of global supply. Brent is trading at $81.9 per barrel, down from a recent high of $86.5.

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