Dollar Roars, Sterling Pounded After Tax Plan

September 23, 2022
  • U.S. yields continue to march higher; S&P Global preliminary September PMI readings will be the highlight; weekly jobless claims are worth discussing; Canada reports July retail sales
  • The U.K government announced a massive tax cut package; this will all come at a huge cost; Truss is taking a huge gamble; BOE tightening expectations have picked up; the U.K. reported soft preliminary September PMI readings; eurozone preliminary September PMI readings were reported; SARB hiked rates 75 bp to 6.25%, as expected
  • Whether the BOJ intervention will succeed depends on how one defines success; the U.S. was noticeably absent from the intervention exercise; Australia reported preliminary September PMI readings

The dollar remains firm as Fed tightening expectations march higher. DXY is up for the fourth straight day and traded at a new cycle high near 112.336 before coming off a bit to trade near 112 currently. Sterling is the worst performer today as markets give a thumbs down to the massive tax cut package that was unveiled (see below). It traded at a new cycle low earlier near $1.1025, the lowest since 1985. Charts point to a test of the February 1985 all-time low near $1.0520 and some sterling bears are talking about parity. USD/JPY is creeping higher to trade near 143 as the BOJ refrained from another round of intervention. The euro remains heavy and also traded at a new cycle low near $0.9735. We maintain our next target at the June 2002 low near $0.9305. The repricing of Fed tightening risks is likely to keep the dollar bid across the board near-term. With the outlook for the rest of the world still worsening, the global backdrop continues to favor the dollar and U.S. assets in general.


Let’s take a step back and review what happened this week with the major central bank decisions. Obviously, the Fed stands out for its 75 bp hike and a more hawkish path. The Riksbank also delivered a hawkish surprise with a 100 bp hike. On the other end of the spectrum, the BOJ stands out for its ongoing dovishness. The BOE also delivered a dovish surprise with a 50 bp hike. In between, the SNB hiked 75 bp and Norges Bank hiked 50 bp, both as expected. That is an awful lot of monetary tightening and there’s more to come. Yes, some of the banks may be nearing the end of their tightening cycles but the big ones (the Fed, ECB, BOJ, and BOE) are nowhere close to the end. As a result, risk assets (EM, equities, spread product) are likely to remain under pressure well into 2023.

U.S. yields continue to march higher. The 2-year yield traded near 4.22%, the highest since October 2007, while the 10-year yield traded near 3.77%, the highest since February 2011. The real 10-year yield traded near 1.35%, the highest since March 2010. This generalized increase in U.S. yields is likely to continue and will ultimately support the dollar. Of note, the 3-month to 10-year curve has steepened to 57 bp, the steepest since July, and so we are not yet ready to call for an imminent recession in the U.S. WIRP suggests a 75 bp hike November 2 is almost fully priced in as well as a terminal rate near 4.75%.

S&P Global preliminary September PMI readings will be the highlight. Manufacturing is expected to fall half a point to 51.0 while services is expected to rise nearly two points to 45.5, which would bring the composite up one and a half points to 46.1. Of note, the S&P Global readings have significantly underperformed the ISM readings in recent months. Given what we are seeing in the hard data, we believe ISM better captures the state of the U.S. economy now than S&P Global does. Yesterday, Kansas City Fed manufacturing survey came in at 1 vs. 5 expected and 3 in August. These regional Fed surveys have been coming in soft as last week, Empire came in at -1.5 vs. -31.3 in August and Philly Fed came in at -9.9 vs. 6.2 in August.

Weekly jobless claims are worth discussing. Initial claims were for the BLS survey week containing the 12th of the month and came in at 213k vs. a revised 208k (was 213k) the previous week, the lowest since late May. The four-week moving average fell to 217k, the lowest since early June. Continuing claims are reported with a one-week lag and so next week’s reading will be for the BLS survey week. That said, these claims fell to 1.379 mln this week, the lowest since mid-July. Current consensus for September NFP is 250k vs. 315k in August but there are still many more clues to come.

Canada reports July retail sales. Headline is expected at -2.0% m/m vs. 1.1% in June, while ex-auto is expected at -1.0% m/m vs. 0.8% in June. After the weaker than expected August jobs data, markets are on alert for further signs of softness in the Canadian economy. Bank of Canada tightening expectations have fallen recently. It's clear from the bank's recent comments that is moving away from jumbo hikes and will instead see how the data come in. WIRP suggests a 50 bp hike is fully priced in for the next meeting October 26, while the swaps market is pricing in 75 bp of tightening over the next 6 months that would see the policy rate peak near 4.0%, down from 4.5% earlier this month. New macro forecasts will be released at next month’s meeting and will be crucial for forward guidance.


The U.K government announced a massive tax cut package, as widely expected. Prime Minister Truss promised these tax cuts during her campaign to lead the Tories and Chancellor Kwarteng has delivered the goods. The planned income tax cut was moved up by a year and leaves the headline rate at 19% in 2023 and eliminated the top 45% rate. The planned 12.5% increase in the National Insurance taxes was eliminated, as was the planned hike in the corporate tax rate that leaves the headline rate at 19%. Kwarteng also cut the stamp duty on property purchases and confirmed the government’s previously announced plans to support U.K. households and firms hurt by high energy costs. Former Chancellor Sunak’s efforts at fiscal conservatism have been totally rejected by Kwarteng.

This will all come at a huge cost. The Debt Management Office increased its gilt sales plan for 2022-23 by GBP62.4 bln ($69.8 bln) to GBP193.9 bln to fund the package, higher than the expected GBP60 bln increase. The increased issuance comes just as the BOE announced active gilt sales beginning next month, which will put even more upward pressure on U.K. yields above and beyond the BOE’s tightening. Government officials are downplaying the inflationary impact of the package but the fact of the matter is that fiscal stimulus will offset monetary tightening at a time when inflation is already running above target.

Truss is taking a huge gamble. While tax cuts are very popular with the Tories and helped her win the leadership, we suspect it will end up being a harder sell for the general populace if the economic outlook continues to deteriorate. The next general election is due by January 2025 and this long-term fiscal experiment may end up in tears over the next 12-18 months. For now, the market is voting with their feet as sterling tumbles and gilt yields spike. This is only likely to get worse.

Bank of England tightening expectations have picked up. WIRP suggests a 100 bp hike at the next meeting November 3 is nearly 50% priced in. Looking ahead, the swaps market is now pricing in 300-325 bp of tightening over the next 12 months that would see the policy rate peak between 5.25-5.5%, up from 4.5-4.75% at the start of this week. And yet the higher expected rate path has done nothing for sterling. Market confidence, once lost, is always difficult to regain. Stay tuned.

The U.K. reported soft preliminary September PMI readings. Headline manufacturing came in at 48.5 vs. 47.5 expected and 47.3 in August, services came in at 49.2 vs. 50.0 expected and 50.9 in August, and the composite came in at 48.4 vs. 49.0 expected and 49.6 in August. This was the lowest composite reading since January 2021.

Eurozone preliminary September PMI readings were reported. Headline manufacturing came in at 48.5 vs. 48.8 expected and 49.6 in August, services came in at 48.9 vs. 49.1 expected and 49.8 in August, and the composite came in as expected at 48.2 vs. 48.9 in August. This was the lowest composite reading since January 2021. Looking at the country breakdown, the German composite came in at 45.9 vs. 46.1 expected and 46.9 in August and the French composite came in at 51.2 vs. 49.9 expected and 50.4 in August. Italy and Spain will be reported with the final PMI readings in early October.

South African Reserve Bank hiked rates 75 bp to 6.25%, as expected. The vote was 3-2, with the dissents in favor of a larger 100 bp hike. Of note, its model rate path was little changed and sees the policy rate at 5.60% by year-end vs. 5.61% previously, at 6.36% by end-2023 vs. 6.45% previously, and at 6.76% by end-2024 vs. 6.78% previously. However, the swaps market is pricing in a peak policy rate near 8.25% over the next 12 months. That disparity between the SARB and the market helps explain recent ZAR weakness. After outperforming in H1, the rand is one of the worst performers so far in Q3. USD/ZAR is trading at the highest since May 2020 and is on track to test the all-time high near 19.3510 from April 2020.


Whether the BOJ intervention will succeed depends on how one defines success. If success means reversing the weak yen trend, then the answer is no, the intervention is doomed to failure as long as the BOJ maintains its ultra-loose policy. Indeed, a 2.5% move overall in USD/JPY is hardly anything to crow about. On the other hand, if success means slowing the move and introducing more two-way risk in the FX market, then success is possible. What’s complicating things is that it’s not really a weak yen problem as much as it is a strong dollar problem. It’s just that the BOJ’s stance is magnifying these FX moves. We continue to believe that the BOJ will keep policy steady at least through the end of Governor Kuroda’s term in April It will be left to his successor to engineer an exit from stimulus when the time is right. This means further yen weakness ahead.

The U.S. was noticeably absent from the intervention exercise. However, a Treasury official noted “The Bank of Japan today intervened in the foreign-exchange market. We understand Japan’s action, which it states aims to reduce recent heightened volatility of the yen.” This comes after Treasury Secretary Yellen said back in July that “In general, our view is that countries like Japan, the United States, the G-7 countries, should have market-determined exchange rates. Only in rare and exceptional circumstances is intervention warranted and we did not discuss intervention.” Treasury reiterated earlier this month that its views had not changed since then.

Australia reported preliminary September PMI readings. Manufacturing came in at 53.9 vs. 53.8 in August, services came in at 50.4 vs. vs. 50.2 in August, and the composite came in at 50.8 vs. 50.2 in August. This was the fist rise in the composite since April but we believe this is an outlier. With its largest trading partner China slowing and the RBA still tightening, the economy will slow further in the coming months. Of note, WIRP suggests around 55% odds of a 50 bp hike October 4, while the swaps market sees the policy rate peaking near 4.5% over the next 12 months vs. 2.35% currently.

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