Dollar Soft Ahead of PPI Data

December 09, 2022

Win Thin

November PPI will be the highlight; the current Fed narrative remains too dovish; University of Michigan consumer sentiment will also be watched; Brazil reports November IPCA inflation
Eurozone banks continue to return TLTRO funding; November BOE survey shows inflation expectations still rising; Norway November CPI came in soft
Potential nominee for BOJ Governor Takehiko Nakao called for a policy review; Australia announced caps on domestic energy prices; China reported November CPI and PPI data

The dollar is slightly softer in rangebound trading ahead of PPI data. DXY is down for the third straight day and trading back below 105 near 104.673. The euro is trading near $1.0555 while sterling is trading near $1.2275, both at the high end of recent ranges. USD/JPY is trading near 135.80 and may again test its 200-day moving average near 135 today. While we still believe the fundamental outlook favors the dollar, we acknowledge that near-term dollar weakness is likely to persist after Powell’s unexpected dovish turn. If the U.S. data continue to come in firm like ISM services did, that dovish Fed narrative could start to crack ahead of next week’s FOMC meeting. Stay tuned.

AMERICAS

November PPI will be the highlight. Headline is expected at 7.2% y/y vs. 8.0% in October, while core is expected at 5.9% y/y vs. 6.7% in October. This report has taken on greater significance after last week’s upside surprise to average hourly earnings. Of note, November CPI will be reported next Tuesday, the day the FOMC meeting begins. Headline is expected at 7.3% y/y vs. 7.7% in October, while core is expected at 6.1% y/y vs. 6.3% in October. We believe markets have gotten too complacent about inflation risks. As the chart shows, both AHE and core PCE have flat-lined near 5% for most of this year despite falling CPI and PPI readings. We believe getting core PCE back down to the Fed’s target of 2% will be much more difficult than markets are pricing in. October wholesale trade sales and inventories and Q3 household net worth will also be reported.

The current Fed narrative remains too dovish. WIRP suggests that a 50 bp hike December 14 is fully priced in, with only around 10% odds of a larger 75 bp move. This seems right. However, the swaps market is pricing in a peak policy rate of 5.0% and no longer sees risks of a higher 5.25% peak. Looking ahead, WIRP suggests around 50% odds of a 50 bp move February 1 and then around 50% odds of a final 25 bp hike in Q2. We don’t think this expected tightening path will get inflation back to target, not when the labor market remains so firm and consumption is holding up. This is where we believe the mispricing continues. Perhaps the PPI data will get the market’s attention. Stay tuned.

University of Michigan consumer sentiment will also be watched. Headline is expected to rise two ticks to 57.0, though current conditions are seen steady 58.8 and expectations are seen falling over a point from November to54.5. Despite weaker consumer sentiment, consumption has held up in recent months. November retail sales data next Thursday will be important. Headline is expected flat m/m vs. 1.3% in October, while sales ex-autos are expected at 0.2% m/m vs. 1.3% in October. The so-called control group used for GDP calculations is expected at -0.1% m/m vs. 0.7% in October. Of note, the Atlanta Fed’s GDPNow model is currently tracking 3.4% SAAR growth in Q4. Lastly, both 1- and 5 to 10-year inflation expectations in the Michigan survey are seen steady at 4.9% and 3.0%, respectively.

Brazil reports November IPCA inflation. Headline is expected at 6.03% y/y vs. 6.47% in October. If so, it would be the lowest since February 2021 and moves closer to the 2-5% target range. Of note, this range falls to 1.5-4.5% in 2023. The bank just left rates steady at 13.75% this week, as expected. However, the tone was hawkish as it reiterated that rates will be kept steady for “a sufficiently long period” and that it will not hesitate to resume hiking rates if inflation doesn’t slow as planned. The swaps market is pricing in 50 bp of tightening hike over the next six months but much will depend on Lula’s fiscal policy once he takes office January 1.

EUROPE/MIDDLE EAST/AFRICA

Eurozone banks continue to return TLTRO funding. Another EUR447.5 bln in cheap funding will be returned to the ECB after the central bank toughened the terms of the program at its October meeting. This was more than expected and follows the EUR296 bln returned last month. Thus, the ECB balance sheet will continue to shrink even as policymakers debate Quantitative Tightening. Further details about QT are expected at next week’s meeting. The pace and timing are key. We expect a strategy similar to the Fed that would set a monthly ceiling for balance sheet runoff that increases over time. In terms of timing, QT starting at the March 16 meeting may prove to be the best bet as updated macro forecasts will be released then. The bank will also have a better idea of how the eurozone economy fared during the risky winter months, when energy prices could again prove disruptive. Ahead of that, the February 2 meeting would provide the ECB with an opportunity to fine tune its policy plans.

ECB tightening expectations have steadied. WIRP suggests a 75 bp hike December 15 is around 20% priced in, down from 45% at the start of last week and fully priced in right after the October decision. Elsewhere, the swaps market is still pricing in a peak policy rate near 3.0% vs. 3.5-3.75% after the October decision. We think there is still room for ECB tightening expectations to fall further and we stand by our call that the ECB will pivot and cut rates before the Fed does.

November BOE survey shows inflation expectations still rising. The showed inflation is expected at 4.8% in one year, down from 4.9% in the August survey. However, it is very worrisome that inflation is expected at 3.4% in two years, up from 3.2% in the August survey. Inflation in five years is seen at 3.3%, up from 3.1% previously, which suggests consumers’ inflation expectations are getting entrenched. Not surprisingly, the survey also showed satisfaction with the BOE’s monetary policy at a net -12% in November, the lowest since the survey began in 1999 and down from -7% in August. Bank of England tightening expectations have fallen ahead of next week’s meeting. WIRP suggests a 50 bp hike December 15 is only about 90% priced in, with no longer any odds of a larger 75 bp hike. The swaps market is pricing in a peak policy rate near4.5%.

Norway November CPI came in soft. Headline came at 6.5% y/y vs. 7.0% expected and 7.5% in October, while underlying came in at 5.7% y/y vs. 6.0% expected and 5.9% in October. This was the first deceleration in headline since August but remains well above the 2% target. Norges Bank meets next Thursday and is expected to hike rates 25 bp to 2.75%. At the last meeting November 3, it delivered a dovish surprise and hiked 25 bp to 2.5% vs. 50 bp excepted. The bank said it would “most likely be raised further in December” without specifying the likely size. Norges Bank also noted “The policy rate has been raised markedly over a short period, and monetary policy is beginning to have a tightening effect on the economy. This may suggest a more gradual approach to policy rate setting.” Updated macro forecasts and expected rate path will be released next week. Currently, the expected rate path sees the policy rate peaking near 3.0% in Q3 23. This is more hawkish than the swaps market, which sees the policy rate peaking near 2.5%.

ASIA

Potential nominee for BOJ Governor Takehiko Nakao called for a policy review at the bank. He said “They should review the side effects and the possible change of policy framework once the leadership is changed” but added that any changes in coming years would need to be gradual to avoid causing any major shocks. Nakao stressed that “We can’t postpone the change of policy forever. That is clear. We should start rethinking about this mix of inflation target, yield curve control, massive purchases of assets and the future commitment.” Nakao currently at a think tank and has been mentioned along with Deputy Governor Masayoshi Amamiya and former Deputy Governor Hiroshi Nakaso as frontrunners to succeed Governor Kuroda when his term ends in April.

Australia announced a cap on domestic energy prices. Prime Minister Anthony Albanese said natural gas prices will be capped at A$12 per gigajoule and thermal coal prices will be capped at AUD125 per ton for 12 months. He added that the government will compensate energy producers if their cost of production exceeds the caps, though this would vary from state to state. Albanese stressed that “One of the things that we were very careful of doing was to not interfere with any of the existing export systems that are in place. With regard to existing , be it gas or coal contracts overseas, this will have no impact on it.” The caps will of course come with a fiscal cost but they will likely impact monetary policy as well. That said, Reserve Bank of Australia tightening expectations are little changed. WIRP suggests around 45% odds of a 25 bp hike February 7, while the swaps market is pricing in a peak policy rate near 3.65%.

China reported November CPI and PPI data. CPI came in as expected at 1.6% y/y vs. 2.1% in October, while PPI came in at -1.3% y/y vs. -1.5% expected and -1.3% in October. With price pressures under control, policymakers will continue focusing on boosting growth. The PBOC cut reserve requirements by 25 bp November 25 and further easing seems likely in the coming months. Indeed, it was just announced overnight that the government will sell CNY750 bln of special sovereign bonds to extra stimulus. The Ministry of Finance said the proceeds will help to support economic and social development.

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