Dollar Soft Despite Growing Risk Off Sentiment

November 28, 2022

Win Thin

The dollar is not benefiting from the risk off sentiment today; we get some important November survey readings this week; Fed expectations remain steady
ECB officials remain hawkish; U.K. CBI reported a very weak November distributive trades survey; BOE tightening expectations have steadied
Australia reported weak October retail sales; RBNZ Assistant Governor Silk sounded hawkish; protests against Covid restrictions are spreading across China; oil is trading at new lows for this cycle

The dollar is mixed today as markets start the week in risk off mode. The situation in China remains fluid but we would downplay any hopes of quicker reopening due to the growing protests (see below). DXY gave up its earlier gains and is trading at the lowest level since August and is testing the 200-day moving average near 105.376. A clean break below would set up a test of the August 10 low near 104.636. The euro is testing the $1.05 area, the highest since July and on track to test the late June high near $1.0615. Sterling is lagging today and trading heavy just below $1.21. USD/JPY traded at a new low for this move near 137.50 and is on track to test the August 23 low near 135.80. While we still like the dollar higher due to our constructive fundamental outlook, we acknowledge that near-term dollar weakness will be seen until the Fed narrative shifts once again in our favor.

AMERICAS

The dollar is not benefiting from the risk off sentiment today. This is unusual, as other markets are clearly reflecting concerns about the situation in China. European and Asian equity markets are lower, while futures point to a lower U.S. open. Global bond yields are lower, gold is higher, and XBT is lower. In FX, the yen and the euro are outperforming while the dollar bloc and Nokkie are underperforming. Of course, yen strength shouldn’t be surprising but euro strength is hard to justify in this current environment. At some point, the dollar should catch a bigger bid if risk off sentiment persists.

We get some important November survey readings this week. Dallas Fed manufacturing survey will be reported today and is expected at -22.0 vs. -19.4 in October. Chicago PMI will be reported Wednesday and is expected at 47.0 vs. 45.2 in October. ISM manufacturing PMI will be reported Thursday. Headline is expected at 49.8 vs. 50.2 in October. Keep an eye on the sub-components. In October, employment stood at 50.0, prices paid stood at 46.6, and new orders stood at 49.2. Last week, S&P Global preliminary November PMI readings came in weaker than expected.

Fed expectations remain steady. WIRP suggests that is fully priced in, with around 15% odds of a larger 75 bp move. The swaps market is still pricing in a peak policy rate of 5.0%, with around 20% odds of a 5.25% peak. Williams and Bullard speak today.

EUROPE/MIDDLE EAST/AFRICA

ECB officials remain hawkish. Knot said that “In Europe, we have to prepare ourselves for a protracted period in which policy makers and central bankers will have to be on it and focus on restoring price stability.” He said that any concerns about over-tightening at this point are “a bit of a joke,” adding that the biggest danger is declaring victory too soon and ending the tightening cycle before the job is really done. WIRP suggests a 75 bp hike December 15 is around 50% priced in, about the same as the start of last week but down from being 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% right 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. De Cos, Lagarde, and Nagel also speak today.

The U.K. CBI reported a very weak November distributive trades survey. Total reported sales came in at -24 vs. 0 in October, while retailing reported sales came in at -19 vs. 18 in October. The CBI noted that retailer headcount has fallen YTD through November, the first decline since August 2021 and reflecting the weaker economic outlook. Adding to the gloom, the CBI said inventories were too high relative to expected sales and that the volume of orders placed with suppliers fell, with a sharper decline expected next month. This survey data should start showing up in the labor market and retail sales data.

Bank of England tightening expectations have steadied. WIRP suggests a 50 bp hike December 15 is priced in, with less than 30% odds of a larger 75 bp hike vs. 35% at the start of last week. The swaps market is still pricing in a peak policy rate between 4.5-4.75%, down sharply from 6.25% right after the mini-budget in late September.

ASIA

Australia reported weak October retail sales. Sales came in at -0.2% m/m vs. 0.5% expected and 0.6% in September. As a result, the y/y rate fell to 12.5% vs. 17.9% in September and was the weakest since June. While the economy is showing some signs of slowing, price pressures remain high and so the RBA will continue tightening. WIRP suggests 70% odds of a 25 bp hike December 6, while the swaps market is pricing in a peak policy rate near 4.0%, up from 3.65% earlier this month.

RBNZ Assistant Governor Silk sounded hawkish. She noted “What we have seen is actual inflation continue to surprise on the upside, but more importantly inflation expectations have moved higher as well. And it’s the persistence factor that has probably been the most surprising.” The bank hiked rates 75 bp last week, shifted its expected rate path upwards, and unveiled a new estimate of the short-run neutral policy rate of 3.6%. That means the RBNZ has only now moved into restrictive policy and clearly has more work to do. Next policy meeting is February 22 and WIRP suggests a 50 bp hike is fully priced in, with 50% odds of a larger 75 bp move. The swaps market is pricing in a peak policy rate between 5.25-5.5% vs. 5.0% at the start of last week.

Protests against Covid restrictions are spreading across China. Some believe this to be the strongest showing of popular discontent since the Tiananmen Square protests in 1989, and come at a time of record Covid infection numbers in China. Will Xi back down and loosen up Covid Zero or will he crack down on dissent? We suspect it will be the latter and again caution against getting too optimistic on the reopening trade. Stay tuned.

COMMODITIES

Oil is trading at new lows for this cycle as optimism regarding China reopening got a big dose of reality. Brent oil traded below $81 per bbl today while WTI traded below $74 per bbl, both the lowest since January.

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