Dollar Soft as Risk-Off Impulses Fade

December 21, 2021
  • Senator Manchin outlined possible changes to the Build Back Better package that might win his support; Democrats need to decide on the next steps; there are no Fed speakers scheduled for the rest of the year; Canada report October retail sales; BOC tightening expectations remain heightened
  • Germany reported weak January GfK consumer confidence; U.K. CBI reported a weak distributive trades survey for December; reports suggest the Johnson government will try to avoid any Covid restrictions ahead of Christmas; markets appear more confident with Bank of England messaging; TRY reversed its losing streak yesterday aft er policymakers announced a series of measures to help stabilize the situation
  • Japan’s Cabinet Office upgrades its monthly view of the economy for the first time since summer 2020; RBA minutes were released; since that meeting, the data have improved and there is a chance that the RBA will end QE altogether in February

The dollar is slightly softer as risk-off impulses ebb. DXY is down for the second straight day but has held on to most of Friday’s gains and is trading near 96.50. The euro remain heavy as it struggles to break back above $1.13, while sterling is bouncing off of support near $1.32 and is trading around $1.3250. USD/JPY remains in narrow trading ranges just below 114 despite the improvement in risk sentiment. TRY has staged a huge comeback after policymakers announced support measures yesterday but we remain skeptical (see below). We are likely in a consolidative period for now given the lack of any major new drivers. Looking ahead to an eventful January, we believe the underlying trend for a stronger dollar remains intact.


Senator Manchin outlined possible changes to the Build Back Better package that might win his support. These include a true overhaul of the U.S. tax code to make it fairer, as well as lowering the cost of prescription drugs. He said he also wants to include work mandates in order to receive benefits such as expanded child tax credits as well as income cutoffs for tax credits on electric vehicle purchases. Should they try to placate Manchin in the hopes of a compromise? This risks alienating those in the progressive wing that warned of giving way any leverage by passing the traditional infrastructure package first.

Democrats need to decide on the next steps. Manchin said that even if these changes are made, he still has other issues with the bill and how it’s been pushed through Congress. He prefers that the bill be put through Senate committees to examine its effects and rejected making any major policy changes through fast-track procedures such as budget reconciliation. Manchin basically buries the lead right then and there. Without using the reconciliation process, the bill would never pass as not one single Republican Senator would vote for it, thereby falling prey to the filibuster that requires 60 votes in a chamber that’s split 50-50. Those also happen to be our perceived odds that a deal is eventually struck in early 2022.

There are no Fed speakers scheduled for the rest of the year. There will be a small two-week window for Fed speaking engagements in January, as the media blackout for the January 25-26 FOMC meeting takes effect at midnight January 14. The Beige Book for that meeting will be released January 12. We also get the December jobs report January 7, CPI data January 12, PPI data January 13, and retail sales January 14. Our only point is that investors should enjoy this period of relative calm now, as things are likely to heat up quickly when markets reopen after the holidays. That said, there is very little U.S. economic data of note this week. Today, Q3 current account data (-$205 bln expected) will be reported.

Canada report October retail sales. Headline sales are expected at 1.0% m/m vs. -0.6% in September, while sales ex-autos are expected at 1.5% m/m vs. -0.2% in September. October GDP will be reported Thursday and is expected at 0.8% m/m vs. 0.1% in September. While this is old news, the economic data have been coming in strong in November as well. While the Bank of Canada maintained its forward guidance at this month’s meeting, updated forecasts will come at the next meeting January 26. 2024 will be added to the forecast horizon and will be an important part of its forward guidance.

Bank of Canada tightening expectations remain heightened. WIRP suggests 60% odds of a hike next month and is almost fully priced in for the March 2 meeting. Five hikes in total are nearly fully priced in for 2022, which is consistent with swaps market pricing for an end-2022 rate of 1.5%. Another two hikes are priced in for 2023 that would take the policy rate up to a peak of 2.0%. Similar to the Fed, this would imply a real policy rate close to zero at the end of a tightening cycle, assuming inflation returns to target. Since this seems very unlikely, we think the risks are tilted toward a higher terminal policy rate than 2%.


Germany reported weak January GfK consumer confidence. It was expected at -2.7 but instead came in at -6.8 vs. a revised -1.8 (was -1.6) in December. This was the second straight monthly decline and the lowest since June 2021. Eurozone December consumer confidence will be reported later today and is expected at -8.3 vs. -6.8 in November. If so, it would be the lowest since April 2021 but there are clear downside risks. The spread of omicron was already having an impact on the PMI readings and so we expect ongoing deterioration in the consumer surveys as well. Of note, the December preliminary composite PMI for Germany was 50, suggesting the nation is very close to tipping into recession.

U.K. CBI reported a weak distributive trades survey for December. Retailing reported sales dropped sharply to 8 vs. 25 expected and 39 in November, while total reported sales fell to 12 vs. 43 in November. Yesterday, the CBI reported its industrial trend survey, where orders came in at 24 vs. 20 expected and 26 in November and selling prices came in at 62 vs. 60 expected and 67 in November. The data have been mixed of late, but renewed Covid concerns appear to be weighing on activity even without significant movement restrictions (see below). Public sector net borrowing for November was also reported, with ex-banking groups coming in at GBP17.4 bln vs. GBP16.0 bln and a revised GBP12.4 bln (was GBP18.8 bln) in October.

Reports suggest the Johnson government will try to avoid any Covid restrictions ahead of Christmas. Cabinet Office Minister Steve Barclay said “We’re saying to people they should continue with Christmas, but in a cautious way.” He added that the government must be “clear-eyed” about the economic impact of any curbs. Other reports suggest Brexit Minister Frost resigned last week due to disagreements about restrictions (he was against any), so we know this is a very divisive debate within the cabinet. Barclay would not rule out eventual restrictions but added that the government needs more information on the omicron variant before making any decision. He added that Chancellor Sunak will speak later today about government support for firms harmed by this latest wave of infections.

Markets appear more confident with Bank of England messaging. After talking up inflation risks in November and then standing pat, the bank seemed to downplay inflation risks in December and then surprised with a rate hike. WIRP now suggests 85% odds of a follow-up hike February 3, while a March 17 hike is fully priced in. Swaps market is pricing in a terminal rate of 1.25% by end-2022, which would imply quarterly hikes next year. As in the case of the Fed, this in turn implies a negative real policy rate at the end of a tightening cycle (assuming inflation returns to target) and that still does not seem right to us.

TRY reversed its losing streak yesterday aft er policymakers announced a series of measures to help stabilize the situation. Of note, the government will compensate holders of lira deposits if the currency loses more value than the interest rates paid by the banks. Also, policymakers will offer non-deliverable forwards (NDFs) to exporters to help them mitigate FX risks stemming from the curet period of high volatility. The withholding tax for investments in lira notes issued by the government will be reduced to 0% from 10% currently. This cut suggests that despite his bluster, President Erdogan still wants to encourage foreign investment and so capital controls appear unlikely, at least for now. He said that “Turkey has neither the intention nor the need to take the slightest step back from the free market economy and the foreign exchange regime.” Yet when all is said and done, these measures simply transfer FX risk from firms and individuals to the government. Without any other change to the underlying policies causing lira weakness, this will just balloon the budget deficit with little appreciable impact on the currency. Simply put, we are no closer to a resolution to this crisis and it’s only a matter of time before this band-aid solution fails.


Japan’s Cabinet Office upgrades its monthly view of the economy for the first time since summer 2020. In its December report, the Cabinet Office said the economy has recently picked up as the impact of the pandemic gradually ease. Specifically, it raised its view of consumption, business confidence, and the labor market. The report said the potential impact of the omicron variant must be closely watched, but still sees the economy picking up further over the-short term. Of note, Japan and much of Asia has so far avoided the sharp increase in virus numbers that are currently being seen in Europe and the U.S. However, the Bank of Japan has made it clear that it is in no hurry to remove accommodation and is likely to be amongst the last to do so.

Reserve Bank of Australia minutes were released. The bank felt that tapering its QE at the February meeting and ending it in May was consistent with its existing macro forecasts. However, it acknowledged that it could also end QE in February if faster than expected progress was made towards its jobs and inflation goals or it could taper in February and review again in May if progress was slower than expected. At this month’s meeting, rates were kept steady at 0.10% and QE was maintained at the current weekly pace of AUD4 bln until the planned review at the next meeting February 1. The bank also felt that omicron is unlikely to derail the recovery but that more information would be on hand by February. Of note, the December jobs report will be released January 20, while Q4 CPI and PPI data will be reported January 25 and 28, respectively.

Since that meeting, the data have improved and there is a chance that the RBA will end QE altogether in February. Governor Orr said as much last week and the jobs data backed him up, with the unemployment rate falling to 4.6% in November. Thus, the labor market has basically recouped its losses stemming from the autumn lockdowns and the unemployment rate is approaching an area (low 4s) where the RBA believes wage pressures will pick up. The swaps market is now pricing in nearly 75-100 bp of tightening over the next twelve months, which seems too aggressive to us. Updated forecasts will come February 1 and would have to show significant upward revisions to the macro outlook from the November forecasts to justify this expected tightening cycle.

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