Dollar Soft as Risk Off Sentiment Ebbs

November 29, 2022

Win Thin

Fed officials reman hawkish; November survey readings continue to roll out; minor data will be reported today; Canada reports Q3 GDP
Eurozone November CPI data have started rolling out; ECB tightening expectations have fallen; BOE will start selling the gilts it bought under its emergency program; BOE tightening expectations have fallen; Switzerland reported soft Q3 GDP data
Japan reported October labor market and retail sales data; China health officials took a conciliatory tone regarding Covid restrictions

The dollar is softer today as risk off sentiment ebbs. The situation in China remains fluid but we continue to downplay any hopes of quicker reopening despite conciliatory comments from mainland health officials (see below). DXY has given up some of its gains from yesterday and is trading near 106.25. The 200-day moving average provided support yesterday and come s in near 105.434 today. A clean break below would set up a test of the August 10 low near 104.636. The euro is testing its 200-day moving average near $1.0380, while sterling continues to struggle above $1.20. USD/JPY remain heavy near 138 and seems likely to test yesterday’s cycle low near 137.50. A break below would set up a test of 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 is likely until the Fed narrative shifts once again in our favor.

AMERICAS

Fed officials reman hawkish. Bullard said the Fed has “a ways to go to get to” restrictive policy, adding that the first 250 bp of tightening was just enough to get to neutral. He added that the Fed needs to move further into restrictive territory and may need to keep rates higher through 2023 and 2024. Lastly, he stressed that market are underpricing the risks that the Fed may be more aggressive. Bullard and the hawks have been right the whole time. We think the less hawkish ones at the Fed are pushing back a bit now but will likely be forced to capitulate once again if inflation remains sticky, as we expect. Elsewhere, Williams said “Stronger demand for labor, stronger demand in the economy than I previously thought, and then somewhat higher underlying inflation, suggest a modestly higher path for policy relative to September. Not a massive change, but somewhat higher.” WIRP suggests that a 50 bp hike 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 small odds of a 5.25% peak.

Important November survey readings continue to roll out. Dallas Fed manufacturing survey was reported yesterday at -14.4 vs. -21.0 expected and vs. -19.4 in October. Chicago PMI will be reported tomorrow 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.

Minor data will be reported today. September FHFA and S&P CoreLogic house price indices are expected to show continued weakness in the housing sector, with both expected at -1.2% m/m. November Conference Board consumer confidence will also be reported. Headline confidence is expected at 100.0 vs. 102.5 in October. If so, it would be the second straight monthly drop to the lowest since July. Yet consumption has held up relatively well so far.

Canada reports Q3 GDP. Growth is expected at 1.5% SAAR vs. 3.3% in Q2. The economy is showing signs of slowing. At the last meeting October 26, the Bank of Canada delivered a dovish surprise and hiked rates 50 bp to 3.75% vs. 75 bp expected. Next meeting is December 7. WIRP suggests a 50 bp hike is nearly priced in vs. 60% odds at the start of this week, while the swaps market is still pricing in a peak policy rate between 4.25-4.5%.

EUROPE/MIDDLE EAST/AFRICA

Eurozone November CPI data have started rolling out. Spain’s EU Harmonized CPI came in at 6.6% y/y vs. 7.1% expected. The drop was driven in large part by declines in electricity and fuel prices. Germany reports later today and is expected at 11.3% y/y vs. 11.6% in October. German state data out already suggest some downside risks to the national number. France and Italy report tomorrow and their EU Harmonized CPI readings are expected at 7.0% y/y and 12.1% y/y, respectively. Eurozone-wide CPI data will also be reported tomorrow. Headline is expected at 10.4% y/y vs. 10.6% in October, while core is expected to remain steady at 5.0% y/y. If so, it would be the first deceleration in headline since June 2021.

ECB tightening expectations have fallen. WIRP suggests a 75 bp hike December 15 is around 25% priced in, down from 45% at the start of this week and fully priced in right after the October decision. Elsewhere, the swaps market is still pricing in a peak policy rate between 2.75-3.0% 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. Guindos and de Cos speak today. Guindos stressed that “The signal we have to keep following is the evolution of underlying inflation. This will tell us how inflation can evolve in coming months.” Yesterday, Lagarde said she wouldn’t go as far as saying inflation has peaked, adding that the risks to the inflation outlook are on the upside.

Bank of England will start selling the gilts it bought under its emergency program. The bank said the sales would be “demand-led” in order to avoid any destabilizing market movements. As such, it will offer amounts of longer maturity and inflation-linked gilts based on market appetite rather than setting a fixed amount to be sold. Auctions will take place Tuesdays, Wednesdays, and Fridays and gilts will be sold at the mid price or higher.

BOE tightening expectations have fallen. WIRP suggests a 50 bp hike December 15 is priced in, with less than 25% odds of a larger 75 bp hike vs. 30% at the start of this week. The swaps market is now pricing in a peak policy rate near 4.5% vs. 4.5-4.75% at the start of this week and down sharply from 6.25% right after the mini-budget in late September. Mann speaks and Bailey testifies to the House of Lords today.

Switzerland reported soft Q3 GDP data. Growth came in at 0.5% y/y vs. 1.0% expected and a revised 2.2% (was 2.8%) in Q2. In q/q terms, growth came in at 0.2% vs. 0.3% expected and a revised 0.1% (was 0.3%) in Q2. November CPI will be reported Thursday. Headline inflation is expected to remain steady at 3.0% y/y while core is expected to rise a tick to 1.9% y/y. At the last policy meeting September 22, the Swiss National Bank hiked rates 75 bp to 0.5%, as expected. SNB President Jordan said “It cannot be ruled out that further increases in the SNB policy rate will be necessary to ensure price stability over the medium term” and stressed that the bank could move intra-meeting if needed. Next meeting is December 15 and a 50 bp hike to 1.0% is expected. Looking ahead, the swaps market is pricing in a peak policy rate near 1.5%, down from 2.0% right after the September meeting.

ASIA

Japan reported October labor market and retail sales data. The unemployment rate was expected to fall a tick to 2.5% but remained steady at 2.6%, while the job-to-applicant ratio rose a tick as expected to 1.35. Despite the firm labor market, wage growth remains low. Until we see wage growth pick up further, the BOJ is likely to remain on hold. Elsewhere, sales came in at 0.2% m/m vs. 1.0% expected and a revised 1.5% (was 1.1%) in September. As a result, the y/y rate came in at 4.3% vs. 5.1% expected and a revised 4.8% (was 4.5%) in September. Recent weakness in the real sector data should also keep the BOJ on hold.

China health officials took a conciliatory tone regarding Covid restrictions. The National Health Commission said that local officials must respond to and resolve “reasonable” Covid requests from residents in a timely manner. It added that China is constantly adjusting its Covid policies, adding that policymakers must work to reduce the inconvenience caused by Covid outbreaks to the minimum. It stressed that local officials must avoid excessive Covid restrictions. This all sounds well and good but we don’t think the problem rests at the local level. Rather, local officials are carrying out a policy directive that’s set by Beijing. It’s way too early to say the situation has been defused, as the Covid protests seem to reflect a wider discontent within the nation. Stay tuned.

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