Dollar Soft as Risk-off Impulses Ease

January 19, 2022
  • U.S. rates market continues to adjust to the hawkish Fed; Fed tightening expectations continue to rise; the weak January Empire Survey is worth discussing; Canada reports December CPI
  • U.K. reported higher than expected December CPI data; BOE tightening expectations continue to rise; South Africa reported higher than expected December CPI data; TRY remains under pressure despite news of another swap deal
  • Reports suggest Tokyo and a dozen other prefectures may be put under a state of quasi-emergency starting Friday as COVID numbers spike

The dollar is slightly softer as risk-off impulses ease a bit. DXY has run into resistance near 95.762 and a break above that is needed to set up a test of the January 4 high near 96.462. Still, DXY has retraced half of the January drop. EUR is leading this move as it broke below its 62% retracement objective yesterday for the same move and is on track to test this year's low near $1.1270. Sterling is holding up better as it saw some support just below the $1.36 area. USD/JPY is lagging the broad dollar bounce and remains pinned below 115. While equity markets are seeing a slight bounce today, USD/JPY and EUR/CHF price action suggests risk-off impulses are still lurking. We believe rising rates should continue to buoy the greenback as it continues to benefit from the so-called dollar smile, gaining during periods of good U.S. data and periods of risk-off behavior.


U.S. rates market continues to adjust to the hawkish Fed. The 2-year yield is trading near 1.06%, while the 10-year is trading near 1.90%. Both are the highest since early 2020. With the 10-year breakeven inflation rates stuck below 2.50%, the real U.S. 10-year yield rose to -0.60%, the highest since March 2021. It’s worth noting that the 3-month to 10-year US curve rose to 175 bp yesterday, the steepest since March 2017. It have moved back to 172 bp today but the overall steepening trend is a welcome development as the curve moves further away from inversion that would signal potential recession. Lastly, the 2-year differentials with Germany and Japan rose to 162 bp and 113 bp, respectively, both new cycle highs.

Fed tightening expectations continue to rise. We fully expect a hawkish hold next week that sets up liftoff at the March 15-16 meeting. WIRP suggests a hike then is now fully priced in, followed by hikes in June, September, and December. A fifth hike this year is more than 25% priced in, while the expected terminal Fed Funds rates is getting close to 2.0%, which is a key part of the market repricing. Indeed, we continue to expect that the terminal Fed Funds rate to end up at 2.25-2.50%, matching the peak in the previous tightening cycle.

The weak January Empire Survey is worth discussing. The headline came in at -0.7 vs. 25.0 expected and 31.9 in December. Looking at the details, the only negative component was new orders at -5.0. The shipments component was the next weakest at +1.0, while every other component was firmly in double digit positive territory. It seems very quirky to get a negative -0.7 reading out of this but here we are. For now, we are downplaying this reading and can trot out the usual blame on omicron since such a sharp monthly drop suggests some sort of one-off event. Still, this warns of weakness in the Philly Fed tomorrow, which is expected at 19.0 vs. 15.4 in December. We will likely have to wait for the February readings to get a clean read of the US economy but it's too early to punch the panic button. December building permits (-0.8% m/m expected) and housing starts (-1.7% m/m expected) will be reported today.

Canada reports December CPI. Headline inflation is expected to rise a tick to 4.8% y/y, while common core is expected to rise a tick to 2.1% y/y. November wholesale trade sales (2.7% m/m expected) will also be reported. With recent data coming in strong, Bank of Canada tightening expectations remain heightened. WIRP suggests nearly 50% odds of liftoff at the next policy meeting January 26 and fully priced in for the March 2 meeting. Current BOC forward guidance suggests liftoff in Q2 but the market has fully priced in three hikes by mid-year. The market now sees 150 bp of tightening this year that would take the policy rate to 1.75%, with 50 bp more is priced in for 2023. This hawkish outlook has helped CAD to become the top performing major year to data, up 1.3%. It’s no coincidence that with the hawkish BOE outlook, GBP is the second best at 0.8% YTD.


U.K. reported higher than expected December CPI data. Headline inflation came in at 5.4% y/y vs. 5.2% expected and 5.1% in November, while core inflation came in at 4.2% y/y vs. 3.9% expected and 4.0% in November. According to the ONS, the increase in headline inflation to the highest since 1992 was driven by food, drink, restaurant meals, and furniture. Households also face a sharp spike in energy costs and payroll taxes this spring, putting the recovery at risk and ratcheting up pressure on the government to soften the blow. Chancellor Sunak said in a statement that “I understand the pressures people are facing with the cost of living, and we will continue to listen to people’s concerns as we have done throughout the pandemic.”

Bank of England tightening expectations continue to rise. WIRP now suggests that another hike February 3 is fully priced in, followed by hikes at every other meeting that would take the policy rate to 1.25% by year-end. Furthermore, the market now sees 40% odds of a fifth hike this year to 1.50%. Along the way, Quantitative Tightening will also kick in as the policy rate moves higher. All in all, the headwinds to the economy are picking up steam.

South Africa reported higher than expected December CPI data. Headline inflation came in at 5.9% y/y vs. 5.7% and 5.5% in November, while core inflation came in at 3.4% y/y vs. 3.3% expected and actual in November. Inflation is the highest since March 2017 and nearing the top of the 3-6% target band. Elsewhere, retail sales rose 1.9% m/m vs. 1.0% expected -1.3% in October. The bank just started a tightening cycle at its last meeting November 18 with a 25 bp hike to 3.75%. However, it was a 3-2 split decision and the lack of consensus suggests that the SARB's rather hawkish rate path will be difficult to meet despite rising inflation. The bank’s model sees quarterly hikes over the course of 2022, 2023 and 2024. Next SARB meeting is January 27 and we see steady rates with some risks of a hawkish surprise.

The Turkish lira remains under pressure despite news of another swap deal. Turkey reportedly signed a $4.9 bln currency swap deal with the United Arab Emirates in an effort to boost its foreign reserves. Turkey has already signed swap deals with Qatar, South Korea, and China but in the end, they are nothing but temporary fixes. Swap deals can tide a country over during temporary periods of turbulence but they must eventually be repaid and so there is no lasting impact on foreign reserves. Market are rightfully looking through this, with USD/TRY up for the second straight days. This pair has been suspiciously stable below 14 all year and we suspect some sort of stealth intervention may be going on here.


Reports suggest Tokyo and a dozen other prefectures may be put under a state of quasi-emergency starting Friday as COVID numbers spike. Three prefectures have already been put there and so the latest move would mean 16 of the 47 total would be affected that account for more than half of the economy. Prime Minister Kishida will reportedly make a final decision soon. The measures allow local governments to limit gatherings and hospitality operations, including shorter opening hours. Other reports suggest Tokyo will soon raise its COVID warning a notch to level 2 as daily new cases are running over 7k vs. a mere 30 just a month ago. The Bank of Japan just delivered a dovish hold and given the spread of omicron, any talk of tightening was clearly premature. There are building downside risks to Q1 activity in Japan, but if the pattern holds as it is elsewhere, the omicron wave should peak quickly with limited damage to the economic outlook.

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