Dollar Softens Ahead of FOMC Minutes

January 04, 2023
  • FOMC minutes will be very important; December ISM manufacturing PMI will be the data highlight; November JOLTS job openings will provide another read on the labor market; the House of Representative remains without a speaker; Lula 2.0 continues to make investors nervous
  • Eurozone inflation readings continue to surprise to the downside; ECB tightening expectations have fallen; firmer eurozone final December services and composite PMIs were reported; BOE tightening expectations have also fallen; Poland is expected to keep rates steady at 6.75%
  • BOJ Governor Kuroda remains dovish; BOJ tightening expectations remain elevated; the market continues to test the BOJ’s commitment to YCC; reports suggest China may resume some imports of Australian coal

The dollar has given up some of yesterday’s gains ahead of FOMC minutes. DXY is back near 104 after trading yesterday at the highest level since December 19 near 104.859. A break above 104.893 is needed to set up a test of the December 7 high near 105.822. The euro is back above $1.06 after trading yesterday at the lowest level since December 12 near $1.0520. A break below $1.0460 is needed to set up test of the November 30 low near $1.0290. Sterling continues to have trouble making much headway above $1.20. USD/JPY broke below the August 2 low near 130.40 to trade as low as 129.50 yesterday before reversing to trade near 130.55 today. Charts suggest the pair will eventually test the May low near 126.35. AUD is outperforming on reports that China may resume coal imports from Australia (see below). We continue to believe that dollar weakness in late 2022 was overdone and we expect the greenback to claw back much of those losses in the coming weeks and months. Of note, ECB and BOE tightening expectations have fallen in recent days (see below) and we see room for Fed tightening expectations to move higher.


FOMC minutes will be very important. At the December meeting, the Fed downshifted to 50 bp hike. However, Chair Powell delivered a very hawkish message at his press conference and so the minutes should help fill in the picture. We continue to believe markets are underestimating the Fed’s capacity to tighten. WIRP suggests a 25 bp hike February 1 is fully priced in, with over 30% odds of a larger 50 bp move. Another 25 bp hike March 22 is fully priced in, with nearly 50% odds of one last 25 bp hike in Q2 that would take the Fed Funds rate ceiling up to 5.25%. However, the swaps market continues to price in an easing cycle by year-end and we just don’t see that happening. Eventually, markets should come around to our view.

December ISM manufacturing PMI will be the data highlight. Headline is expected at 48.5 vs. 49.0 in November. Keep an eye on prices paid, which is expected to fall a tick to 42.9. ISM services PMI will be reported Friday and headline is expected at 55.0 vs. 56.5 in November. Last week, Chicago PMI came in 44.9 vs. 40.0 expected and 37.2 in November. Recent data suggest the U.S. economy remains relatively firm. The Atlanta Fed’s GDPNow model is tracking 3.9% SAAR growth in Q4, up from 3.7% previously. The next model update will come tomorrow. December vehicle sales (13.4 mln annualized) will also be reported today.

November JOLTS job openings will provide another read on the labor market. Consensus sees 10.05 mln vs. 10.334 mln in October and comes ahead of the December jobs report Friday. With the labor market holding up relatively well, consensus for NFP stands at 200k vs. 263k in November, while the unemployment rate is seen steady at 3.7% and average hourly earnings are seen down a tick to 5.0% y/y. Ahead of that report, ADP releases its private sector job estimate tomorrow and is expected at 150k vs. 127k in November. If the labor market remains tight, the Fed will be forced to tighten even more to get the desired fall in wage and price pressures.

The House of Representative remains without a speaker. Frontrunner Kevin McCarthy yesterday failed to win the post after three rounds of voting. Twenty rebels in his party refused to support his bid, a much greater number than previously expected. Given the party’s slim majority, McCarthy can only afford to see four dissents and so the path forward for him will be very difficult. The House will reconvene today at noon for another round of voting . Of note, the House cannot undertake any legislative matters until a Speaker has been chosen.

Lula 2.0 continues to make investors nervous. After recent reports that the fuel tax cut would be extended rather than allowed to expire, subsequent reports suggest that shielding consumers from higher energy prices will be a priority for the new administration, along with boosting investment in refinery projects. Markets are increasingly nervous that Lula will push populist policies that will require more spending and borrowing. In order to calm markets, the economic team is reportedly discussing a plan to balance the budget by cutting spending and increasing revenues to get a net budget gain of BRL223 bln this year, or around 2.1% of GDP. Despite this news, USD/BRL ended yesterday at the highest level since November 17 near 5.4625 and is on track to test that day’s high near 5.5270. After that is the January 2022 high near 5.7240 followed by the December 2021 high near 5.7565.


Eurozone inflation readings continue to surprise to the downside. France reported its EU Harmonized measure at 6.7% y/y vs. 7.3% expected and 7.1% in November and was the lowest since September. This continues the string of favor CPI data as Spain reported its EU Harmonized measure at 5.6% y/y vs. 5.8% expected and 6.7% in November and Germany reported its EU Harmonized measure at 9.6% y/y vs. 10.2% expected and 11.3% in November. Italy reports tomorrow and its EU Harmonized measure is expected at 12.3% y/y vs. 12.6% in November. If so, it would be the lowest since September. Eurozone reports Friday, with headline expected at 9.5% y/y vs. 10.1% in November, which would be the lowest since August, while core is expected at a new cycle high of 5.1% y/y vs. 5.0% in November. Of note, November PPI will be reported tomorrow and is expected at 27.5% y/y vs. 30.8% in October.

ECB tightening expectations have fallen. WIRP suggests a 50 bp hike February 2 is nearly 90% priced in, followed by 70% odds of another 50 bp hike March 16. A 25 bp hike May 4 is 80% priced in, but odds of one last 25 bp hike after that have fallen below 70% and so the peak deposit rate is now seen close to 3.25% vs. 3.5% at the start of this week. If inflation continues to slow, the expected peak rate is likely to move closer to 3.0%, which is where it stood back in mid-December.

Firmer eurozone final December services and composite PMIs were reported. Headline services rose to 49.8 vs. 49.1 preliminary and dragged the headline composite PMI half a point higher to 49.3. The German composite rose a tick from the preliminary to 49.0 while the French composite rose over a point from the preliminary to 49.1. Italy and Spain were reported for the first time and their composite readings came in at 49.6 and 49.9, both up modestly from November. We continue to believe markets are reading too much into the recent modest improvement in the sentiment indicators. The ECB tightening cycle began in July and so the full impact of the 250 bp in rate hikes so far has yet to be felt, not to mention the additional 150 bp that’s still priced in for 2023.

BOE tightening expectations have also fallen. WIRP suggests 70% odds of a 50 bp hike February 2, while a 25 bp hike March 23 is priced in rather than 50 bp previously. After that, a 25 bp hike is priced in for Q2, with only low odds of final 25 bp hike in Q3 and so the peak bank rate is now close to 4.5% vs.4.75% at the start of the week. Sterling has been a laggard of late and remains stuck near $1.20 after trading as high as $1.2445 in mid-December. We expect sterling to continue underperforming this year and note that the major retracement objectives from the September-December rally come in near $1.1645 (38%), $1.14 (50%), and $1.1150 (62%).

National Bank of Poland is expected to keep rates steady at 6.75%. December CPI will be reported Thursday, with headline expected to fall a tick to 17.4% y/y. If so, it would continue the deceleration from the 17.9% peak in October. Minutes to the December 7 meeting will also be released Thursday. At that meeting, the bank left rates steady at 6.75% even as Governor Glapinski said that the tightening cycle is paused and that the bank did not discuss ending rate hikes. That said, the swaps market is pricing in steady rates over the near-term with some risks of a final 25 bp hike to 7.0% over the next twelve months.


Bank of Japan Governor Kuroda remains dovish. He said that the BOJ will continue with monetary easing in order to achieve its 2% inflation target along with more robust wage growth. Kuroda said that the Japan economic growth will remain relatively stable due to the BOJ’s accommodative policy. He admitted that uncertainties remain high but the bank expects global inflation to peak and global growth to slow down. Elsewhere, Prime Minister Kishida urged Japan firms to boost wages faster than inflation, noting that “For the last 30 years, even when corporate profits increased, pay didn’t rise in line with expectations and the ‘trickle-down’ effect that had been envisioned didn’t happen. I will create a system where pay rises every year.” We also know that higher wages is something the BOJ wants to see before tightening policy. November cash earnings will be reported Friday.

BOJ tightening expectations remain elevated. WIRP suggests nearly 40% odds of liftoff at the March 9-10 meeting and is nearly price in at the April 27-28 meeting. Liftoff is likely to come earlier than we previously anticipated, with risks of a move in Q2 vs. H2 seen previously. Given Kuroda’s penchant for surprises, we cannot rule anything out right now and even Q1 is possible.

The market continues to test the BOJ’s commitment to Yield Curve Control. The central bank announced a fourth straight day of unscheduled bond-buying today and offered to buy unlimited amounts of 2- and 5-year JGBs and JPY600 bln of 1- to 25-year JGBs. These purchases are in addition to unlimited amounts of 10-year JGBs and JGB futures at the new 0.50% ceiling for YCC. Last week, the bank was forced into bond-buying across the curve for three straight days as yields continued to climb in anticipation of the end of YCC. Of note, the 10-year swap rate is nearly double the new YCC ceiling.

Reports suggest China may resume some imports of Australian coal. The National Development and Reform Commission reportedly discussed proposals to allow its major importers to restart purchases from Australia this year, perhaps as early as April 1. China implemented the ban in late 2020 as tensions between the two nations worsened after Australia called for an independent probe into the origins of Covid. Relations have been thawing, as Australian Foreign Minister Wong visited Beijing last month for the first official visit in years. AUD is the top performer today on the news, trading above the 200- day moving average near 0.6855 and nearing the December 13 high near 0.6895. After that is the September high near 0.6915 and then the late August high near 0.7010.

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