Dollar Softens Ahead of Jobs Data

January 07, 2022

Jobs data is the main event; it’s clear that the jobs data have taken on less importance to the Fed; U.S. rates market continues to adjust to the new Fed messaging; Canada reports December jobs data too; Argentina started the tightening cycle with a 200 bp hike to 40%; Peru delivered the expected 50 bp hike to 3.0%
Eurozone real sector data were mixed; December eurozone inflation continues to rise; Turkish central bank intervened heavily in December to support the lira
Japan reported disappointing data; BOJ tightening expectations have gone nowhere; China’s policymakers are trying to stabilize market sentiment by promising various supportive measures

The dollar is trading a bit softer ahead of the jobs data. After trading as high as 96.387 yesterday, DXY is down slightly today and trading near 96.165. After a slight pop from the CPI data (see below), the euro remains heavy and unable still to get much traction above $1.13. GBP also remains heavy after failing to break above $1.36 earlier this week and is trading near $1.3550. Lastly, USD/JPY is struggling to make a clean break above 116 for the fourth straight day and is recording a series of lower highs. Despite today’s drop back below 116, we continue to target the December 2016 high near 118.65. Indeed, the dollar should mount a broad-based leg higher in the coming days and weeks as the rates market continues to adjust to the more hawkish Fed outlook (see below).

AMERICAS

Jobs data is the main event. Consensus sees 447k vs. 210k in November, while the unemployment rate is expected to fall a tick to 4.1%. Average hourly earnings are expected to slow to 4.2% y/y from 4.8% in November. Yesterday, ISM services PMI came in a bit softer than expected at 62 vs. 69.1 in November but still points to robust growth. Readings above 60 are typically rare but ISM services has been above 60 for 10 straight months now. Of note, the employment component fell to 54.9 vs. 56.5 in November, signaling continued job growth in this sector, albeit at a slightly slower rate. All indicators suggest the labor market continues to heal, albeit unevenly. November consumer credit ($22.5 bln expected) will also be reported.

That said, it’s clear that the jobs data have taken on less importance to the Fed. Barring a total collapse in the labor market, the Fed is tapering faster and is looking towards liftoff sometime in H1 followed quickly be balance sheet reduction. Yesterday, Bullard said that the Fed could star hiking as soon as March. WIRP suggest nearly 90% odds of March liftoff now. At the beginning of December, the odds were around 25% so this is a big move. Lastly, a fourth hike is now seen at almost 50/50.

The U.S. rates market continues to adjust to the new Fed messaging. The U.S. 2-year yield is trading at new cycle highs near 0.88%., which in turn has pushed the differentials with Germany and Japan higher as well to 147 bp and 95 bp, respectively. The 10-year yield traded at a new cycle high near 1.75% yesterday but has fallen back to 1.73% today. However, the real 10-year yield continues to climb and at -78 bp is the highest since mid-June. All of these moves are likely to continue and underpins our strong dollar call for 2022. Lastly, the US curve steepening continues in force, with the 3-month to 10-year curve at 164 bp, just short of the October cycle high near 166 bp. Coming up is the May 2021 high near 169 bp and then the March 2021 high near 173 bp. This steepening may have been helped by FOMC discussions of using balance sheet reduction to keep the yield curve steep.

Canada reports December jobs data too. Consensus sees 25.0k jobs added vs. the blockbuster 153.7k gain in November, with the unemployment rate expected to remain steady at 6.0%. The Canadian economy continues to recover nicely from the pandemic, leading Bank of Canada tightening expectations to remain elevated. WIRP suggests a little less than 50-50 chances of liftoff at the next meeting January 26, which seems too soon given the BOC’s forward guidance for likely Q2 liftoff. Those odds rise to 100% for the March 2 meeting. All told, 5-6 hikes are priced in for 2022 that would take the policy rate up to 1.50-1.75%. Swaps market is pricing in another 50 bp of tightening next year that would see that rate peak between 2.00-2.25% by end-2023. A word of warning: recent lockdowns in Ontario could have a significant impact on the national economy in Q1 and so market pricing for BOC tightening seems too aggressive. Stay tuned.

Argentina central bank started the tightening cycle with a 200 bp hike to 40.00% in the benchmark Leliq rate. The rate had been stuck at 38% since the last cut back in March 2020, despite inflation running over 50% vs. the trough near 36% from late 2020. The IMF urged the central bank in December to implement “appropriate” monetary policy as part of ongoing talks for a new loan program that would reschedule payments on about $40 bin that Argentina already owes. A $2.8 bln payment is coming due in March and so the clock is ticking. Yet we don’t want to read too much into the rate hike, as the two sides have been at odds about a wide range of issues and a deal remains elusive. This week, Economy Minister Guzman cited disagreement on how quickly the government must reduce the budget deficit, adding that IMF proposals would likely “halt the economic recovery that Argentina is witnessing and is essentially a program of real spending cuts.”

Peru’s central bank delivered the expected 50 bp hike to 3.0% yesterday and the communication was decidedly hawkish. In particular, the statement now confirms this is an ongoing tightening cycle and dropped the reference to not necessarily tightening at every meeting. Now the bank says it is necessary to continue the normalization process, even opening the door for larger moves. That said, the bank expects CPI to converge to the target range of 2.0% +/- 1% by the end of the year. Bloomberg consensus sees the policy rate peaking at 4.0% at year-end but there are now clear upside risks here. Of note, CPI jumped 6.4% y/y in December and it’s hard to see inflation falling back below 3% by year-end.

EUROPE/MIDDLE EAST/AFRICA

Eurozone real sector data were mixed. Germany reported November IP and trade data. IP was expected to rise 1.0% m/m but instead fell -0.2% vs. a revised 2.4% (was 2.8%) gain in October. Exports rose 1.7% m/m vs. -0.2% expected and a revised 4.2% (was 4.1%) gain in October, while imports jumped 3.3% vs. -1.3% expected and a revised 5.2% (was 5.0%) gain in October. The strength in the external sector has not been enough to offset domestic weakness, with the composite PMI falling to 49.9 in December. Elsewhere, French IP came in at -0.4% m/m vs. 0.5% expected and 0.9% in October. November eurozone retail sales were also reported and came in at 1.0% m/m vs. -0.5% expected and a revised 0.3% (was 0.2%) in October.

December eurozone inflation continues to rise. Headline inflation came in at 5.0% y/y vs. 4.8% expected and 4.9% in November, while core came in at 2.6% y/y vs. 2.5% expected and 2.6% in November. The acceleration to a new record high came despite German inflation slowing and French inflation stable. This will certainly keep the ECB hawks agitated but the near-term policy implications are limited since it has already announced plans to taper QE aggressively in Q2. Market pricing for a possible 2022 rate hike has been edging higher in recent weeks but we still view this as very unlikely. Next ECB policy decision is February 3, but this is widely expected to be a placeholder.

The Turkish central bank intervened heavily in December to support the lira. Data from the bank show total intervention last month was $7.3 bln spread out over five days. It’s becoming clear that the strong rally in the second half of the month was not driven by a significant shift in local depositor behavior, but rather by good old-fashioned intervention. Of course, this is unsustainable given its dwindling reserves and so with the bank likely dialing it back this month, the lira has given back nearly half of its gains. We expect the slow bleed to continue.

ASIA

Japan reported disappointing data. December Tokyo CPI was mixed, Headline inflation came in a tick higher than expected at 0.8% y/y vs. 0.5% in November, while core (ex-fresh food) came in as expected at 0.5% y/y vs. 0.3% in November. November real cash earnings and household spending were also reported. Earnings were expected at -0.5% y/y but instead plunged -1.6% vs. -0.7% in October, so it’s no surprise that spending fell -1.3% y/y vs. an expected 1.2% gain and -0.6% in October. Q4 was expected to show a nice rebound since movement restrictions had been lifted for much of the country in October. Instead, the real sector data have been disappointing and spending in particular should have picked up more in November. Bloomberg consensus sees GDP growth of 6.1% q/q but we think there are clear downside risks. Looking ahead to Q1, the impact of the omicron variant could mean that recent softness carries over into 2022.

No wonder that Bank of Japan tightening expectations have gone nowhere. And that’s the way it should be. The bank has clearly set itself up to be amongst the last of the major central banks to remove accommodation. The swaps market sees no tightening through 2024 and we expect this to be codified by the BOJ when it includes FY24 in its macro forecasts starting with the April Outlook Report. This should keep the yen under selling pressure, though it is always subject to some temporary bouts of strengthening due to periodic risk off impulses.

Chinese policymakers are trying to stabilize market sentiment by promising various supportive measures. Reports claim they will evaluate the timing and conditions first before making any firm announcement, so we’re not sure what these measures could be. However, we suspect it will be usual mix of rate cuts, reserve requirement cuts, and debt-fueled infrastructure spending. Still, it would be noteworthy shift from the so-called “targeted” support from policymakers in 2021 and marks rising concerns amongst China’s leaders. Elsewhere, reports suggest policymakers are calling on local banks to boost real estate lending in Q1, another sure sign that they are working to prevent a full-blown crisis in that sector as developers struggle with rising default risks. While we expect China to muddle through, investor sentiment will take time to recover. The Shanghai Composite closed marginally lower overnight, but it’s so far down 1.6% on the year, having fallen in all of the last four sessions.

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