Dollar Stabilizes After Powell Drops a Bombshell

December 01, 2021

Fed Chair Powell dropped a bombshell on the markets; Fed tightening expectations quickly adjusted and this is unequivocally dollar positive; Fed Beige Book report has been rendered moot; ADP private sector jobs estimate and ISM manufacturing PMI will be the data highlights; Banco de Mexico releases its quarterly inflation report
Final eurozone November manufacturing PMI readings came in softer; the pace of weekly ECB net asset purchases has been creeping higher; TRY is seeing a strong rebound on headlines of FX intervention by the central bank
Australia reported stronger than expected Q3 GDP data; Korea trade data defied the virus headwinds; manufacturing PMI readings across EM Asia were generally strong in November

The dollar is stabilizing today after yesterday’s wild moves on the Fed’s hawkish tilt. DXY is trading just below 96, pretty much in the middle of yesterday’s trading range. With market sentiment improving a bit, USD/JPY is trading near 113.35 after trading yesterday at the lowest level since October 11 near 112.55. Elsewhere, EUR/CHF is trading near 1.0422 after trading yesterday at a new low for this move near 1.039. The euro feels heavy after being unable to break above $1.14 and is trading near $1.1330, while sterling remains stuck near $1.33. Looking through the distorted month-end price movements, the underlying signal is that the Fed has moved closer to liftoff than previously thought (see below) and this is unequivocally dollar-positive.

AMERICAS

Fed Chair Powell dropped a bombshell on the markets. He said that it is time to retire the word “transitory” regarding inflation. Powell added the threat of persistently higher inflation has grown, and that the Fed will use all its tools to stop the threat of entrenched inflation. Lastly, he said that Fed can consider wrapping up taper a few months sooner than planned, noting that recent data since the November FOMC show elevated inflation. This is about as hawkish as Powell has been. Ever. The Fed will definitely discuss a faster pace at the December 14-15 meeting but we would still be surprised if they actually pulled the trigger just one month after starting taper. That said, it's clear the Fed is preparing the markets for an eventual change in the pace of tapering and so at the very least, we will get a hawkish hold this month and at the very most, we will get a faster pace of tapering.

Why now? Why not wait a week or two until omicron's potential impact (health and economic) is better known? What's changed that made the Fed turn more hawkish? More to the point, what does the Fed know that we don't? We don't have a clear answer, but we suspect that we will get another strong jobs report this Friday that points to upside wage pressures. Without a doubt, we are surprised by the timing of Powell's comments, but the Fed is clearly worried it's falling behind the curve and is starting to set the table for eventual liftoff.

Fed tightening expectations quickly adjusted and this is unequivocally dollar positive due to monetary policy divergences. Odds of Q2 liftoff have risen to 75% vs. 40% at the start of the week and 50-50 last week. Liftoff in Q3 22 is back to fully priced in, with some odds of a second hike in the same quarter. A follow up 25 bp hike in Q4 22 has also moved back to being fully priced vs. 65% at the start of the week. Elsewhere, ECB, BOJ, SNB, and Riksbank all are unlikely to hike before 2023 or perhaps even 2024. The dollar did gain sharply as Powell spoke but later gave back the lion’s share by the North American close. The U.S. 2-year yield had an intra-day range of 0.44-0.57%, ended the day at the highs, and has tacked on another few bp to 0.60% today. However, the 10-year yield ended the day near 1.44% after trading as high as 1.52% intra-day but has tacked on another 5 bp to 1.49% today. Powell and Yellen testify before the House later today.

The Fed Beige Book report has been rendered moot. Whatever it contains has been superseded by Powell’s hawkish tilt. Still, it’s worth repeating what we think has changed since the last meeting November 2-3 that led to the new Fed messaging. We’ve gotten a very good jobs number (with another one expected Friday) and higher than expected inflation readings. Jobless claims have fallen to new lows, while wage readings have crept higher. Reports suggest that the manufacturing sector remains strong, but we expect the Fed to acknowledge that supply chain issues to remain in place. We expect this Beige Book to acknowledge all of these upside risks, which would support the case for a faster pace of tapering. Minutes to the November meeting were released last week and showed that “Various participants noted that the Committee should be prepared to adjust the pace of asset purchases and raise the target range for the federal funds rate sooner than participants currently anticipated if inflation continued to run higher.” It seems we are closer to that moment than we thought.

ADP private sector jobs estimate and ISM manufacturing PMI will be the data highlights. Consensus for ADP sees 525k vs. 571k in October. November ISM manufacturing PMI is expected at 61.2 vs. 60.8 in October. Keep an eye on the employment component, which stood at 52.0 in October. These are the final two major clues ahead of November jobs data Friday. ISM services PMI will be reported Friday after the jobs data. Consensus for NFP has crept up a bit to 548k vs. 531k in October, with the unemployment rate see dropping a tick to 4.5%. Average hourly earnings are expected to pick up a tick to 5.0% y/y. October construction spending (0.4% m/m expected) and November auto sales (13.40 mln annual rate expected) will also be reported today.

Banco de Mexico releases its quarterly inflation report. The bank just delivered its fourth 25 bp hike of the cycle November 11. With the policy rate now at 5.0% and headline inflation at 7.05% y/y in mid-November, there is clearly need for a more aggressive tightening cycle. However, the outlook has been made cloudier by AMLO’s decision to nominate Hacienda official Victoria Rodriguez as the next Banxico Governor after initially choosing former Finance Minister Arturo Herrera. Rodriguez has limited monetary policy experience and is little known to financial markets, which makes her a poor choice at a time when inflation is surging and the peso slumping. Next policy meeting is December 16 and another 25 bp hike to 5.25% is expected.

EUROPE/MIDDLE EAST/AFRICA

Final eurozone November manufacturing PMI readings came in softer. The headline PMI fell two ticks from the preliminary to 58.4, driven largely by a similar drop in Germany to 57.4. France saw its PMI rose to 55.9 vs. 54.6 preliminary. Italy and Spain were reported for the first time, with the former rising to 62.8 vs. 61.1 in October and the latter falling to 57.1 vs. 57.4 in October. The Netherlands fell sharply to 60.7 vs. 62.5 in October. This will be followed by final eurozone services (56.6 expected) and composite (55.8 expected) PMIs Friday. Germany reported weak October retail sales, falling -0.3% m/m vs. an expected 0.9% gain. Eurozone reports October retail sales Friday, which are expected to rise 0.3% m/m vs. -0.3% in September. Obviously, the German reading points to some downside risks. Indeed, with lockdowns falling into place even before omicron, downside risks to the eurozone are building in Q4. Elsewhere, U.K. final November manufacturing PMI fell a tick from the preliminary to 58.1.

The pace of weekly ECB net asset purchases has been creeping higher. The four-week moving average fell to a low of EUR15 bln for the week ending November 5 but has since risen every week to stand at EUR17.3 bln for the latest week ending November 26. Net purchases have risen despite fairly high redemptions, and this is reflected in gross asset purchases averaging EUR21.1 bln for the latest week, the highest since October. Recall that the ECB announced a “moderately lower pace” of purchases in Q4 at its September 9 meeting. We think the increased purchases presage an extension of QE at the next policy meeting December 16. As we’ve said many times before, we believe Madame Lagarde is determined not to be the second French head of the ECB to tighten prematurely.

The Turkish lira is seeing a strong rebound on headlines of FX intervention by the central bank. The bank’s statement noted “unhealthy price formations,” a peculiar euphemism for a 40% depreciation against the dollar on the year. We have no doubt that intervention will fail if the intention is to stabilize the currency, though it could provide some more two-way risk in the near term. In fact, the move worries us even more. Spending precious FX reserves suggests that the government is still holding the line in its economic policies, making the adjustment even more painful. The lira is appreciating 5% against the dollar so far today to TRY 12.8. Without proper monetary policy support (higher rates), this should prove to be a brief respite. Next policy meeting December 16 will be key, as another rate cut would bring on another wave of lira selling.

ASIA

Australia reported stronger than expected Q3 GDP data. GPD contracted -1.9% q/q vs. -2.7% expected and 0.7% growth in Q2. The drop was due largely to the lockdowns seen across most of the country and so the economy should rebound nicely in Q4 as movement restrictions were lifted. Elsewhere, final November manufacturing PMI came in at 59.2 vs. 58.5 preliminary. Final services and composite PMIs will be reported Friday. The RBA has maintained its dovish tone, with forward guidance still emphasizing 2024 as likely timing for liftoff. However, the swap market still sees 75 bp of tightening over the next twelve months and this still strikes us as too aggressive. Next RBA meeting is December 7 and we expect the bank to push back against market expectations.

Korea’s external trade figures defied the virus headwinds. Exports for November rose 32.1% y/y and imports rose 43.6% y/y. Seasonal factors played a role, but the numbers suggest that external demand remained strong going into the holiday season and ahead of the impact of omicron. Semi-conductor exports remained strong with a 40.1% increase in the value of shipments. Today’s strong numbers come after considerably robust PMI readings.

Manufacturing PMI readings across EM Asia were generally strong in November. China’s Caixin manufacturing PMI dipped slightly into contractionary territory at 49.9, but we think yesterday’s official PMIs provide a more robust reading. Malaysia’s figure rose slightly on the month to 52.3 and Indonesia was off its recent highs but remains strong at 53.9. Again, the numbers suggest the region is entering the new stage of the pandemic on relatively good footing.

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