Dollar Stable as Markets Await Fresh Drivers

January 20, 2022
  • With no Fed speakers nor major U.S. data, markets have shifted to consolidation mode after this past week’s big moves; we continue to focus on the expected terminal Fed Funds rate; regional Fed manufacturing surveys for January will continue rolling out; weekly jobless claims will be of interest; Brazil presidential candidate Lula said he would like former Sao Paulo Governor Alckmin as his running mate
  • ECB President Lagarde continues to push back against market tightening expectations; ECB publishes its account of the December 16 meeting; market pricing for ECB liftoff has picked up recently; Norges Bank kept rates steady at 0.5%, as expected; Turkey kept rates steady at 14.0%, as expected
  • Japan reported firm December trade data; Australia reported firm December jobs data; RBA tightening expectations are picking up; commercial banks in China took the PBOC’s lead and cut their lending rates; Indonesia delivered a hawkish hold; Malaysia delivered a dovish hold

The dollar is slightly firmer as markets await fresh drivers. DXY is hanging on to its recent gains, trading near 95.605 after returning to its familiar 95-97 trading range that has largely held since mid-November. EUR remains heavy as ECB officials push back on tightening expectations (see below), trading near $1.1340 and on track to test this year's low near $1.1270. Sterling is seeing a series of lower highs since peaking near $1.3750 on January 13 and is testing support near the $1.36 area. USD/JPY is lagging the broad dollar bounce and remains pinned near 114 after three straight down days. Recent USD/JPY and EUR/CHF price action suggests risk-off impulses are still lurking.


With no Fed speakers nor major U.S. data, markets have shifted to consolidation mode after this past week’s big moves. The U.S. 2-year yield has drifted lower to 1.03% after trading as high as 1.07% yesterday, while the 10-year yield is trading near 1.83% after trading as high as 1.90% yesterday. This leaves the dollar consolidating its recent gains within well-worn ranges. DXY is trading back at the lower end of the 95-97 range that has held since mid-November. What will it take to get the next leg higher for the greenback? So much Fed hawkishness has been priced in but we continue to feel that further repricing is needed.

We continue to focus on the expected terminal Fed Funds rate. That has crept higher from 1.5% in Q4 to 1.75% currently, and the market is starting to think about 2%. We say it should think higher. If the Fed does its job successfully, it will have brought inflation back down close to the 2% target by 2023 or 2024 (according to its own December forecasts). With the economy nearing full employment, this will require a restrictive Fed Funds rate that is positive in real terms. That will require a nominal rate of at least 2.25-2.50%, which coincides with the Fed’s own view on the longer-term rate. It is also where the rate topped out in 2019 in the previous tightening cycle.

Regional Fed manufacturing surveys for January will continue rolling out. Philly Fed is expected at 19.0 vs. 15.4 in December, but there are downside risks after the shock Empire survey earlier this week, which came in at -0.7 vs. 25.0 expected and 31.9 in December. While we suspect it was statistical quirks coupled with the impact of omicron, the situation clearly bears watching. Will other survey data be similarly impacted? We will know more next week, as preliminary January Markit PMI readings will be out Monday, followed by Richmond Fed survey Tuesday and Kansas City Fed survey Thursday.

Weekly jobless claims will be of interest. Initial claims will be for the BLS survey week containing the 12th of the month and are expected at 225k vs. 230k the previous week. Continuing claims are reported with a one-week lag and so next week’s reading will be for the survey week. This week, they are expected at 1.563 mln vs. 1.559 mln the previous week. The initial Bloomberg consensus for January jobs data stands at 290k vs. 199k in December, with the unemployment rate expected to remain steady at 3.9%. As we’ve noted before, the U.S. is very close to full employment and so it wouldn’t take more than a couple of decent jobs reports to get unemployment down to pre-pandemic levels. This is why the Fed is so keen to tighten policy sooner rather than later. Existing home sales (-0.5% m/m expected) will also be reported.

Brazilian assets rallied yesterday on reports that presidential candidate Lula said he would like to have former Sao Paulo Governor Geraldo Alckmin as his running mate. Lula noted that “We have divergences, and different visions of the world, but I will not have any problem in making a ticket with Alckmin to win the elections and govern this country.” Obviously, this is a good sign that Lula is reaching out for support from the centrists, something every successful Brazilian leader has done in the modern post-military era. Even without the choice of Alckmin, we don’t sense that markets are particularly concerned about a Lula presidency like they were back in 2002, when Lula was first elected. Over his two terms, Lula ended up being quite pragmatic and orthodox in his economic policies. Polls currently suggest 44% would back Lula for president vs. 23% for Bolsonaro, and Alckmin’s choice will likely boost Lula’s support. USD/BRL is trading at the lowest level since mid-November and is on track to test that month’s low near 5.3890. Beyond that lies the 200-day moving average near 5.3785, while a break below 5.3610 is needed to set up a test of the August 31 low near 5.1165.


ECB President Lagarde continues to push back against market tightening expectations. She said “We have every reason to not react as quickly and as abruptly as we could imagine the Fed might. But we have started to respond and we, of course, stand ready to respond with monetary policy if figures, data, facts, require it.” She stressed that “We’re all in very different situations,” adding that inflation is “clearly weaker” in the eurozone even as the economic recovery is not as advanced as in the U.S. Villeroy and de Cos made similar statements but both are well-known doves.

The ECB publishes its account of the December 16 meeting. We know there is a huge split within the ECB and the account may help us better understand the dynamics that Madame Lagarde is dealing with. At that meeting, the bank delivered a hawkish hold. Rates were kept steady but the bank announced that PEPP would end in March as scheduled. Since mid-December, the pace of PEPP buying has already fallen significantly. The 4-week total net purchases was around EUR26 bln last week, down from around EUR60 bln that held from August through mid-December. In other words, ECB has already begun tapering PEPP ahead of its expiry.

Market pricing for ECB liftoff has picked up recently. There is now around 20 bp of tightening priced in for this year, followed by another 35 bp next year that would take the deposit facility rate into positive territory for the first time since July 2012. It stands at -0.50% currently. This seems overdone to us, as the ECB will most likely be amongst the last (along with SNB, Riksbank, and BOJ) holdouts to hike rates. Eurozone yields have been rising, though not by as much as the U.S. Still, the 10-year German bund yield is flirting with positive territory for the first time since May 2019. The 10-year spread with Italy is currently just below the cycle high of 137 bp from December and looks likely to head even higher.

Norges Bank kept rates steady at 0.5%, as expected. At the last policy meeting December 16, it hiked rates 25 bp to 0.50%, as expected. Governor Olsen confirmed his forward guidance from the last meeting by noting that “Based on the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised in March.” New macro forecasts and an updated rate path won’t be released until that March 24 meeting. Swaps market is pricing in a terminal policy rate between 1.50-1.75% by end-2024, which is consistent with the central bank’s December expected rate path.

Turkey central bank kept rates steady at 14.0%, as expected. No forward guidance was given but the bank said it will conduct a comprehensive review of its policy framework “with the aim of prioritizing the Turkish lira in all policy tools.” The bank added that the recent rise in inflation was driven “by distorted pricing behavior due to unhealthy price formations in the foreign exchange market, supply side factors such as the rise in global food and agricultural commodity prices, supply constraints, and demand developments.” By downplaying its role in the current debacle, that tells us right there that the bank still sees no need to provide the much-needed monetary anchor. CPI rose 21.31% y/y in December, the highest since November 2018 and further above the 3-7% target range. The latest central bank survey sees end-2022 inflation at 25.37% and end-2023 at 15.54%, while USD/TRY is seen at 16.13 at end-2022.


Japan reported firm December trade data. Exports rose 17.5% y/y vs. vs. 15.9% expected and 20.5% in November, while imports rose 41.1% y/y vs. 43.0% expected and 43.8% in November. Robust export growth was driven by autos and steel and will help offset risks to domestic activity from omicron. Of note, Toyota suspended some operations at a plant in central Japan due to the virus. A halt in the first shift of the production line will be through Saturday and will reported impact 1500 vehicles. One can only hope that the variant’s impact on society and the economy will be quick and limited, as we have so far seen in other countries. That said, it’s no wonder that the BOJ pushed back so hard this week on talk of tightening.

Australia reported firm December jobs data. A total of 64.8k jobs were added vs. 60.0k expected and 366.1k in November, while the unemployment rate fell to 4.2% vs. 4.5% expected and 4.6% in November. This was the lowest since August 2008 and came even as the participation rate was steady at 66.1%. The RBA expects wage pressures to rise when unemployment approaches the low 4s, and now here we are. As a result, the bank will likely have to update its forward guidance at the next meeting to acknowledge earlier than expected liftoff.

Reserve Bank of Australia tightening expectations are picking up. WIRP suggests liftoff is almost fully priced in for June 7, with another hike each to follow in Q3 and Q4. The next policy meeting is February 3 and the RBA will be reviewing its QE policy whilst updating its macro forecasts in its Statement of Monetary Policy. After the firm labor market data, we think it is a given that the RBA ends its QE then rather than extend it for another three months. The next Statement of Monetary Policy comes at the May 3 meeting and so we suspect markets will start focusing on that date for potential liftoff rather than June 7. Right now, WIRP sees 50-50 odds for May liftoff. The yield on the 2-year government bond is trading near 0.89%, the highest since the start of 2020 and on track to test the December 2020 high just below 1.0%.

Commercial banks in China took the PBOC’s lead and cut their lending rates. The 1-year Loan Prime Rate was cut 10 bp to 3.7% and the 5-year rate was cut 5 bp to 4.6%. The cuts were fully expected after the PBOC earlier this week cut its 1-year MLF rate 10 bp to 2.85%. It’s clear that policymakers have pivoted from structural reforms to boosting the economy, and further easing is to be expected this year.

Bank Indonesia delivered a hawkish hold. It kept rates steady at 3.5%, as expected, but Governor Warjiyo said the bank will start raising the reserve requirement ratio for commercial banks. The process will begin with an increase to 5% in March followed by additional increases during the rest of the year. It seems that the bank is taking the first steps towards normalizing policy, by first mopping up liquidity it created with its pandemic bond-buying program. Bloomberg consensus sees steady rates through H1, with 25 bp of tightening seen in H2.

Bank Negara Malaysia delivered a dovish hold. It kept rates steady at 1.75%, as expected, and said “Growth is expected to gain further momentum in 2022. This will be driven by the expansion in global demand and higher private sector expenditure amid improvements in the labor market and continued policy support. Risks to the growth outlook, however, remain tilted to the downside.” The bank does not seem in any hurry to tighten but noted that “The stance of monetary policy will continue to be determined by new data and their implications on the overall outlook for inflation and domestic growth.” December CPI will be reported tomorrow, with headline inflation expected at 3.1% y/y vs. 3.3% in November. If so, this would be the first deceleration since August. The central bank does not have an explicit inflation target but easing price pressures should allow it to remain on hold for most of this year. Bloomberg consensus sees steady rates through H1, with 25 bp of tightening seen in H2.

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