Dollar Steady Ahead of ADP

December 06, 2023

Win Thin

U.S. yields are moving lower and financial conditions remain loose; data highlight will be November ADP private sector jobs estimate; October JOLTS data are worth discussing; November ISM services PMI came in firm; BOC is expected to keep rates steady at 5.0%
Eurozone October retail sales were soft; Germany reported weak October factory orders; BOE released its Financial Stability Report; Poland is expected to keep rates steady at 5.75%
BOJ Deputy Governor Himino downplayed the potential impact of hiking rates; Australia reported soft Q3 GDP data

The dollar is hanging on to its recent gains ahead of ADP. DXY is trading flat near 104.05 after two straight up days. The euro continues to lead this move lower in the foreign currencies and is trading lower near $1.0780 while sterling is trading lower near $1.2585. USD/JPY is trading higher near 14745 despite BOJ comments on hiking rates (see below). At this point, it will likely take a string of firm U.S. data to truly challenge the current dovish Fed narrative. We continue to stress that the U.S. economy continues to grow at or above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed will not be able to cut rates as soon and by as much as the markets think. The dollar should see another leg higher when market expectations for the Fed finally shift, though that may be a 2024 story.

AMERICA

U.S. yields are moving lower again. The 10-year yield traded as low as 4.16% yesterday and is now trading near 4.20%, while the 30-year yield traded as low as 4.30% yesterday and is now trading near 4.32%. The 2-year yield traded near 4.56% yesterday and is now trading near 4.61%. However, lower yields have had little impact on the dollar as it continues its recovery. Fed easing expectation remain in play. WIRP suggests no change this month but after that it’s all about the cuts. There are 15% odds of a cut January 31, rising to nearly 70% March 20 and fully priced in for May 1 vs. June 12 at the start of last week. Five cuts are fully priced in by end-2024 and we continue to expect an eventual repricing of such dovish expectations.

Financial conditions remain loose. The Chicago Fed’s weekly measure through November 24 were the loosest since early February 2022. Last week, yields fell, equities rose, spreads narrowed, and the dollar weakened and so conditions likely loosened again through December 1, which will be reported today. If yields continue to fall this week, we may get more loosening of conditions.

No wonder the U.S. economy remains robust. The Atlanta Fed’s GDPNow model is now tracking Q4 growth at 1.2% SAAR vs. 1.8% previously. Next update will be today after the data. October trade data will be reported, and the deficit is expected at -$64.2 bln vs. -$61.5 bln in September. Of note, the New York Fed’s Nowcast model is tracking 2.3% SAAR and will be updated Friday. Readings early in the quarter are typically volatile as more and more data are incorporated into these models. Lastly, we’d note that the current early reads are based largely on strike-depressed October data. If November data bounce back as we expect, the Q4 estimates should rise accordingly.

The data highlight will be November ADP private sector jobs estimate. Bloomberg consensus sees 130k vs. 113k in October. This is the final major clue for November NFP this Friday. Bloomberg consensus stands at 187k vs. 150k in October, while its whisper number stands at 155k. The unemployment rate is expected to remain steady at 3.9% while average hourly earnings are expected to fall a tick to 4.0% y/y.

October JOLTS data are worth discussing. Job openings fell to 8.733 mln vs. 9.300 mln expected and a revised 9.350 mln (was 9.553 mln) in October. While this is the lowest since March 2021, openings are still high by historical standards. The details are more encouraging. Hires were little changed at 5.866 mln vs. 5.904 mln in September, while quits were also little changed at 3.628 mln vs, 3.646 mln in September. This suggests less churn. However, layoffs rose slightly to 1.642 mln vs. 1.610 mln in September and are nearing the cycle high of 1.682 mln in August. Bottom line: there has been some softening in the labor market but not by a lot.

November ISM services PMI came in firm. Headline came in at 52.7 vs. 52.3 expected and 51.8 in October and was the first increase since August. The details were also solid, with employment rising half a point from October to 50.7 and activity rising a full point from October to 55.1. Prices paid fell three ticks to 58.3 but remains near the cycle high of 58.9 in August and September. Last week, ISM manufacturing PMI came in a weaker than expected at 46.7 but prices paid rose to 49.9, the highest since April. This supports our belief that markets have gotten too sanguine about disinflation, as it appears price pressures are picking up again.

Bank of Canada is expected to keep rates steady at 5.0%. At the last meeting October 25, the bank delivered a dovish hold and since then, the data have come in mostly softer. WIRP suggests nearly 20% odds of a rate cut January 24, rising to 70% March 6 and fully priced in for April 10 vs. June 5 at the start of last week. Nearly four cuts are priced in by the end of 2024 and this seems very unlikely.

Canada reported soft November PMI readings. S&P Global services and composite PMIs came in at 44.5 and 44.8, respectively. Both were down around two full points from October, with the composite reading at the lows for this cycle. Ivey PMI will be reported today, and we see downside risks after the S&P Global readings. Q3 labor productivity and October trade data will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

Eurozone October retail sales were soft. Sales came in a tick lower than expected at 0.1% m/m vs. a revised -0.1% (was -0.3%) in September, while the y/y rate came in a tick lower than expected at -1.2% vs. -2.9% in September. Italy reports its retail sales data tomorrow.

Germany reported weak October factory orders. Orders came in at -3.7% m/m vs. 0.2% expected and a revised 0.7% (was 0.2%) in September. The WDA y/y rate fell to -7.3% vs. -3.9% expected and a revised -3.8% (was -4.3%) in September. It reports October IP tomorrow and it is expected at 0.2% m/m vs. -1.4% in September. After today’s orders data, there are clearly downside risks to the IP reading as Germany continues to struggle. As we’ve seen elsewhere, the modest recovery in China has yet to make a positive impact on the world’s exporter nations

No wonder European Central Bank easing expectations have picked up. WIRP suggests 5% odds of a cut December 14, rising to 15% January 25, 75% priced in for March 7 and fully priced in for April 11 vs. June 6 at the start of last week. A fifth cut by the end of next year is now fully priced in. ECB officials continue to push back against this dovish narrative. Kazaks said that given the current economic outlook and medium-term forecasts, there’s no need for rate cuts in H1.

Bank of England released its Financial Stability Report. Like other central banks have done this past year, it warned of the risks of the so-called basis trade. The bank noted that “Sharp increases in volatility in market interest rates could lead to increases in margin required on the futures positions, or hedge funds may find it harder to refinance their borrowing in the repo market. This, combined with any breaches of risk- or loss-limits, could force funds rapidly to unwind their positions.” The bank also focused on so-called Liability-driven Investment (LDI) funds, noting that regulations that require LDI funds to have enough cash to withstand a rise in bond yields of up to 2.5 percentage points had boosted their resilience. Those LDIs were the source of gilt market instability last year. However, the BOE warned that some LDI funds were still too slow to recapitalize their positions to offset falling gilt prices.

Bank of England Governor Bailey spoke. He said the bank will set interest rates with financial stability in mind, adding that U.K. banks are well placed to support borrowers. However, Bailey acknowledged that businesses are under pressure due to high rates while household finances are stretched. BOE easing expectations continue to pick up. WIRP suggests no odds of a hike December 14, rising modestly to top out near 5% February 1. After that, rate cuts are priced in with the first one now fully priced in for June 20 vs. September 19 at the start of last week. Three cuts are priced in by the end of 2024.

National Bank of Poland is expected to keep rates steady at 5.75%. Minutes from the November 8 meeting will be released Friday. At that meeting, the bank delivered a hawkish surprise and kept rates steady vs. an expected 25 bp cut to 5.5%. Governor Glapinski said then that the scope for lower rates was limited as fiscal and regulatory risks had grown. That said, the swaps market is pricing in a 25 bp cut over the next three months, followed by another 25 bp over the subsequent three months.

ASIA

Bank of Japan Deputy Governor Himino downplayed the potential impact of hiking rates. Himino said households would most likely benefit from higher net income, while the impact on the corporate sector would likely be limited. He also stressed that the financial system is resilient enough to cope with higher rates, adding that if done properly, “there would be a sufficient possibility of achieving a positive outcome from the exit, since a wide range of households and firms would benefit from the virtuous cycle between wages and prices.” He added that while financial institutions might face unrealized losses on their holdings of long-term bonds, they’d also have the opportunity to boost their returns by replacing the bonds they hold with new ones. Still, Bank of Japan liftoff expectations continue to get pushed out. At the end of September, the market was pricing in liftoff in March; by early November, it was seen in April and now liftoff is seen in June.

Australia reported soft Q3 GDP data. Growth came in at 0.2% q/q vs. 0.5% expected and 0.4% in Q2, while the y/y rate came in at 2.1% vs. 1.9% expected and a revised 2.0% (was 2.1%) in Q2. Of note, household spending was flat q/q, while government expenditure rose 1.1% q/q. Net exports subtracted -0.6 percentage points from growth, while inventories added 0.4 percentage points. With recent data softening, RBA expectations have shifted from tightening to easing. WIRP no longer suggests any odds of a hike February 6, while odds of a cut start off at 5% in March and rise to 40% in May, 50% in June, 85% in August, and fully priced in for September.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.