Dollar Steady Ahead of FOMC Decision

September 22, 2021
  • The two-day FOMC meeting ends with a decision this afternoon; new macro forecasts and Dot Plots will be released; U.S. is inching towards another possible government shutdown; Brazil COPOM is expected to hike rates 100 bp to 6.25%
  • Gas supplies in Europe have become an increasingly important geopolitical touchpoint over the last few days; ECB will discuss ways to maintain stimulus once PEPP ends in March; U.K. trade outlook has dimmed; Hungary delivered a smaller-than-expected rate increase yesterday of only 15 bp but kept up the hawkish tone
  • There was some supportive news from China; BOJ meeting ended with a dovish hold; RBA said it is constantly assessing the need for curbs on mortgage lending; the digital asset space saw another huge bout of volatility over the last couple of days

The dollar is little changed ahead of the FOMC decision this afternoon. Of note, the dollar tends to weaken on FOMC decision days. DXY has fallen on three of the past four and five of the past seven dating back to last November. DXY is flat around 93.22 but remains on track to test the August 20 high near 93.729. The euro has found some support this week near $1.17 but also remains on track to test of the August 20 low near $1.1665. Sterling remains under pressure and is trading at new lows for this move near $1.3630, while USD/JPY is edging higher but remains below 110 despite the recovery in risk sentiment. There has been no major fallout in Chinese stocks on the first day back from holiday, with the Shanghai Composite up 0.3%. The same cannot be said for many EM Asian markets such as Taiwan (-2%) and Malaysia (-0.5%) but overall, the tone was of relief with most other bourses making small gains on the day. We believe a hawkish Fed and ongoing China risks will help keep the dollar rally going.

AMERICAS

The two-day FOMC meeting ends with a decision this afternoon. No change in policy is expected but we expect a hawkish hold as the official statement and the minutes should continue to lay the groundwork for imminent tapering. We believe the Fed is likely to wait until the November 2-3 meeting to make an official tapering announcement, followed by a likely start in December. The Fed will of course discuss developments abroad but we strongly believe that the Evergrande crisis will have no impact whatsoever on policy. Existing home sales (-1.7% m/m expected) will be reported today.

New macro forecasts and Dot Plots will be released today. There may be some modest tweaks to the forecast but nothing that would suggest a significant shift in Fed policy. According to the Fed’s June projections, it will have met its dual mandate by the end of 2023 and supports the view that rate hikes will begin sometime that year. Of note, 2024 will be added to the forecast horizon today and will be another crucial part of the Fed’s forward guidance.

Recall that in the June 15-16 Dot Plots, seven FOMC members saw the first hike in 2022 vs. four in March. This shift was enough to move the median expectations for lift-off forward into 2023. Today’s Dot Plots will be very interesting, as we suspect that more than seven will see the first hike coming in 2022. If another three policymakers move their lift-off expectations up to 2022, then the median will also shift forward to 2022. In the June Dot Plot, six saw the first hike in 2023 while five still saw no hikes through 2023. It will be interesting to see how this outlook shifts today, especially with 2024 being added to the plots. The Fed Funds futures strip shows solid odds for the first hike starting in Q4 22. Those odds quickly jump to being nearly fully priced in Q1 23.

The U.S. is inching towards another possible government shutdown. House Democrats yesterday passed a stopgap spending bill with a suspension of the debt ceiling attached to it. It now goes to the Senate, where 60 votes are needed to pass and none of the Republicans willing to support it. If that happens, then emergency measures in place can only keep the government running until late October. Many observers feel that the Democrats will eventually peel of the debt ceiling suspension and pass it by the budget resolution process that only requires a simple majority to pass in the Senate. Yet this rather pointless exercise revolving around the debt ceiling still has potential to disrupt global financial markets at a time of great uncertainty. Stay tuned

Brazil COPOM is expected to hike rates 100 bp to 6.25%. A 125 bp hike is possible, in our view, but unlikely. It would really muddle BCB’s communication strategy given the dovish comments last week from Governor Campos Neto. Reacting to the latest inflation surprise, he said “the central bank will [not] react to every high-frequency data point.” Mid-September IPCA inflation and August current account data will be reported Friday. Inflation is expected at 9.93% vs. 9.30% in mid-August. If so, it would be the highest since February 2016 and further above the 2.25-5.25% target band. This would also suggest another big hike at the next COPOM meeting October 27.

EUROPE/MIDDLE EAST/AFRICA

Gas supplies have become an increasingly important geopolitical touchpoint over the last few days, with U.S. now commenting on Russia’s policy towards Europe. The widely accepted angle here is that Russia is using the energy crisis to gain leverage over approving the Nord Stream 2 pipeline. We've already discussed the risks posed to the U.K. and the eurozone from the ongoing energy crisis. Eventually, Russia is likely to open the taps in order to take advantage of high prices but make no mistake, Putin first wants to extract maximum political gains from this episode.

ECB Governing Council member Muller said the bank will discuss ways to maintain stimulus once PEPP ends in March. He said one option would be to increase the pre-crisis AP program above the current EUR20 bln per month, something that Madame Lagarde has also hinted at. Muller stressed that “I realize that it would be a problem if there is a very sharp cliff effect at the end of the pandemic emergency purchase program.” A potential boost to the existing AP is “part of the discussion we will have on how to phase out PEPP and what it would mean for asset purchases going forward. And of course the decision will depend on market conditions next spring and the economic outlook at that point.” Lagarde has said that the post-PEPP landscape will be determined at the December 16 meeting. Of course, discussions are likely at the next meeting October 28 but given the sharp divide at the ECB, consensus is unlikely until we get closer to the March end of PEPP.

The U.K. trade outlook has dimmed. President Biden seemed less than eager when asked about the potential for the U.S.-U.K. trade deal that Prime Minister Johnson has been touting for months. Expectations were already low when Johnson admitted that a deal was unlikely before the next U.K. general election that’s due in 2024. Other reports emerged that the U.K. is exploring ways it could join the existing USMCA. What’s becoming clearer is that the smooth transition to a post-Brexit world that was promised by the Brexiteers is anything but smooth. On top of the energy crisis and a likely dovish hold from the BOE tomorrow, the reasons to be increasingly negative on sterling keep piling up.

Hungarian central bank (NBH) delivered a smaller-than-expected rate increase yesterday of only 15 bp but kept up the hawkish tone. The base rate is now at 1.65%, lower than the 1.75% expected in Bloomberg’s survey. But this was offset by assurances that the tightening cycle will continue, coupled with a substantial upward revision of the CPI forecast for this year from 2.1% to 3.4-3.8%. The NBH also decreased its weekly bond purchases by HUF10 bln to HUF50 bln. On net, the reaction to the event was modest and, even if at a slower pace, the NBH remains well in the hawkish side of the EM spectrum.

ASIA

There was some supportive news from China. First, Evergrande managed to negotiate a deal with some investors and will make meet the interest repayment due tomorrow for its 2025 bond. The PBOC also stepped in with heavy capital injections to the tune of RMB90 bln. It’s still unclear how officials will resolve the situation, but we stand firmly by our call for a managed debt restructuring or some sort of official unwind program.

The two-day Bank of Japan meeting ended with a dovish hold. All policy settings were kept steady and the bank released some more details of its green lending program. New macro forecasts won’t be released until the October 27-28 meeting. Governor Kuroda stressed that coordinated policy with the government will continue, noting that “The joint statement has played a major role in supporting Japan’s economy. The BOJ intends to continue conducting monetary policy appropriately in line with the statement.” Of course, Kuroda was alluding an expected fiscal package that should emerge once the LDP leadership has been settled next week. Kuroda also said that the global economy can withstand the Evergrande crisis, a view that we think is shared by the Fed and most major central banks. For now, the BOJ is on hold for the foreseeable future and we do not believe monetary policy will be impacted by the upcoming change to the LDP leadership.

RBA Assistant Governor Bullock said the bank is constantly assessing the need for curbs on mortgage lending. She added that unlike past times when regulators sought to affect specific instruments such as interest-only loans, the concerns now are more wide-ranging. Bullock said that means that the tools used in 2014 and 2017 aren’t really appropriate this time around, adding that if any so-called macro-prudential measures are needed, they should target “risks arising from highly indebted borrowers. Tools that address serviceability of loans and the amount of credit that can be obtained by individual borrowers are more likely to be relevant.” What this tells us is that the RBA is serious about keeping rates steady until 2024, focusing instead on regulatory measures to cool the housing market before it becomes a source of financial instability. Next policy meeting is October 5 and no change in policy is expected. However, the RBA may offer some more details about possible macro-prudential measures then.

COMMODITIES AND ALTERNATIVE INVESTMENTS

The digital asset space saw another huge bout of volatility over the last couple of days, in part driven by overall risk aversion and in part by regulatory concerns. Yesterday, SEC Chair Gensler reiterated his concerns about the digital asset space and the need for regulation. In our view, the main takeaways here were: (1) The SEC looks ready to actively engage in the debate over which assets should be classified as securities, and will push for exchanges to register; (2) Stablecoins are a big concern, akin to “casino chips”; (3) There has been increasing focus on lending platforms, both in centralized and DeFi, but also in staking (a big problem for coins implementing Proof of Stake such as Ethereum). Both Bitcoin and Ethereum are well off yesterday’s lows, but sentiment remains fragile.

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