Dollar Steady Ahead of a Potentially Hawkish FOMC Decision

June 16, 2021
  • The two-day FOMC meeting ends with a decision this afternoon; May PPI surprised to the upside; May retail sales data are worth discussing; Canada reports May CPI; Brazil COPOM is expected to hike rates 75 bp to 4.25%
  • The ECB will reportedly extend bank capital relief by nine months; details of ECB asset purchases for the week ending June 11 were reported; the U.K. reported higher than expected May CPI
  • The two-day BOJ meeting began today and ends with a decision tomorrow; Japan reported May trade and April core machine orders; today’s data from China came in decidedly on the weaker side

The dollar is largely flat ahead of the FOMC decision today. DXY continues to trade in narrow ranges around 90.5, slightly below the June 4 high around 90.627. The euro continues to trade heavy in the wake of the dovish ECB decision just above $1.21 and a clean break below would set up a test of the May 13 low near $1.2050. Sterling is outperforming on higher than expected CPI readings (see below) but remains stuck just above $1.41. USD/JPY is trading just above 110 and needs to break the June high near 110.35 to set up a test of the March high near 111. We believe the fundamental story favors the dollar and today’s FOMC decision may be the key to the next leg up in the greenback. Of note, the U.S. 10-year yield is stuck below 1.50%, trading around 1.49% currently after moving as low as 1.43% late last week.

AMERICAS

The two-day FOMC meeting ends with a decision this afternoon. We warn of a hawkish surprise. Please see our preview here. In brief, we see potential for a hawkish shift in the Dot Plots that moves median expectations for the first hike into 2023. We also believe that tapering may actually be mentioned in the official statement after informal discussions began at the last meeting in April. Lastly, the updated macro forecasts will have to acknowledge the much higher than expected inflation numbers. The Fed will likely reaffirm its view that this is transitory but will need to reaffirm its commitment not to let inflation get out of hand. Besides the FOMC decision, May building permits (-0.2% m/m expected), housing starts (4.5% m/m expected), and import/export prices will be reported.

May PPI surprised to the upside. Headline inflation picked up to 6.6% y/y vs. 6.2% expected and actual in April, while core picked up as expected to 4.8% y/y from 4.1% in April. The Fed continues to say this spike in inflation is transitory. However, food and energy prices are soaring and are already feeding into higher core inflation. Of note, the Fed’s preferred inflation measure core PCE came in at 3.1% y/y in April, the highest since July 1992 and above the 2% target. May readings will be reported June 25 and there are clear upside risks, to state the obvious.

May retail sales data are worth discussing. While the m/m drops were larger than expected for May, the large upward revisions to April largely offset the downside misses. For instance, headline sales fell -1.3% m/m vs. -0.8% expected, but April was revised to a 0.9% m/m gain from flat previously. We also caution against reading the retail sales report too negatively. Sales fell in May from record levels well above trend and so while one can say that May sales softened a bit, the readings are by no means weak. With the labor market expected to continue improving, consumption should be well-supported. Consensus for June jobs data is currently at 750k vs. 559k in May.

Canada reports May CPI. Headline inflation is expected to pick up a tick to 3.5% y/y, while common core inflation is expected to pick up a tick to 1.8% y/y. Bank of Canada just met June 9 and kept policy steady. The bank also maintained its view that slack in the economy will be absorbed and inflation at the 2% target in 2022, as well as its commitment to keep rates steady to H2 2022. Since the April taper, the labor market has posted two straight months of job losses and so there really was no need for the bank to change anything this month. That said, the bank said that it will adjust the QE program based on its “ongoing assessment of the strength and durability of the recovery.” That suggests further tapering is in the cards as the recovery continues. There will be updated macro forecasts released at the next meeting July 14. If the outlook continues to improve and jobs growth resumes in June, then the next round of tapering at that meeting is very possible.

Brazil COPOM is expected to hike rates 75 bp to 4.25%. Last week, May IPCA inflation came in higher than expected at 8.1% y/y, further above the 2.25-5.25% target range. Despite official comments about “partial normalization” of policy, the higher than expected inflation prints in recent weeks suggest the bank will eventually be forced to move toward a more aggressive tightening cycle. Of note, the CDI market is pricing in another 75 bp hike to 5.0% at the August 4 meeting. Bloomberg consensus sees another 100 bp of hikes in Q3, followed by 50 bp more in Q4 that would take the policy rates to 5.75% by year-end. More hikes are seen in 2022. Complicating matters is a severe drought that is likely to lead to considerable food price inflation ahead.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank will reportedly extend bank capital relief by nine months. The bank’s supervisory board plans to allow eurozone banks to continue excluding deposits held at the central banks when calculating their leverage ratios until March 2022. This exemption was set to expire on June 27. The extension is meant to allow banks to keep supplying credit to the economy with fewer limitations. Of note, the SNB and the Fed have already allowed their leverage ratio relief measures to expire this year. The eurozone typically has a stronger reliance on bank loans rather than capital markets, and that is why the ECB remains sensitive to the impact of leverage ratios on economic activity. It is also another sign that the bank remains concerned about the durability of the current recovery. Elsewhere, the ECB’s supervisory board will reportedly discuss next month whether to lift a cap on bank dividends at the end of September.

Details of ECB asset purchases for the week ending June 11 were reported. Redemptions were rather high at EUR7.3 bln and so gross purchases came in at EUR18.1 bln vs. EUR21.3 bln for the week ending June 4 vs. EUR25.0 bln for the week ending May 28. Net purchases were already reported at only EUR10.8 bln vs. EUR20.6 bln for the week ending June 4 and EUR20.0 bln for the week ending May 28. This is about half the weekly average during the period of accelerated purchases and so the drop off is a little puzzling. Madame Lagarde hinted at seasonal flexibility that would require fewer purchases in thin summer markets, but this seems too early. Let’s see how next week’s purchases come in before making any hasty judgments.

The U.K. reported higher than expected May CPI. Headline inflation picked up to 2.1% y/y vs. 1.8% expected and 1.5% in April, while CPIH picked up to 2.1% y/y vs. 1.9% expected and 1.6% in April. This puts inflation above the 2% target for the first time in nearly two years. Of note, PPI input prices surged 10.7% y/y, suggesting pipeline pressures remain strong. The BOE has long said that a temporary spike in inflation would arrive this year and here we are. While BOE tightening expectations have picked up recently as the recovery picks up steam, today’s data did little to change the rates outlook. The short sterling strip still shows the first hike largely priced in by mid-2022 and fully priced in by Q3 22, while gilt yields are little changed on the day.

ASIA

The two-day Bank of Japan meeting began today and ends with a decision tomorrow. At the last decision April 27, it delivered a dovish hold as new forecasts were unveiled. The bank saw targeted core inflation at 0.1% (0.5% previously) for FY2021, 0.8% (0.7% previously) for FY2022, and 1.0% for FY23, which was first added to the forecast horizon. The bottom line is that inflation is likely to remain below the 2% target through FY23 and so the BOJ has signaled that it intends to keep policy accommodative until FY24 at least. There won’t be updated forecasts until the July 15-16 meeting and so this one is just a placeholder with no changes expected.

Japan reported May trade and April core machine orders. Exports rose 49.6% y/y vs. 50.8% expected and 38.0% in April, while imports rose 27.9% y/y vs. 26.6% expected and 12.8% in April. This led to an adjusted surplus of JPY43.1 bln vs. JPY241.8 bln expected and a revised JPY84.4 bln (was JPY65.2 bln) in April. Exports to the U.S. rose 87.9% y/y and those to the EU rose 69.6% y/y. Exports to China came in quite a bit lower at 23.6% y/y. Elsewhere, orders rose 0.6% m/m vs. 2.5% expected and 3.7% in March.

Today’s data from China came in decidedly on the weaker side. However, the underlying recovery story hasn’t been threatened. Retail sales decelerated to 12.4% y/y in May vs. 14.0% expected and considerably lower than the 17.7% gain in April. Industrial production slowed to 8.8%, close to the consensus 9.2% but slower than the 9.8% gain in April. An interesting data point on the consumption side was the 25% y/y decline in spending during the Dragon Boat Festival long weekend, suggesting there is still a long way towards full normalization. External demand remains robust but this could start to taper off with the new virus wave in many of its regional trading partners. Chinese equities underperformed on the day with the Shanghai Composite down 1%, but not too far out of line with the broader risk off move.

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