Dollar Steady as Markets Await Fresh Drivers

November 16, 2023

Win Thin

Retail sales data were solid; the U.S. economy remains relatively robust; even the Fed doves may be growing concerned with the market’s aggressive easing expectations; financial conditions continue to loosen; September TIC data will be of interest
ECB doves remain in control of the narrative; new MPC member Greene has quickly become a leading hawk at the BOE
Japan reported September core machine orders and soft October trade data; Australia reported solid October jobs data; U.S.-China relations appear to be thawing, albeit slowly; Philippines kept rates steady at 6.5%, as expected

The dollar has steadied as markets digest recent U.S. data. DXY is trading flat near 104.35 as this week’s selloff ran out of steam near 104. The euro is trading slightly higher near $1.0855 while sterling is trading slightly lower near $1.24. USD/JPY is trading slightly lower near 151.20. With the dollar rally stalled, it will take some firm real sector data to challenge the current dovish Fed narrative. Yesterday’s retail sales data was a good start but more needs to be seen. If the data do remain firm as we expect, the market will eventually have to capitulate on its aggressive Fed easing expectations. We stress that the U.S. economy continues to grow above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed may have to hike again, and it definitely will not be able to cut rates as soon and as much as the market thinks. That said, the dollar remains vulnerable until this shift happens.

AMERICAS

Retail sales data were solid. Headline came in at -0.1% m/m vs. -0.3% expected and a revised 0.9% (was 0.7%) in September, while sales ex-auto came in at 0.1% m/m vs. -0.2% expected and a revised 0.8% (was 0.6%) in September. The so-called control group used for GDP calculations came in as expected at 0.2% m/m vs. a revised 0.7% (was 0.6%) in September. The y/y rates slowed to 2.5% vs. revised 4.1% (was 3.8%) in September for headline and to 2.3% vs. revised 3.5% (was 3.2%) for ex-autos. Control group slowed to 3.5% vs. revised 4.0% (was 3.8%) in September. Bottom line: there seems to be some modest slowing in consumption as Q4 got under way but there is still solid momentum there.

Indeed, the U.S. economy remains relatively robust. Atlanta Fed’s GDPNow model is now tracking Q4 growth at 2.2% SAAR, up from 2.1% previously. Next update comes tomorrow after the data. The New York Fed’s Nowcast model is tracking 2.5% SAAR growth and will also be updated tomorrow.

October PPI data came in cool. Headline came in at 1.3% y/y vs. 1.9% expected and 2.2% in September, while core came in at 2.4% y/y vs. 2.7% expected and actual n September. The PPI data support the disinflation story. However, firms appear to still have a lot of pricing power and may not pass on lower input costs to the consumer. That typically doesn’t happen until the labor market weakens significantly and consumers start to pull back. In our view, we’re not there yet.

Even the Fed doves may be growing concerned with the market’s aggressive easing expectations. Yesterday, Barkin acknowledged that continued strong growth could warrant higher rates. In the not-too-distant past, Barkin was firmly in the peak rates camp along with Bostic and the other doves. WIRP suggests no odds of a hike at either the December or January FOMC meetings. After that, there are 30% odds of a rate cut March 20 that rise to nearly 80% May 1. Four cuts are priced in by end-2024 and this dovish rate path is highly unlikely given the current evolution of the U.S. economy. Even the doves are getting a bit uncomfortable with this narrative. Barr, Mester, Williams, Waller, and Cook all speak today.

Financial conditions continue to loosen. Latest Chicago Fed reading for last week fell to the lowest since February 2022, before the Fed started hiking rates. If yields, spreads, and equities hold on to this week's moves, we believe financial conditions will loosen even further. Recall that higher long-term rates were a major reason why many Fed officials felt that it had done enough tightening. With markets buying into the dovish narrative, the Fed really has to start acknowledging that headwinds to the economy have fallen sharply this month.

Regional Fed surveys for November will continue rolling out. Empire survey kicked things off yesterday and came in at 9.1 vs. -3.0 expected and -4.6 in October. New York Fed services and Philly Fed manufacturing surveys will be reported today, and the latter is expected at -8.0 vs. -9.0 in October. Kansas City Fed also reports its manufacturing survey, which stood at -8 in October. Kansas City then reports its services survey tomorrow, which stood at -1 in October.

September TIC data will be of interest. Despite all the pearl-clutching about falling foreign demand for U.S. Treasuries, Japan has slowly built up its total UST holdings to $1.116 trln in August from $1.064 trln in October 2022. While below the peak of $1.325 trln in November 2021, the number remains sizable. Japan data suggests it bought a net JPY3.3 trln ($22 bln) of dollar-denominated bonds in September and so the TIC data should reflect this. On the other hand, China continues to sell, and its UST holdings fell to $805 bln in August, the lowest since June 2009.

Weekly jobless claims will be reported. Initial claims are expected at 220k vs. 217k last week. This reading is for the week ending November 11 and so next week’s initial claims data will be for the BLS survey week containing the 12th of the month. There is no Bloomberg consensus yet for November NFP but its whisper number stands at 143k vs. 150k actual in October. November NAHB housing market index will be reported and is expected to remain steady at 40, the lowest since January. October import/export prices and IP will also be reported, with IP expected at -0.4% m/m vs. 0.3% in September.

EUROPE/MIDDLE EAST/AFRICA

ECB doves remain in control of the narrative. Centeno said “We’re at a crossroads of many policies. Monetary policy has to decide its path because it will have already arrived at the maximum nominal level of interest rates. But inflation continues to fall. We have had enormous success in reducing inflation. It’s coming down faster than it went up.” No surprise then that ECB tightening expectations remain subdued. WIRP sees no odds of a hike December 14. After that, only cuts are priced and the first one is nearly 75% priced in for April 11 and fully priced in for June 6. Lagarde, Knot, de Cos, and Guindos all speak later today.

New MPC member Greene has quickly become a leading hawk at the Bank of England. She and Mann are in the hawkish camp, along with Haskel. Greene said she is still worried about persistent inflation, which she sees in the services component of the CPI. Greene noted that wage growth was still “incredibly high” and added that “If we have an economy with fairly low productivity growth and really high wage growth, it’s going to be hard to hit the target.” Greene has voted to hike rates 25 bp at all three meetings she has attended, once with the majority and twice with the dissents. While she was noncommittal, her comments suggest Greene may vote to hike again at the next meeting. Yet tightening expectations have evaporated. WIRP now suggests less than 5% odds of a hike December 14, rising modestly to top out near 10% February 1. The first cut is largely priced in for June 20, moving up from August 1 at the start of this week. Ramsden speaks later today.

ASIA

Japan reported September core machine orders. Orders came in at -2.2% y/y vs. -3.7% expected and -7.7% in August. However, machine tool orders slowed in October, suggesting downside risks for core machine orders next month. After the weaker than expected Q3 GDP data reported earlier this week, it seems that the weakness is carrying over to Q4. Both the BOJ and IMF forecast GDP growth of 2% in 2023 and 1% in 2024, which lines up with Bloomberg consensus.

Japan reported soft October trade data. Exports came in at 1.6% y/y vs. 1.0% expected and 4.3% in September, while imports came in at -12.5% y/y vs. -12.8% expected and a revised -16.6% (was -16.3%) in September. It’s clear last month’s acceleration in exports was a bit of a head fake and we expect net exports to subtract from growth again in Q4. While regional trade and activity may be stabilizing, a strong export recovery is unlikely until 2025.

Australia reported solid October jobs data. 55.0k jobs were added vs. 24.0k expected and a revised 7.8k (was 6.7k in) September. However, the bulk of the gain was driven by 37.9k part-time jobs while 17.0k full-time jobs were added. The unemployment rate rose a tick to 3.7%, as expected. This matches the high for this cycle but is only slightly above the 3.4% low from October 2022. Of note, the rise in the unemployment rate was due in large part to the rise in the participation rate to 67.0% vs. 66.8% expected and actual in September. By all accounts, the labor market remains relatively tight. WIRP suggest no odds of a hike December 5, but those odds rise over the course of H1 to top out near 40% in Q2.

U.S.-China relations appear to be thawing, albeit slowly. After the meeting on the sidelines of the APEC summit, the tone from both Presidents Biden and Xi was much less confrontational, with the former saying that “my responsibility is to make this rational and manageable so it doesn’t result in conflict” and the latter saying “China has no intention to challenge the United States or to unseat it.” There were some positive gestures from China, such as the return of its pandas to U.S. zoos as well as a promised crackdown on shipments of fentanyl ingredients. Most importantly, the two countries reinstated regular high-level military-to-military contacts.

Philippine central bank kept rates steady at 6.5%, as expected. The bank said “Guided by incoming data, the BSP remains prepared to resume monetary policy tightening as necessary to steer inflation towards a target-consistent path. The Monetary Board continues to deem it necessary to keep monetary policy settings sufficiently tight until a sustained downtrend in inflation becomes fully evident and inflation expectations are firmly anchored.” Since the surprise intra-meeting hike October 26, the peso has strengthened over 2% vs. the dollar and inflation has come down to 4.9% y/y, the lowest since July. We see steady rates for the time being. However, the swaps market is pricing in the start of an easing cycle over the next three months, which seems very unlikely given the bank’s hawkish tone.

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