Dollar Steady as Risk-Off Impulses Hit Global Markets

December 20, 2021
  • Markets are starting of the week in risk-off mode; the removal of accommodation by many of the major central banks will hit EM hard; there are no Fed speakers scheduled for this week; the market still does not believe the Fed in terms of the magnitude of the tightening cycle; Chilean assets are likely to come under pressure as leftist Boris won the presidential election
  • Joachim Nagel will be the next Bundesbank President; market pricing suggests the ECB is in no hurry to hike rates; U.K. CBI released its industrial trend survey for December; expect Brexit to remain in the headlines a full year after the deal was reached; markets are still struggling with BOE messaging; TRY remains under pressure as President Erdogan doubled down on his policy gamble
  • BOJ made its uniquely dovish stance perfectly clear; China took another small step in its pivot towards easing; Taiwan reported firm November export orders

The dollar is steady as risk-off impulses take hold. DXY has held on to most of Friday’s gains and is trading near 96.55. The euro saw some support near $1.1235 but remain heavy, while sterling continues to underperform and is trading back below $1.32 after its brief post-BOE bounce. USD/JPY is holding up well despite the risk-off vibes hitting markets today and is trading within recent ranges near 113.650. TRY continues to weaken on Erdogan comments, while CLP is sharply weaker after the presidential election (see below). We believe the underlying trend for a stronger dollar remains intact.


Markets are starting of the week in risk-off mode. The ostensible trigger was Senator Manchin’s blanket rejection of President Biden’s Build Back Better package. Democratic leaders must now decide whether to pare it down again or simply give up altogether. Manchin’s announcement came just days after Senate Democrats pushed back likely passage of the bill into next year, with the implicit understanding that the Senator from West Virginia was still on board. Coming on top of a hawkish shift last week from the Fed, ECB, and BOE, markets are suddenly faced with the reality that 2022 will see less monetary and fiscal stimulus than what was expected.

The removal of accommodation by many of the major central banks will hit EM hard. This will be true for most other risk assets that are dependent on cheap and plentiful liquidity. As such, EM is likely to remain under pressure as we move into 2022 even as MSCI EM is making new lows for this year near 1190. Charts point to a test of the late October 2020 low near 1100. After that is the late September 2020 low near 1053. Not only is the global liquidity story turning negative for EM, but so is the global growth story.

There are no Fed speakers scheduled for this week. However, Governor Waller closed out last week with a hawkish tilt. Regarding liftoff, he said "We'd like to put March on the table as a possible date to start lifting if we need to." Waller added that the “whole point” of moving to a faster pace of tapering was to allow for a quicker liftoff. WIRP suggests 50-50 odds for March 16 liftoff, while Q2 liftoff is fully priced in. A follow-up hike in Q3 is fully priced in, while another Q4 hike is about 60% priced in. November leading index (0.9% m/m expected) will be reported today.

The market still does not believe the Fed in terms of the magnitude of the tightening cycle. Fed Funds futures are pricing in a terminal Fed Funds rate between 1.50-1.75% by end-2024. The swaps market is even more dovish, with a terminal rate priced in closer to 1.25%. Contrast this to the updated Dot Plots, where the median Fed Funds rate is 1.625% by end-2023 and 2.125% by end-2024. We saw a similar dynamic during the 2015-2019 tightening and when all was said and done, the Fed moved towards the market’s dovish narrative. Will history repeat? Only time will tell. However, we do note that even with the truncated tightening cycle of 2019 at saw the Fed Funds rate peak at 2.25-2.50%, the real rate was still positive. Again, a negative real rate at the end of a tightening cycle is simply unheard of.

Chilean assets are likely to come under pressure as leftist Boris won the presidential election. The margin was a wider than expected 56-44% over right win candidate Kast. While Boric has taken pains to stress that his economic model will not be a radical one, it’s clear that the market-friendly policies are likely a thing of the past. Along with the planned re-writing of its Constitution, Chile is moving on to a new path with an unknown destination. The wide margin of victory may give Boric more confidence to push a more left-wing agenda but only time will tell. Markets have uncertainty and Chile is offering years of it.


Joachim Nagel will be the next Bundesbank President. Finance Minister Lindner said that “Considering the risk of inflation, stability-oriented monetary policy is of increasing significance. This is an experienced personality who will ensure continuity at the Bundesbank.” Nagel had nearly twenty years at the Bundesbank before departing first to work at state-owned development bank KfW and then at the BIS. His choice and background suggests continuity at the top of the eurozone’s most important member central bank. He of course inherits a backdrop of rising inflation but markets must know that he is but one voice at the ECB. While Nagel will of course be suitably hawkish, the ECB is clearly maintaining a cautious stance in its delicate balancing act to placate the hawks on the Governing Council.

While the ECB delivered a hawkish hold last week, market pricing suggests the bank is in no hurry to hike rates. Swaps market is pricing in no ECB tightening whatsoever over the next twelve months. Madame Lagarde stressed that 2022 was unlikely after last week’s decision and we agree. However, we believe the bank took a risky move to taper its asset purchases just as Germany appears to be tipping into recession. ECB speakers are limited this week. Kazimir speaks tomorrow and Holzmann speaks Wednesday. Last week, Holzmann said the ECB will adjust policy if upside risks to inflation materialize.

U.K. CBI released its industrial trend survey for December. Orders came in at 24 vs. 20 expected and 26 in November, while selling prices came in at 62 vs. 60 expected and 67 in November. CBI distributive trades survey will be released tomorrow, with retailing reported sales expected at 25 vs. 39 in November. The data have been mixed of late, but renewed Covid restrictions are likely to weigh on the economy as we move into 2022.

Expect Brexit to remain in the headlines a full year after the deal was reached. With the departure of Frost, incoming Brexit Secretary Truss will have to hit the ground running. Disputes over the Northern Ireland Protocol and EU fishing rights remain on a slow boil, and so-called equivalency for U.K. financial firms hasn’t even made it off the back burner. Before Frost’s abrupt resignation, he and the EU said that they wanted to resolve their differences in early 2022. Truss is regarded as a Brexit hardliner and so it remains to be seen if this ambitious timetable will be met.

Markets are still struggling with Bank of England messaging. After talking up inflation risks in November and then standing pat, the bank seemed to downplay inflation risks in December and then surprised with a rate hike. WIRP suggests 80% odds of a follow-up hike February 3, while a March 17 hike is fully priced in. Swaps market is pricing in a terminal rate of 1.25% by end-2022, which would imply quarterly hikes next year. As in the case of the Fed, this in turn implies a negative real policy rate at the end of a tightening cycle (assuming inflation returns to target) and that just does not seem likely to us.

The Turkish lira remains under pressure as President Erdogan doubled down on his policy gamble. Over the weekend, he pledged to continue cutting rates. Erdogan said “We are lowering interest rates. Don’t expect anything else from me. As a Muslim, I’ll continue to do what is required by nas,” an Arabic word referring to Islamic teachings. USD/TRY is making new all-time highs near 18 today as the move is quickly becoming exponential. Even a shock rate hike of 10 percentage points or so is unlikely to turn sentiment around near-term. What Turkey needs now is an IMF to help stabilize sentiment but will not happen until things get even worse. As we know all too well, a currency crisis can quickly morph into a solvency crisis as external debt becomes impossible to service.


Bank of Japan made its uniquely dovish stance perfectly clear. Governor Kuroda told parliament that the bank is still in a continual easing stance and that it’s too early to think about normalizing policy. He stressed that normalization will only be discussed when inflation moves closer to its 2% target. Last week, the BOJ delivered a dovish hold and Kuroda stressed that “Each country decides their monetary policy seeking stability in their economy and prices. It’s only natural that there’ll be directional differences.” In other words, don’t look for the BOJ to follow the Fed, ECB, or BOE down the normalization path anytime soon. This inherently favors a weaker yen, though it will always gain from periodic bouts of risk-off sentiment.

China took another small step in its pivot towards easing. PBOC cut the 1-yrear Loan Prime Rate 5 bp to 3.80% whilst leaving the 5-year rate steady at 4.65%. This was the first cut in the LPR since April 2020 and follows two cuts to the RRR already this year. Despite all of Xi’s efforts at structural reform and income redistribution, it’s clear that when push comes to shove, policymakers will support growth above all else. If the mainland economy continues to slow, we can expect deeper rate cuts and even more RRR cuts. Fiscal stimulus has already been seen but here too, more is likely in the coming months. The central bank divergence theme and broad-based EM FX weakness has finally started to take a toll on the yuan after peaking December 9. It should continue to weaken in the new year as both of these drivers continue to move in the dollar’s direction.

Taiwan reported firm November export orders. Orders rose 13.4% y/y vs. 5.2% expected and 14.6% in October. While this is the second straight month of deceleration, the drop off was not as bad as feared. If orders continue to slow, however, the outlook for H2 22 will weaken further. The central bank just left rates steady but raised the possibility of a rate hike in 2022. Much will depend on how the economic outlook develops but recent forward-looking indicators (export orders, leading index) have been softening and so some caution is warranted. For another snapshot of regional trade and activity, Korea reports trade data for the first 20 days of December tomorrow.

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