Dollar Steady at End of Eventful Week

December 17, 2021
  • Markets are still digesting the Fed’s hawkish turn; U.S. data remain firm; President Biden’s Build Back Better package remains elusive; Colombia is expected to hike rates 50 bp to 3.0%; Mexico delivered a hawkish surprise yesterday
  • ECB delivered a hawkish hold; Germany reported November PPI and December IFO business climate survey; U.K. reported strong November retail sales; BOE Chief Economist Pill said it will likely need to hike rates further to curb inflation; the Tories suffered a big defeat in the North Shropshire by-election; Russia hiked rates 100 bp to 8.5%
  • The two-day BOJ meeting ended with a dovish hold

The dollar is stabilizing as an eventful week winds down. DXY continues to find support near 96. The euro rally ran out of steam near $1.1360 and is trading heavy, while sterling has given up much of its post-BOE gains and is trading back below $1.33. USD/JPY reversed lower after this week’s break above 114 and is trading back near 113.50. The dollar is clearly suffering from positioning adjustment and some “buy the rumor, sell the fact” price action. Looking ahead, we believe the underlying trend for a stronger dollar remains intact.

AMERICAS

Markets are still digesting the Fed’s hawkish turn. Fed Governor Waller speaks today and should offer further clarification of the Fed’s likely path towards liftoff. Of note, rates and rate expectations have paradoxically fallen since the FOMC decision. While Q2 liftoff is still fully priced in and follow-up hikes in Q3 and Q4 largely priced in, the swaps market is moving closer to a terminal Fed Funds rate of 1.25% vs. 1.50% at the start of the week. As it is, that 1.50% was too low in our view and it’s getting even worse. The 2-year UST yield is currently around 0.62% vs. 0.72% Wednesday, while the 10-year yield is near 1.41% vs. 1.48% Wednesday. While remaining largely rangebound, we continue to look for an upside breakout in the coming days.

U.S. data remain firm. Regional Fed manufacturing surveys for December continued to roll out as Philly and Kansas City Feds both reported yesterday. The former came in at 15.4 vs. 29.1 expected and 39.0 in November, while the latter came in at 24 vs. 25 expected and 24 in November. Markit preliminary December PMI readings and November IP were also reported yesterday. Manufacturing PMI came in at 57.8 vs. 58.5 expected and 58.3 in November, services PMI came in at 57.5 vs. 58.8 expected and 58.0 in November, and the composite PMI fell to 56.9 vs. 57.2 in November. IP rose 0.5% m/m vs. 0.6% expected and 1.6% in October.

President Biden’s Build Back Better package remains elusive. Biden said “It takes time to finalize these agreements, prepare the legislative changes, and finish all the parliamentary and procedural steps needed to enable a Senate vote. We will advance this work together over the days and weeks ahead.” Senate Democrats have been unable to break the deadlock within its own members and so reports suggest it will have to be taken up again in the new year. West Virginia Democrat Manchin remains the key holdout in the 50-50 Senate, calling for a $1.75 trln package. Stay tuned.

Colombia central bank is expected to hike rates 50 bp to 3.0%. A handful of analysts look for larger 75 bp or 100 bp moves. After starting the tightening cycle with a 25 bp hike to 2.0%, the bank delivered a hawkish surprise October 29 with a 50 bp hike vs. 25 expected. November CPI rose 5.26% y/y, the highest since January 2017 and further above the 2-4% target range. As such, we see some risks of a hawkish surprise today.

Banco de Mexico delivered a hawkish surprise yesterday. The bank hiked 50 bp to 5.50% vs. 25 bp expected. the vote was 4-1, with the dissent was in favor of the consensus 25 bp hike. The bank sees inflation converging back to target in Q4 23, which suggests a long, protracted tightening cycle. November CPI rose 7.37% y/y, the highest since January 2001 and further above the 2-4% target range. The bank warned of Swaps market is pricing in a peak policy rate of 8.0% by end-2022.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank delivered a hawkish hold. Rates were kept steady but the bank announced that PEPP would end in March as scheduled. However, in an effort to minimize the shock, the ECB will boost its long-standing APP program to a pace of EUR40 bln per month in Q2 from EUR20 bln currently. Since PEPP purchases have been averaging about EUR60 bln per month recently, this still amounts to tapering of EUR40 bln per month. PEPP purchases would then fall to EUR30 bln per month in Q3 and then revert to EUR20 bln per month in Q4. The ECB said APP purchases would continue under for “as long as necessary” and added that PEPP could be resumed if necessary. Unlike the Fed, the ECB is in no hurry to hike rates. Indeed, Madame Lagarde said it was “very unlikely” that the ECB will hike rates in 2022. We agree.

New macro forecasts were released and 2024 was added to the forecast horizon. Inflation forecasts were raised significantly, while growth forecasts were adjusted modestly. The new 2024 forecast for inflation is a key factor in its forward guidance. As that forecast along with 2023 remains substantially below the 2% target, we think it sends a very dovish signal on possible liftoff. That said, ECB officials are sounding cautious. Villeroy noted that the difference between those forecasts and the target are within the “margin of uncertainty” while Weidmann urged vigilance due to “risks to the upside” for inflation. While Weidmann’s hawkish take is no surprise, Villeroy is typically one of the doves and so bears watching.

Germany reported November PPI and December IFO business climate survey. PPI rose 19.2% y/y vs. 20.0% expected and 18.4% in October, which suggests further upside pressures on CPI in the coming months. The headline IFO reading came in at 94.7 vs. 95.3 expected and a revised 96.6 (was 96.5) in November. Both the current assessment and expectations components fell a couple of points to 96.9 and 92.6, respectively. As the virus numbers worsen in Europe, we see greater downside risks to the outlook for Q4 and Q1.

The U.K. reported strong November retail sales. Headline sales rose 1.4% m/m vs. 0.8% expected and a revised 1.1% (was 0.8%) in October, while sales ex-auto fuel rose 1.1% m/m vs. 0.8% expected and a revised 2.0% (was 1.6%) in October. Reports suggest Black Friday discounts were a big factor, with sales of clothing, computers, toys, and jewelry driving the gains. Of note, consumers may be front-loading holiday purchases due to supply chain concerns and so there is a risk of a drop-off in the December data. Other headwinds include the spread of the omicron variant and yesterday’s BOE surprise rate hike.

BOE Chief Economist Pill said that it will likely need to hike rates further to curb inflation. He noted “What we saw yesterday was the bank’s response to a view which has been building through time, accumulating evidence, that underlying more domestically generated inflation here in the U.K., probably centered around cost and wage pressures in a tight and tightening labor market are going to prove more persistent through time.” That said, market pricing on further BOE tightening remains rather restrained. WIRP suggests a 3 in 4 chance of another hike February 3, while the swaps market is pricing in a peak policy rate of 1.25% by end-2022.

The Tories suffered a big defeat in the North Shropshire by-election. While typically a safe Tory seat, the Liberal Democrats handily won the seat vacated by Owen Paterson over an ethics row by a margin of 17,957 to 12,032. The Tories won this seat in 2019 with close to 23,000 votes, and the only good news for the Tories was that Labour only received 3,686 this time around. This suggests that Labour may not benefit from protest votes, though national polls suggest the party is enjoying stronger support overall as Johnson and his party suffer from a series of self-inflicted wounds. Talk of a leadership challenge to Johnson will of course pick up after this by-election.

Central Bank of Russia hiked rates 100 bp to 8.5%, as expected. The bank warned that inflation risks are “markedly tilted to the upside.” It said that monetary conditions remain neutral and that another rate hike is possible at one of the next meetings. It sees inflation falling to 4-4.5% by late 2022 but warned of possible substantial deviation from the 4% target. Of note, November CPI rose 8.40% y/y, the highest since January 2016 and more than double the 4% target. Next policy meeting is February 11 and another big hike then seems likely.

ASIA

The two-day Bank of Japan meeting ended with a dovish hold. Rates were kept on hold but the bank will allow its holdings of corporate bond and commercial paper to gradually fall starting in April from about JPY11 trln total currently to JPY2 trln and JPY3 trln for each, respectively, across five years. The BOJ also extended its loan support for small and medium-sized firms to September. Of note, Governor Kuroda acknowledged the slow pace of policy normalization, saying “Each country decides their monetary policy seeking stability in their economy and prices. It’s only natural that there’ll be directional differences.” Next policy meeting is January 17-18. New macro forecasts will be released then.

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