Dollar Surrenders Some Post-FOMC Gains

September 23, 2021
  • The Fed delivered a hawkish hold, as we expected; we think if job growth improves to around 500k this month, the Fed will pull the trigger on tapering; Powell said that gradual tapering is likely to conclude around mid-2022; there was a hawkish shift in the Dot Plots; Fed regional manufacturing surveys will continue to roll out; Brazil hiked rates by 100 bp to 6.25%, as we expected; Mexico reports mid-September CPI
  • Eurozone and U.K. reported weak preliminary September Markit PMI readings; Norges Bank hiked rates 25 bp to 0.25%, as expected; SNB delivered a dovish hold, as expected; BOE is likely to deliver a dovish hold; Turkey is expected to keep rates steady at 19.0%
  • China regulators are stepping in with regards to Evergrande; Philippines and Taiwan kept rates on hold, as expected

The dollar is giving back some of its post-FOMC gains. After trading at a new high for this move near 93.524 earlier today, DXY is trading back near 93.222. We believe it remains on track to test the August 20 high near 93.729. The euro has found some support this week just below $1.17 but remains heavy and on track to test of the August 20 low near $1.1665. Sterling found support near $1.36 but a dovish hold from the BOE shortly (see below) is likely to lead to further losses. USD/JPY is edging higher but has so far been unable to break back above 110 despite the recovery in risk sentiment. We believe the hawkish Fed and ongoing China risks will help keep the dollar rally going.

AMERICAS

The Fed delivered a hawkish hold, as we expected. It said that tapering “may soon be warranted” as the economy and employment have continued to strengthen. Powell later said that if the economy progresses as expected, the Fed may move at the next meeting. He added that the Fed needs to see a “reasonably good” jobs report but that in his thinking, the test is “all but met.” The key takeaway is that tapering is likely to be announced at the November 2-3 FOMC meeting.

We think if job growth improves to around 500k this month, the Fed will pull the trigger on tapering. Current Bloomberg consensus for September NFP is 513k vs. 235k in August. Today's initial claims data (320k expected vs. 332k the previous week) will be the first clue as they are for the BLS survey week containing the 12th of the month. Continuing claims (2.6 mln expected vs. 2.665 mln the previous week) are reported with a 1-week lag so next Thursday's reading will be for the survey week.

Powell said that gradual tapering is likely to conclude around mid-2022. This is a very hawkish statement. The last time the Fed tapered, it was spread out over a year. Now, Powell is saying it will only take 6 months. This timeline suggests tapering of $20 bln in UST and $10 bln of MBS at each meeting to get to an end of QE by mid-2022. We are of course assuming equal tapering increments over four FOMC meetings. Powell stressed that the Fed’s taper timing doesn’t carry a direct signal on lift-off. This is of course true but it's also a truism that the sooner QE ends, the sooner rate hikes can start. The Fed Funds futures strip shows now shows significantly higher odds for the first hike starting in Q4 22. Those odds quickly jump to being fully priced in for Q1 23.

There was a hawkish shift in the Dot Plots. Similar to its June projections, the Fed signaled that it will have met its dual mandate by the end of 2023. Two officials moved up lift-off expectations to 2022 and that led to an even split. If three had done so, then the median lift-off would have moved up from 2023 to 2022. The Dot Plots now show a median policy rate of 0.25% in 2022, 1.0% in 2023, and 1.75% in 2024. In the June Dots, the median policy rates were 0.125% in 2022 and 0.625% in 2023. 2024 was just added. This was a hawkish shift in the dots.

Fed regional manufacturing surveys will continue to roll out. Kansas City is expected at 25 vs. 29 in August. Last week, Empire and Philly Fed surveys surprised to the upside at 34.3 and 30.7, respectively. Preliminary September Markit PMI readings will also be reported today. Manufacturing is expected at 61.0 vs. 61.1 in August, while services is expected at 54.9 vs. 55.1 in August. If so, the composite would likely fall slightly from 55.4 in August. August Chicago Fed National Activity Index (0.50 expected) and leading index (0.7% m/m expected) will also be reported.

The Brazilian central bank (BCB) hiked rates by 100 bp to 6.25%, as we expected. The communique signaled that “another adjustment of the same magnitude” is on the way for the next meeting October 27. The language was in line with Governor Campos Neto’s recent comments, downplaying the CPI acceleration last month. In short, the tightening cycle will continue but it will not be as frontloaded as previously thought. We expect another two 100 bp hikes before considering reducing the magnitude, with rates settling somewhere around 8.5-9.0%. The decision was expected so we shouldn’t see much resulting price action, but the increasingly high carry will start to kick in as tailwind for the real.

Mexico reports mid-September CPI. Headline inflation is expected at 5.72% y/y vs. 5.58% in mid-August. If so, it would be the first acceleration since April and further above the 2-4% target range. Next policy meeting is September 30 and rising inflation could force Banco de Mexico to continue tightening with another 25 bp hike to 4.75%.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported weak preliminary September Markit PMI readings. Headline manufacturing fell to 58.7 vs. 60.3 expected and 61.4 in August, services fell to 56.3 vs. 58.5 expected and 59.0 in August, and the composite fell to 56.1 vs. 58.5 and 59.0 in August. The composite has fallen two straight months after peaking at 60.2 in July and is the lowest since April. Looking at the limited country breakdown, the German composite fell to 55.3 vs. 59.2 expected and in 60.0 August, while the French composite fell to 55.1 vs. 55.7 expected and 55.9 in August. While the absolute levels for the PMI readings remain fairly high, the trajectory is worrisome and should hopefully quiet the hawks at the ECB that are squawking about removing accommodation.

Norges Bank hiked rates 25 bp to 0.25%, as expected. It became the first major central bank to hike rates and cited a “normalizing” economy. Officials said that the next hike is “most likely” in December, adding that their forward guidance was for a “slightly” elevated trajectory for the policy rate than it signaled in June. New macro forecasts and an updated rate path were released. The new rate path sees the policy rate at 0.1% at end-2021, 0.9% at end-2022, 1.4% at end-2023, and 1.6% at end-2024. Governor Olsen has suggested in the past that the bank could hike rates 25 bp per quarter, which was much more hawkish than what this rate path would suggest and so we look for a much steeper path in December.

Swiss National Bank delivered a dovish hold, as expected. The SNB still characterized the franc as “highly valued” and pledged to continue FX interventions as necessary. Inflation has moved higher in recent months to a cycle high of 0.9% y/y in August, but the underlying message remains that the policy rate is likely to remain at -0.75% for the foreseeable future. SNB President Jordan said “The development of inflation, of the price level, is a confirmation that we’re currently assessing things correctly and our monetary policy is still justified.” We don’t think the SNB will do anything to rock the boat for the foreseeable future.

Bank of England is likely to deliver a dovish hold. Recent softness in the real sector data and the expiry of the jobs furlough program this month should keep the bank in cautious mode. At the August 5 decision, new inflation forecasts were released that suggested no hurry to hike and no need to hike aggressively. Saunders dissented in favor of reducing QE then but he has since sounded dovish, saying any rate hikes next year will be limited. 2024 will be added to the forecast horizon with the next update to the macro forecasts with the next decision November 4 and should add to the BOE’s dovish message.

U.K. reported weak preliminary September Markit PMI readings. Manufacturing fell to 56.3 vs. 59.0 expected and 60.3 in August, services fell to 54.6 vs. 55.0 expected and actual in August, and the composite fell to 54.1 vs. 54.6 expected and 54.8 in August. That’s the fourth straight down month for the composite since the 62.9 peak in May and is now at the lowest since February.

Turkey central bank is expected to keep rates steady at 19.0%. As always, we see the risk that that central bank may succumb to political pressure and ease prematurely but doubt it. CPI rose 19.25% y/y in August, the highest since April 2019 and further above the 3-7% target range. Governor Kavcioglu recently hinted that the bank may start to pay more attention to core inflation, which has been moderating slightly to a still-high 16.76% y/y. A shift in regimes to justify an easing cycle would not be taken well by the markets.

ASIA

China regulators are stepping in with regards to Evergrande. Just now, wires report that Chinese authorities are discussing with local governments how to prepare for the downfall of Evergrande. This doesn't strike us as anything usual. It would have been far more concerning if there were no preparation. It's still unclear what form of resolution we will get but by now, everyone knows that Evergrande will not remain in its current form. The strong upwards price action in China’s property developer stocks says it all. The sector’s shares traded in Hong Kong are up sharply, led by Evergrande up 18% and Country Garden up 12%. Bloomberg reports that officials told Evergrande to complete unfinished projects and repay individual investors. It also looks clear that a default is not in the cards for the near term but, as far as we know, there has been no direct official financial support. All of the above came in the form of guidance.

The Philippine central bank (BSP) kept rates on hold at 2.0%, as widely expected. We doubt that any change is imminent. Inflation is picking up, surprising on the upside at 4.9% y/y for August, but not enough to tilt the balance away from supporting growth. The bank did, however, revise upward its inflation forecast by 0.3 ppt to 4.4% for the year, and slightly increased the forecasts for the next two subsequent years. There was no sustained price action following the decision.

Taiwan central bank kept rates steady at 1.125%, as expected. The bank upgraded its macro forecasts, with growth this year seen at 5.75% vs. 5.08% previously and inflation seen at 1.7% vs. 1.6% previously. The bank does not have an explicit inflation target and so it can maintain its current accommodative stance well into 2022 despite somewhat elevated price pressures. August export orders will be reported Friday and are expected to rise 20.4% y/y vs. 21.4% in July. If so, it would be the fourth straight month of deceleration and warns of slowing exports as we move into 2022. Of note, Korea reported trade data for the first twenty days of September. Exports rose 22.9% y/y while imports rose 38.8% y/y.

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