Dollar Under Pressure as U.S. Yields Sink

November 17, 2023

Win Thin

U.S. yields are making new lows for this move; yet the 2-year differentials have not moved all that much; the U.S. economy remains robust; Fed easing expectations have picked up
ECB officials are pushing back against aggressive easing expectations; U.K. reported weak October retail sales data; BOE easing expectations have picked up
BOJ Governor Ueda said that the weak yen has both positive and negative implications; New Zealand reported mixed Q3 PPI data

The dollar remains under pressure as U.S. yields fall. DXY is trading lower near 104.169 and is testing support that comes in near 104. The euro is trading slightly higher near $1.0865 while sterling is trading slightly lower near $1.2425. Neither have been able to build on the cycle highs hit earlier this week. USD/JPY is the big mover today, trading lower near 149.50 despite Ueda showing little concern about the weak yen (see below). With the dollar rally stalled, it will take some firm real sector data to challenge the current dovish Fed narrative. 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. The Fed will not be able to cut rates as soon and by as much as the market thinks (see below). That said, the dollar remains vulnerable until we see a shift in market sentiment and expectations.

AMERICAS

U.S. yields are making new lows for this move. The 10-year yield traded as low as 4.38% today, down from the late October peak near 5.02% and the lowest since late September, while the 30-year yield traded as low as 4.56%, down from the late October peak near 5.18% and the lowest since late September. Even the short end is taking part, with the 2-year yield trading as low as 4.79% and nearing the early September low near 4.75%. We ask again: does one month of somewhat favorable inflation data really warrant such a massive move in rates? We think not and yet here we are. We must respect this move while wholeheartedly disagreeing with it.

Yet the 2-year differentials have not moved all that much. While down from the recent peaks, these differentials remain relatively high in terms of favoring the dollar. That’s because easing expectations for the ECB and BOE have picked up while tightening expectations for the BOJ have fallen. As such, we do not believe that this selloff in the dollar is really warranted. These moves still have some room to run but at some point, we believe the dovish narrative will eventually reverse once again.

The U.S. economy remains robust. The Atlanta Fed’s GDPNow model is tracking Q4 growth at 2.2% SAAR and will be updated today after the data. October building permits and housing starts are expected at -1.4% m/m and -0.6% m/m, respectively. The New York Fed’s Nowcast model is tracking 2.5% SAAR growth and will also be updated later today. Simply put, the economy continues to grow above trend at a time when the Fed is trying to get it below trend in order to lower inflation. Financial conditions will continue to loosen and so there are really no headwinds that will slow growth significantly in Q4.

Fed easing expectations have picked up. WIRP suggests no odds of a hike either December 13 or January 31, then pivoting to 40% odds of a rate cut March 20 and nearly priced in for May 1. A total of 100 bp easing in 2024 is fully priced in, with some odds of another 25 bp on top of that. Given how the economy is evolving, we continue to think that the market has gotten the Fed pivot wrong once again. Yet Fed officials are not pushing back yet. Yesterday, Mester said she was unsure about the need for further hikes, noting “I haven’t assessed that yet. Where I think we are right now is we’re basically in a very good spot for policy.” Elsewhere, Cook said “As we try to identify the full, lagged effects of monetary policy tightening, I am considering whether small businesses, the housing sector, and low- and moderate-income households could be warning of broader stress ahead.” Collins, Barr, Goolsbee, and Daly speak today.

Weekly jobless claims are worth discussing. Initial claims came in at 231k vs. 220k expected and a revised 218k (was 217k) last week and was the highest since mid-August. The 4-week moving average rose to 220k, the highest since late August. Next week's initial claims reading will be for the BLS survey week containing the 12th of the month. There's no Bloomberg consensus yet for NFP but its whisper number stands at 143k, moving a bit lower after the claims data. Elsewhere, continuing claims came in at 1.865 mln vs. 1.843 mln expected and a revised 1.833 mln (was 1.834 mln) last week, the highest since late November 2021. These are some further signs of softening in the labor market.

EUROPE/MIDDLE EAST/AFRICA

ECB officials are pushing back against aggressive easing expectations. WIRP is pricing in the start of an easing with nearly 40% odds of a cut March 7 and rising to 90% April 11. Nagel said the ECB won’t cut rates in Q2, stressing “That would be somewhat early. We are still trying to communicate, please, don’t think that we are already at the end of the path.” While Nagel is firmly in the hawk camp, we tend to agree with his view that markets are getting carried away with the dovish policy narrative, not just for the Fed but now for the ECB too. Indeed, the market is pricing in 100 bp of easing by the ECB and that just seems too aggressive. Lagarde, Villeroy, Holzmann, Vujcic, Wunsch, and Cipollone also speak today.

U.K. reported weak October retail sales data. Headline came in at 0-.3% m/m vs. 0.4% expected and a revised -1.1% (was -0.9%) in September, while sales ex-auto fuel came in at -0.1% m/m vs. 0.5% expected and a revised -1.3% (was -1.0%) in September. Both y/y rates worsened more than expected to -2.7% and -2.4%, respectively. Consumption had held up relatively well in recent months but appears to have finally succumbed to the sharp rise in interest rates. With unemployment expected to rise further, consumption should continue weakening into 2024.

Bank of England easing expectations have picked up. WIRP now suggests less than 5% odds of a hike either December 14 or February 1. The first cut is largely priced in for May 9 vs. August 1 at the start of this week, with 75 bp of total easing now priced in. Similar to our beliefs about the Fed and ECB, this market pricing also seems too aggressive. Ramsden and Greene both speak later today. Greene has emerged as a leading hawk during her short tenure on the MPC.

ASIA

Bank of Japan Governor Ueda said that the weak yen has both positive and negative implications for the economy. He noted that while a weak yen pushed up import prices, it also helps boost export competitiveness and multinational corporate profits. Ueda noted that “It’s hard to definitely say that a current weak yen is negative for the economy.” Ueda’s statement is certainly true and suggests he is in no hurry to normalize BOJ policy, which is widely expected to lead to a stronger yen. As a result, BOJ liftoff expectations keep getting pushed out and now center on June 14 rather than April 26 or even March 19, which were both priced in at times earlier this year.

New Zealand reported mixed Q3 PPI data. PPI output came in at 0.8% q/q vs. 0.2% in Q2, while PPI input came in at 1.2% q/q vs. -0.2% in Q2. However, the PPI output y/y rate eased to 2.1% vs.3.0% in Q2 while the PPI input y/y rate picked up to 1.5% vs. 1.1% in Q2. Both are well down from the highs of the cycle and will hopefully feed into lower price pressures at the consumer level. RBNZ tightening expectations have evaporated. WIRP suggest no odds of a hike November 29, rising modestly to top out near 15% February 28. After that, the market starts to price in an easing cycle and sees nearly 75% odds of the first cut coming May 22 and is fully priced in for July 10.

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