Higher Rates Continue to Support the Dollar

January 04, 2022
  • Higher rates continue to underpin the dollar; December ISM manufacturing will be the data highlight; potential candidates for the Fed Board of Governors are starting to emerge; Ontario is locking down as virus numbers spike from omicron; BOC tightening expectations need to adjust lower as a result
  • Germany reported firm data; December eurozone inflation readings are starting to come out; U.K. reported firm data; Poland is expected to hike rates 50 bp to 2.25%
  • Japan reported final December manufacturing PMI; Caixin reported firm December manufacturing PMI; Korea is gearing up for an expansionary budget ahead of the March presidential election

The dollar continues to gain as U.S. rates rise. DXY is up for the second straight day and is trading near 96.40. A break above this level would set up a test of the December cycle high near 96.91. As it stands, the greenback has pretty much recouped most of last week's losses, which in hindsight looks like the result of year-end positioning. The outlook for 2022 remains the same, with a hawkish Fed helping to push the dollar higher. The euro remains heavy and a clean break below $1.1285 would set up a test of the mid-December low near $1.1220. GBP is holding up relatively better and so the EUR/GBP is trading at new two-year lows around .8360. We think there will be growing debate about ECB liftoff in 2022 (though we think it unlikely), but most agree that the BOJ will be remain the most dovish and so the weak yen trade may have the most room to go this year. For starters, USD/JPY has broken above the November high to trade at the highest level since January 2017 near 116.15. There are no significant chart points now until the December 2016 high near 118.65.


Higher rates continue to underpin the dollar. Of note, the US 2-year yield traded yesterday at a new high for this cycle near 0.80%, and is around 0.78% today. The 2-year differentials continue to rise, with U.S.-Germany matching the cycle high of 139 bp and U.S.-Japan making new cycle highs today near 86 bp. Elsewhere, the U.S. 10-year yield of 1.63% is the highest since November 24 and is headed towards its cycle high of 1.70% from October.

December ISM manufacturing will be the data highlight today. Headline is expected at 60.0 vs. 61.1 in November. Keep an eye on the employment component, which is expected at 53.6 vs. 53.3 in November. ISM services will be reported Thursday, with the headline expected at 67.0 vs. 69.1 in November. Here, the employment component stood at 56.5 in November. JOLTS job openings (11.1 mln expected) and December auto sales (13.1 mln annual pace expected) will also be reported today.

Potential candidates for the Fed Board of Governors are starting to emerge. Reports suggest President Biden is likely to nominate Philip Jefferson for one of the vacant seats on the Board. Jefferson has a Ph.D. in economics from the University of Virginia and is currently on the faculty at Davidson College in North Carolina. He has prior experience at the Fed, serving as an economist in the Board’s monetary affairs division from 1996-1997 and as a research assistant in the fiscal analysis section from 1983-1985. Elsewhere, reports suggest Sarah Bloom Raskin is President Biden’s leading choice for the Fed’s Vice Chair of Supervision. Of note, Raskin is a lawyer by training but has an undergraduate degree in economics. She has already served as a Fed Governor from 2010-2014, followed by a stint as Deputy Treasury Secretary from 2014-2017. During her time at the Fed, Raskin focused on consumer protection and income inequality.

The province of Ontario is locking down as virus numbers spike from omicron. All schools will move to remote learning, while indoor dining, gyms, and movie theaters will close. Hospitals have been asked to pause all non-urgent surgeries. Retail stores will be limited to 50% capacity and indoor social gatherings will be limited to five people. While the response seems drastic compared to other countries, Premier Ford said projections show the total number of patients in hospitals would exceed capacity within a few weeks unless urgent action was taken. Local health officials acknowledged that Canada has one of the lowest number of hospital beds per capita in the developed world. Ontario is the most populous province in Canada and so these measures will have a significant impact on the national economy in Q1. Canada reports December Markit manufacturing PMI today.

Bank of Canada tightening expectations need to adjust lower as a result. WIRP suggests a 65% chance of liftoff at the next meeting January 26, which now seems too aggressive in light of the developments in Ontario. Those odds rise to nearly 100% for the March 2 meeting, which also seems too soon given the BOC’s forward guidance for likely Q2 liftoff. All told, five hikes are priced in for 2022 that would take the policy rate up to 1.5%. Until the uncertainty regarding omicron clears, we think that such an aggressive tightening cycle is unlikely to pan out. Of note, swaps market is pricing in another 50 bp of tightening next year that would see that rate peak at 2% by end-2023. CAD was the only major currency to post gains against USD in 2021, but we may be in for a period of underperformance to start off 2022. For USD/CAD, a break above 1.2835 is needed to set up a test of the December high near 1.2965.


Germany reported firm data. November retail sales rose 0.6% m/m vs. -0.3% expected and a revised 0.5% (was -0.3%) in October. November eurozone sales data will also be reported Friday and are expected at -0.5% m/m vs. 0.2% in October. After the German data, we see upside risks to the eurozone reading. Germany also reported December unemployment, which fell -23.0k vs. -15.0k expected and -34.0k in October. This led the unemployment rate to fall a tick to 5.2%. The improved German data is welcome, as the preliminary composite PMI reading of 50.0 warns that the eurozone’s largest economy is close to tipping into recession. We continue to see headwinds in 2022, not the least of which is the ECB’s decision to taper QE starting in Q2. The ongoing energy crisis is particularly worrisome, as it not only crimps activity but also feeds into higher inflation. Stay tuned.

December eurozone inflation readings are starting to come out. France reported December CPI, with headline EU Harmonized inflation coming in at 3.4% y/y vs. 3.5% expected and 3.4% in November. Italy reports December CPI tomorrow, with headline EU Harmonized inflation expected at 4.2% y/y vs. 3.9% in November. Germany then reports CPI data Thursday, with headline EU Harmonized inflation expected at 5.6% y/y vs. 6.0% in November. The eurozone reports Friday, with headline inflation expected at 4.8% y/y vs. 4.9% in November and core expected at 2.5% y/y vs. 2.6% in November. Last week, Spain reported headline EU Harmonized inflation at 6.7% y/y vs. 5.7% expected and 5.5% in November.

U.K. reported firm data. Final December manufacturing PMI came in at 57.9 vs. 57.6 preliminary. Final services and composite PMIs will be reported Thursday. November consumer credit was also reported and came in at GBP1.2 bln vs. GBP800 mln expected and GBP828 mln in October, and was the strongest pace since July 2020. . Much of the November data came in firmer than expected, though some of the strength in consumption was attributed to early shopping due to supply chain concerns ahead of the holidays. We may have to wait until January to get a cleaner read on the U.K. economy but we see headwinds ahead from Brexit (still!), energy shortages, and both fiscal and monetary tightening.

National Bank of Poland is expected to hike rates 50 bp to 2.25%. A couple of analysts look for a larger 75 bp move. December CPI will be reported Friday, with headline inflation expected at 8.2% y/y vs. 7.8% in November. If so, it would be the highest since December 2000 and further above the 1.5-3.5% target range. The central bank just delivered a consensus 50 bp hike to 1.75% at the December 8 meeting and said future moves would depend on incoming data. Swaps market is pricing in 125-150 bp of tightening in Q1 followed by another 25 bp in Q2, but we think this understates the case as the bank is falling further behind the curve and needs to take more aggressive action.


Japan reported final December manufacturing PMI. It rose a tick from the preliminary to 54.3. Final services and composite PMIs will be reported Thursday. While the recovery continues, Bank of Japan tightening expectations have gone nowhere. And that’s the way it should be. The bank has clearly set itself up to be amongst the last of the major central banks to remove accommodation. The swaps market sees no tightening through 2024 and we expect this to be codified by the BOJ when it includes FY24 in its macro forecasts starting with the April Outlook Report. This should keep the yen under selling pressure, though it is always subject to some temporary bouts of strengthening due to periodic risk off impulses.

Caixin reported firm December manufacturing PMI. It came in at 50.9 vs. 50.0 expected and 49.9 in November. Caixin services and composite PMI readings will be reported Thursday, with services expected at 51.9 vs. 52.1 in November. Last week, official PMI readings were reported, with manufacturing at 50.3 vs. 50.1 in November, non-manufacturing at 52.7 vs. 52.3 in November, the composite steady at 52.2. While the economy appears to be steadying, policymakers have signaled that further stimulus is likely as the focus shifts from structural reforms to promoting growth. Reports suggest local governments will issue more than CNY800 bln of bonds in Q1, mostly to fund infrastructure projects. Elsewhere local analysts are expecting banks to boost loans in Q1.

Reports suggest Korea is gearing up for an expansionary budget ahead of the March presidential election. Ruling Democratic Party candidate Lee Jae-myung said a realistic target size for an extra budget is around KRW25-30 trln and called for swift action before the Lunar New Year holiday at the end of this month. Of note, the latest polls show Lee leading main opposition candidate Yoon Suk-yeol by nearly 10 percentage points. Reports suggest some ruling party officials are calling for an even larger extra budget of KRW100 trln. Elsewhere, BOK Governor Lee warned that omicron is the biggest threat to the recovery, though he noted other risks from abroad such as rising global inflation, policy normalization by major central banks, and a possible economic slowdown in China. For now, the BOK is in a cautious tightening cycle and has the flexibility to change the pace as needed. It meets next Friday and no change is expected since it just hiked 25 bp to 1.0% at the last meeting November 24.

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