Lack of Fresh Drivers Keeps Dollar Rangebound

December 08, 2022

Win Thin

The Fed narrative remains too dovish; BOC hiked rates 50 bp to 4.25%, as expected; Mexico reports November CPI; Peru appears to have survived an attempted coup
ECB staff are reportedly discussing possible actions after rejecting a pay offer; ECB tightening expectations have steadied
Japan reported final Q3 GDP data; October current account data are worth discussing

The dollar is slightly firmer in rangebound trading. DXY is trading 105.25 and needs to break above the 106 area to set up a test of last week’s high near 107.195. The euro is trading near $1.05 while sterling is trading near $1.2175, both well within recent ranges. USD/JPY is trading near 137 and a clean break above 137.50 is needed to set up a test of last week’s high near 140. While we still believe the fundamental outlook favors the dollar, we acknowledge that near-term dollar weakness is likely to persist after Powell’s unexpected dovish turn. If the U.S. data continue to come in firm like ISM services did, that dovish Fed narrative could start to crack ahead of next week’s FOMC meeting. Stay tuned.

AMERICAS

The Fed narrative remains too dovish. WIRP suggests that a 50 bp hike December 14 is fully priced in, with only around 10% odds of a larger 75 bp move. The swaps market is pricing in a peak policy rate of 5.0% and no longer sees risks of a higher 5.25% peak. Looking ahead, WIRP suggests around 50% odds of a 50 bp move February 1 and then around 50% odds of a final 25 bp hike in Q2. With both AHE and core PCE flat-lining near 5% for most of this year, we don’t think this tightening path will get inflation back to target, not when the labor market remains so firm and consumption is holding up. This is where we believe the mispricing continues. Perhaps tomorrow’s PPI data will get the market’s attention. Today, only weekly jobless claims will be reported. Initial claims are expected at 230k vs. 225k previously, while continuing claims are expected at 1.618 mln vs. 1.608 mln previously.

Bank of Canada hiked rates 50 bp to 4.25%, as expected. The bank said “Governing Council will be considering whether the policy rate needs to rise further to bring supply and demand back into balance and return inflation to target.” This suggests a potential pause. It said inflation remains too high but sees signs that price pressures may be easing. It stressed growing evidence that its rate hikes are restraining domestic demand. The tone was decidedly less hawkish and calls into question if it will indeed hike further. WIRP suggests around 50% odds of a 25 bp hike at the next meeting January 25, while the swaps market is pricing in a peak policy rate near 4.5%, suggesting one last 25 bp hike.

Mexico reports November CPI. Headline is expected at 7.94% y/y vs. 8.41% in October, while core is expected at 8.58 % y/y vs. 8.42% in October. While the deceleration in headline would be the second straight month to the slowest since May, the central bank has become increasingly concerned with the continued rise in core. At the last policy meeting November 10, Banco de Mexico hiked rates 75 bp to 10.0%. Next policy meeting is December 15 and we expect the bank to match the Fed with a 50 bp hike to 10.5%. The swaps market is pricing in a peak policy rate between 10.75-11.0%.

Peru appears to have survived an attempted coup. After dissolving congress hours before an impeachment vote, President Castillo was met with stiff opposition from the military, the judiciary, and member of his own cabinet. Congress eventually voted overwhelmingly to impeach Castillo, who was eventually arrested. Vice President Boluarte will try to finish out Castillo’s five-year term that runs through mid-2026 but politics in Peru remains anything but stable as she is the sixth president in the last four years. Of note, the central bank hiked rates 25 bp to 7.5% yesterday, as expected.

EUROPE/MIDDLE EAST/AFRICA

ECB staff are reportedly discussing possible actions after rejecting a pay offer. Reports suggest protest action and possible strikes are on the table. The union rejected the proposed 4.07% salary increase for next year as inadequate, especially after the 1.48% hike in 2022 that has eroded real wages. Stay tuned.

ECB tightening expectations have steadied. WIRP suggests a 75 bp hike December 15 is around 20% priced in, down from 45% at the start of last week and fully priced in right after the October decision. Elsewhere, the swaps market is still pricing in a peak policy rate near 3.0% vs. 3.5-3.75% after the October decision. We think there is still room for ECB tightening expectations to fall further and we stand by our call that the ECB will pivot and cut rates before the Fed does. Lagarde, de Cos, and Villeroy speak today.

ASIA

Japan reported final Q3 GDP data. Growth was revised to -0.8% SAAR vs. -1.0% expected and -1.2% preliminary, while the q/q rate was revised to -0.2% vs. -0.3% expected and preliminary. Private consumption was revised down modestly to 0.1% q/q, while inventories and net exports helped offset this. The growth mix is concerning, as private consumption remains at risk from falling real wages, net exports are likely to soften along with global growth, and inventories will eventually subtract from growth. Business spending held up at 1.5% q/q but this is unlikely to be sustained if the rest of the economy is slowing. Bottom line: the data remain weak enough to keep policymakers in easing mode. Next Bank of Japan meeting is December 19-20 and no change is expected then.

October current account data are worth discussing. The adjusted balance came in at -JPY609 bln vs. JPY353 bln expected and JPY671 bln in September. This was the first deficit since March 2014 and continues the deterioration in the external accounts. The OECD forecasts the current account surplus narrowing to 1.1% of GDP in 2023 and 0.9% in 2024 vs. an expected 1.8% this year. The surplus was 4.0% of GDP in 2021 and so the deterioration has been quick. At the margin, this removes one pillar of support for the yen.

The investment flows will be of most interest. October data showed that Japan investors were net sellers of U.S. bonds for the second straight month (-JPY985 bln) and in eleven of the past twelve. Japan investors remained net sellers (-JPY266 bln) of Australian bonds for the fourth straight month and Canadian bonds (-JPY85 bln) for the ninth straight month, but became net buyers of Italian bonds (JPY184 bln) after two straight months of net selling. Overall, Japan investors were total net sellers of foreign bonds in October of over -JPY3 trln. Preliminary MOF data suggest Japanese life insurers continued to sell foreign bonds (mostly U.S.) in November to the tune of nearly -JPY2 trln.

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