Powell Throws the Dollar a Lifeline

May 18, 2022

Fed Chair Powell said the Fed will continue hiking until inflation comes down; Fed tightening expectations picked up a bit; April retail sales data support our view that the U.S. economic outlook remains solid; U.S. yields are moving higher in response to the strong data and hawkish Powell comments; Canada highlight will be April CPI data

U.K. reported April CPI data; BOE tightening expectations have stalled; ECB officials remain hawkish; ECB tightening expectations have picked up; South Africa reported April CPI

Japan reported Q1 GDP data; we believe inflation will prove to be stickier than anticipated

The dollar is getting some traction after Powell comments.  DXY is up for the first time after three straight down days and is trading near 103.565.  The euro is trading back near $1.05 after trading at the highest level since May 12 near $1.0565.  USD/JPY remains stuck near 129 despite the return of risk on sentiment and a break above 129.90 is needed to set up a test of the May 9 high near 131.35.  Sterling is trading back near $1.24 after failing to break above $1.25.  We look for the dollar to build on its recent gains as this week’s move lower was simply a correction within its broad rally.


Fed Chair Powell said the Fed will continue hiking until inflation comes down.  Period.  Specifically, he said “What we need to see is inflation coming down in a clear and convincing way, and we’re going to keep pushing until we see that.  If that involves moving past broadly understood levels of ‘neutral,’ we won’t hesitate at all to do that.”  Regarding inflation, Powell noted that “We all read -- of course, everyone reads -- the inflation reports very carefully, and looks for details that look positive, and that kind of thing.  But truthfully, we don’t -- this is not a time for tremendously-nuanced readings of inflation.”  Bottom line:  full speed ahead for the Fed.  Harker speaks today. 

Bullard added his hawkish two cents.  Regarding QT, he noted “All else equal, that should put upward pressure on longer-term yields. We certainly have seen that so far. There should be more of that ahead as we proceed and we’ll watch this carefully going forward.”  Bullard added that “It is not just the US that is pulling back on asset purchases. Basically, all the central banks around the world are pulling back. So you’ve got global quantitative tightening.”  Regarding the Fed’s rate path, he said “My message to you is: we’ve got 50 bp at coming meetings. We’ve also got balance-sheet policy pulling back with a big confidence band around what the affects will actually be.”

Fed tightening expectations picked up a bit.  WIRP suggests 50 bp hikes in June, July, and September will be followed by 25 bp hike in November, December, and most likely February, which would see the Fed Funds rate peak near 3.25%.  The swaps market also sees a terminal Fed Funds rate closer to 3.25% after starting out the week at 3.0%.  In light of high inflation and Powell’s hawkish tone, we continue to believe that the terminal rate will be 3.5% with risks to the upside if inflation proves to be even stickier (see Commodities section below).  

April retail sales data support our view that the U.S. economic outlook remains solid.  Headline rose 0.9% m/m vs. 1.0% but March was revised significantly higher to 1.4% m/m vs. 0.5% previously.  Similarly, ex-auto rose 0.6% m/m vs. 0.4% expected and  revised 2.1% (was 1.1%) in March while the so-called control group used for GDP calculations came in at 1.0% m/m vs. 0.7% expected and a revised 1.1% (was -0.1%) in March.  As expected, the Atlanta Fed’s GDPNow model is now tracking 2.5% SAAR growth for Q2 after the data vs. 1.8% before, moving it closer to current Bloomberg consensus of 3.0% SAAR.  The upward March revisions should also see Q1 growth marked up from -1.4% SAAR with the first revision May 26.  April IP came in at 1.1% m/m vs. 0.5% expected and 0.9% in March.  April building permits (-3.0% m/m expected) and housing starts (-2.1% m/m expected) will be reported today.   

U.S. yields are moving higher in response to the strong data and hawkish Powell comments.  The 10-year yield is trading near 2.99% after it ended the week near 2.92%, up from Thursday’s low near 2.81% but still below the cycle high near 3.20% from last Monday.  The 10-year breakeven inflation rate fell as low as 2.59% Thursday but recovered to currently trade near 2.75% so as a result, the real 10-year yield has edged higher to around 0.24% vs. the 0.34% cycle high last week.  Similarly, the 2-year UST yield is trading near 2.70% after it ended the week near 2.58%, up from Thursday’s low near 2.51% but still below the peak near 2.85% from May 4.  As risk off impulses ebb and the data remain strong, U.S. yields should continue to rise.  With the dollar smile clearly in play, the greenback should resume rising. 

Canada highlight will be April CPI data.  Headline is expected to remans steady at 6.7% y/y while core common is expected to pick up a tick to 2.9% y/y.  If so, headline would remain at the cycle peak and well above the 1-3% target range and so the Bank of Canada is likely to continue hiking rates for the time being.  WIRP suggests a 50 bp hike June 1 is fully priced in.  Looking ahead, the swaps market is pricing in 225 bp of tightening  over the next 24 months that would see the policy rate peaking near 3.25%.   


U.K. reported April CPI data.  Headline came in a tick lower than expected at 9.0% y/y vs. 7.0% in March, while core and CPIH came in as expected at 6.2% y/y and 7.8% y/y vs. 5.7% and 6.2% in March, respectively.  Headline inflation is the highest since March 1982 and moves further above the 2% target.  The Bank of England warned of double digit inflation this fall.  Energy costs are obviously a big factor, but the elevated core readings point to more broad-based price pressures.  This is a major reason why the Bank of England should be sending a more hawkish message.    

Yet Bank of England tightening expectations have stalled.  WIRP suggests another 25 bp hike is priced in for the next meeting June 16.  Looking ahead, the swaps market is still pricing in 150 bp of total tightening over the next 12 months that would see the policy rate peak near 2.50%, steady from the start of last week.  Unlike the Fed, the BOE has not shown much enthusiasm for an aggressive tightening cycle to choke off inflation.  That is because recent real sector data underscore a loss of momentum as we move through Q2, with rising risks of a recession ahead that the BOE itself is forecasting.  High inflation is hurting pocketbooks, which is likely to be reflected in another weak GfK consumer confidence reading tomorrow and another weak retail sales reading Friday.

ECB officials remain hawkish.  Today, it was Rehn’s turn as he stressed that “It is my view that it seems necessary that in our policy rates we move relatively quickly out of negative territory and continue our gradual process of monetary policy normalization.  I am not alone, as this is also the indication given by many of my colleagues in the ECB Board and Governing Council.”  While this might seem to imply that he is open to larger moves, Rehn did not specifically say it as Knot did yesterday.  That said, we continue to downplay the risks of a 50 bp move. 

ECB tightening expectations have picked up.   WIRP suggests liftoff July 21 remains fully priced in followed by three subsequent 25 bp hikes that would take the deposit rate to 0.5% by December 15.  Looking ahead, the swaps market is now pricing in 200 bp of tightening over the next 24 months that would see the deposit rate peak near 1.5% vs. 1.25% at the start of this week.   

South Africa reported April CPI.  Headline inflation came in steady as expected at 5.9% y/y while core came in a tick higher than expected at 3.9% y/y.  South African Reserve Bank meets tomorrow and is expected to hike rates 50 bp to 4.75%.  A few analysts look for a 25 bp move.  At the last meeting March 24, the vote to hike 25 bp was 3-2 with the two dissents in favor of a 50 bp move.  The bank warned that inflation is likely to breach the 3-6% target range in Q2 and raised its 2022 inflation forecast to 5.8% vs. 4.9% previously.  Its repo rate forecasts were tweaked modestly to 5.06% by end-2022 vs. 4.91% previously, 6.1% by end-2023 vs. 5.84% previously, and 6.68% by end-2024 vs. 6.55% previously.  That is an even more aggressive rate path than we expected for a country that still has 35% unemployment and is struggling to grow.  


Japan reported Q1 GDP data.  The q/q rate came in at -0.2% vs. -0.4% expected and a revised 0.9% (was 1.1%) in Q4, while the annualized rate came in at -1.0% vs. -1.8% expected and a revised 3.8% (was 4.6%) in Q4.  Private consumption came in flat q/q vs. -0.5% expected, while business spending came in at 0.5% q/q vs. 0.7% expected.  Inventories were a slight positive while net exports were a slight negative.  While the data were a bit better than expected, the contraction in Q1 will underscore policymakers’ commitment to stimulus, both monetary and fiscal.  Bloomberg consensus sees annualized growth rebounding to 5.0% in Q2, which seems overly optimistic given the headwinds seen so far.  Stay tuned. 


We believe inflation will prove to be stickier than anticipated.  One reason is that commodity prices continue to rise with little relief in sight.  Much of the rise in global energy and grain prices can be directly attributable to the Ukraine crisis.  With Russia showing it’s ready to dig in, it would seem that commodity prices are not coming back down to earth anytime soon.  Another reason for sticky inflation is that global supply chains have yet to be recover.  Here, China’s COVID Zero policy is a major culprit as hard lockdowns have hit mainland factory output. 

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