U.S Dollar Stabilises As Markets Await Fresh Drivers
The United States dollar is slightly firmer as markets await fresh drivers, according to a note from the private investment banking firm Brown Brothers Harriman.
It said today that the dollar index (DXY) is hanging on to its recent gains, trading near 95.605 after returning to its familiar 95-97 trading range that has largely held since mid-November.
However, analysts see EUR remains heavy as European Central Bank (ECB) officials push back on tightening expectations (see below), trading near $1.1340 and on track to test this year’s low near $1.1270.
Also, British Pounds or Sterling is seeing a series of lower highs since peaking near $1.3750 on January 13 and is testing support near the $1.36 area.
Meanwhile, USD/JPY is lagging the broad dollar bounce and remains pinned near 114 after three straight down days. Recent USD/JPY and EUR/CHF price action suggest risk-off impulses are still lurking.
In the United States, with no Fed speakers nor major U.S. data, markets have shifted to consolidation mode after this past week’s big moves. The U.S. 2-year yield has drifted lower to 1.03% after trading as high as 1.07% yesterday, while the 10-year yield is trading near 1.83% after trading as high as 1.90% yesterday.
This leaves the dollar consolidating its recent gains within well-worn ranges. DXY is trading back at the lower end of the 95-97 range that has held since mid-November, the note hinted.
“What will it take to get the next leg higher for the greenback”, it asked. The firm noted that so much Fed hawkishness has been priced in but the private firm analysts continue to feel that further repricing is needed.
“We continue to focus on the expected terminal Fed Funds rate. That has crept higher from 1.5% in Q4 to 1.75% currently, and the market is starting to think about 2%.
“We say it should think higher. If the Fed does its job successfully, it will have brought inflation back down close to the 2% target by 2023 or 2024 -according to its own December forecasts”.
The note reads that with the economy nearing full employment, this will require a restrictive Fed Funds rate that is positive in real terms.
That will require a nominal rate of at least 2.25-2.50%, which coincides with the Fed’s own view on the longer-term rate. It is also where the rate topped out in 2019 in the previous tightening cycle.
Regional Fed manufacturing surveys for January will continue rolling out. Philly Fed is expected at 19.0 as against 15.4 in December, but there are downside risks after the shock Empire survey earlier this week, which came in at -0.7 vs. 25.0 expected and 31.9 in December.
Weekly jobless claims will be of interest, the firm hinted, saying initial claims will be for the BLS survey week containing the 12th of the month and are expected at 225k against 230k the previous week.
Continuing claims are reported with a one-week lag and so next week’s reading will be for the survey week. This week, they are expected at 1.563 mln compared to 1.559 mln the previous week.
The initial Bloomberg consensus for January jobs data stands at 290k against 199k in December, with the unemployment rate expected to remain steady at 3.9%.
“As we’ve noted before, the U.S. is very close to full employment and so it wouldn’t take more than a couple of decent jobs reports to get unemployment down to pre-pandemic levels. This is why the Fed is so keen to tighten policy sooner rather than later”.
Elsewhere, the European Central Bank (ECB) President Lagarde continues to push back against market tightening expectations. She said “We have every reason to not react as quickly and as abruptly as we could imagine the Fed might.
“But we have started to respond and we, of course, stand ready to respond with the monetary policy if figures, data, facts, require it.”
She stressed that “We’re all in very different situations,” adding that inflation is “clearly weaker” in the Eurozone even as the economic recovery is not as advanced as in the U.S. Villeroy and de Cos made similar statements but both are well-known doves.
The ECB publishes its account of the December 16 meeting.
“We know there is a huge split within the ECB and the account may help us better understand the dynamics that Madame Lagarde is dealing with”, the private investment noted.
At that meeting, the bank delivered a hawkish hold. Rates were kept steady but the bank announced that PEPP would end in March as scheduled.
Since mid-December, the pace of PEPP buying has already fallen significantly. The 4-week total net purchases were around EUR26 bln last week, down from around EUR60 bln that held from August through mid-December. In other words, ECB has already begun tapering PEPP ahead of its expiry.
Market pricing for ECB liftoff has picked up recently. There is about 20 basis points of tightening priced in for this year, followed by another 35 basis points next year that would take the deposit facility rate into positive territory for the first time since July 2012.
It stands at -0.50% currently. This seems overdone to us, as the ECB will most likely be amongst the last (along with SNB, Riksbank, and BOJ) holdouts to hike rates.
Eurozone yields have been rising, though not by as much as the U.S. Still, the 10-year German bond yield is flirting with the positive territory for the first time since May 2019.
Read: Funding Rates Jump as System Liquidity Tightening Persists
The 10-year spread with Italy is currently just below the cycle high of 137 bp from December and looks likely to head even higher. #U.S Dollar Stabilises As Markets Await Fresh Drivers
By Adebowale Akanji, United States Reviewed by Julius Alagbe, Editor.
