Dollar Firm as Yields Rise Ahead of Beige Book

April 19, 2023

Win Thin

U.S. yields continue to rise; Fed Beige Book for the May 2-3 FOMC meeting will be the highlight; Fed officials remain hawkish; BOC Governor Macklem testified before Parliament
ECB Chief Economist Lane is ready to hike rates in May; U.K. March CPI data continue to run hot; BOE tightening expectations have risen significantly
The HKMA continues to defend the HKD peg

The dollar is firm as yields rise ahead of the Beige Book. DXY is trading higher just above 102 as rising U.S. yields lend some support. Break above 102.036 sets up a test of the April 10 high near 102.807. The euro is trading lower near $1.0940 and a clean break below $1.0925 sets up a test of the April 10 low near $1.0830. Sterling is trading flat near $1.2430 despite higher than expected CPI data (see below). Cable remains on track to test its April 10 low near $1.2345. USD/JPY traded at the highest since March 10 near 135.15 today before falling back to trade near 134.80 currently. A clean break of the March 15 high near 135.10 sets up a test of the March 8 high near 138. Recent data have been dollar-supportive and we are finally seeing a reaction in U.S. yields. Until rate cuts this year are finally priced out, the dollar is likely to remain vulnerable. However, it seems that this process is under way.

AMERICAS

U.S. yields continue to rise. The 2-year yield traded near 4.28% today, the highest since March 15. While it is well off the 3.55% low from March 24, it is still well below the March 8 high near 5.08%. Elsewhere, the 10-year yield traded near 3.63% today, the highest since March 22. Similarly, it is well off the 3.25% low from April 6 but it is still well below the March 2 high near 4.09%. As markets normalize and Fed rate cuts get priced out, U.S. yields should continue to edge higher. In turn, this should help the dollar.

The Fed Beige Book for the May 2-3 FOMC meeting will be the highlight. Since the March 21-22 meeting, the data suggest that activity is slowing, the labor market is softening, and price pressures are easing. Notably, supply chains continue to improve. We believe the Beige Book will highlight these trends that could support a pause after what is widely expected to be another 25 bp hike. However, we believe it will also leave the door open for further tightening if needed. Between the May 2-3 and June 13-14 meetings, the Fed will have digested two more job reports, two CPI/PPI reports, and one retail sales report. At this point, a pause in June might just be the most likely outcome but it really will depend on how all that data come in. Goolsbee and Williams speak today.

Fed officials remain hawkish. Yesterday, Bullard reiterated his call for 50 bp of further tightening this year. He added that “The labor market just seems very, very strong” and that “it doesn’t seem like the moment to be predicting that you have a recession in the second half of 2023.” Elsewhere, Bostic said he favors one more hike followed by rates staying there for “quite some time.” He added that he expects the economy to avoid a recession in his baseline forecast. Fed tightening expectations have picked up bit. WIRP suggests 90% odds of 25 bp hike May 3, up from 70% at the start of last week and 50% at the start of the week before that. After that, odds of a hike June 14 sit near 20%. More importantly, a rate cut by year-end is no longer priced in.

Bank of Canada Governor Macklem testified before Parliament. Macklem said demand is still running ahead of supply in Canada, adding that he would call the bank’s forecast a “soft landing.” He said declining inflation is encouraging but there is more work to do. Macklem said that there needs to be wage moderation in order to get inflation back to target and stressed that he cannot rule out another rate hike. Inflation continued to ease in March. Yesterday, headline CPI came in as expected at 4.3% y/y vs. 5.2% in February, the lowest since August 2021 but still well above the 1-3% target range. More importantly, core measures continued to decelerate substantially. Canada is one of the few countries to be experiencing this and is a big factor that allowed it to pause the tightening cycle March 8 and follow up with another hold April 12. Next policy meeting is June 7 and another hold is expected. However, WIRP shows odds of one last 25 bp hike topping out near 30% in Q4.

EUROPE/MIDDLE EAST/AFRICA

ECB Chief Economist Lane is ready to hike rates in May. He said that “As of now, two weeks away, I think the baseline is that we should indeed increase interest rates in May. Exactly what we do, I’m going to wait until we have that data before deciding.” Lane added that “We are now in an intense phase of data dependence. I’m very much in wait-and-see mode.” Regarding the June meeting, he said “Let’s focus on what we do now in the May meeting, and then essentially the dominant driver of what we do in June is what the data tell us between now and June.” Regarding rate cuts, he said “It would be appropriate to keep rates at the plateau level for a while before returning back to normal.” ECB tightening expectations have picked up a bit. WIRP suggests a 25 bp hike is fully priced in for May 4, with over 30% odds of a larger 50 bp move. After that, another 25 bp hike is priced in for June 15 followed by another one July 27. Odds of one last 25 bp hike in September or October top out around 45% and so the peak policy rate is now seen between 3.75-4.0%, up from3.5-3.75% at the start of this week and 3.50% at the start of last week. Lane, Knot, de Cos, and Schnabel speak today.

U.K. March CPI data continue to run hot. Headline came in at 10.1% y/y vs. 9.8% expected and 10.4% in February, core came in at 6.2% y/y vs. 6.0% expected and 6.2% in February, and CPIH came in at 8.9% y/y vs. 8.7% expected and 9.2% in February. Yesterday’s wage data pointed to upside risks to inflation and here we are. This is the second straight month of big upside misses to the inflation data as price pressures remain stickier than many expected. Despite falling PPI inflation, consumer inflation appears to be flatlining a bit and that’s quite worrisome.

BOE tightening expectations have risen significantly. The next policy meeting is May 11 and WIRP suggests a 25 bp hike is fully price in along with around 15% odds of a larger 50 bp move. A 25 bp hike is fully priced in for June 22, followed by another 25 bp hike September 21. As a result, the peak policy rate is now seen near 5.0% vs. 4.75% at the start of this week and between 4.50-4.75% at the start of last week. Mann speaks today. As the hawkiest hawk on the MPC, expect hawkish comments to emerge, especially after the CPI data. Yet the adjustment in BOE expectations has had little lasting impact on sterling, which is down on the day after a brief post-data spike.

ASIA

The HKMA continues to defend the HKD peg. With USD/HKD continuing to trade at the upper end of the 7.75-7.85 trading band around the 7.80 peg rate, the HKMA has so far bought HKD20.0 bln ($2.6 bln) in several rounds this month to defend it. Before these interventions began the first week of April, the last time the HKMA intervened was February14. While no one really expects the peg to break, low local rates have led some to sell HKD and buy the higher yielding USD. This week’s FX interventions are meant to reverse this and has drained liquidity in the Hong Kong system as measured by the so-called aggregate balance to levels seen in early 2020. This most recent round of intervention is seen pushing the aggregate balance down to HKD49 bln, the lowest since the Great Financial Crisis and so local rates should continue to rise as a result. While this will support the HKD, it is negative for the local equity market.

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