The Greenback has Struggled even as Rate Expectations Rise

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Marc Chandler
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The effectiveness of the Federal Reserve's communication seems clear. The market has nearly 90 bp of tightening discounted here in Q2. This means that after a 25 bp hike to initiate the tightening cycle, the labor market's strength will allow the central bank to accelerate the pace. By the end of the week, the market will also have a better idea of the timing and pace of the balance sheet unwind.

The March nonfarm payroll growth may have missed median estimates, but when coupled with the 95k upward revisions, including 72k in February, and other details (from the household survey), the report must be considered strong. The household survey found that 736k people found jobs, and the unemployment rate fell to 3.6% (from 3.8%), even though the participation rate ticked up to 62.4% (from 62.3%). In addition, average hourly earnings rose by 0.4%, and February was revised from flat to 0.1%. The one negative was that the average workweek slipped to 34.6 hours from 34.7. With around 131.1 mln workers, six minutes less work is tantamount to the loss of output of 378.9k full-time equivalents.

Meanwhile, the March manufacturing PMI was revised higher to 58.8 from 58.5. It is a six-month high and contrasts with the preliminary estimates of the EMU and UK downward revisions. On the other hand, the manufacturing ISM unexpectedly softened to 57.1 from 58.6. It is the lowest since September 2020. Production (54.5 from 58.5) and new orders fell (53.8 from 61.7) while prices paid rose sharply (87.1 from 75.6).

Investors also learned that February construction spending rose half as much as the median forecasts projected (0.5%, not 1.0%). It was partly blunted by the January revision to 1.6% from 1.3%. March auto sales disappointed too. They slowed to a 13.33 mln vehicle pace from 14.07 mln. The March sales were about a quarter less than March 2021. The 12-month moving average stands at 14.3 mln and matches last year's low, slightly below the 2020 average. Although the shortage of chips is widely blamed as the chief culprit, note that Canada's vehicle sales were off a little less than 20% year-over-year in March. Japan's were off 14.8%.

The unexpectedly strong eurozone March CPI (7.5%  vs. 5.9% in February) reinforces speculation that the ECB will hike rates this year. The swaps market has almost a 15 bp increase discounted by the end of July. On the eve of Russia's invasion of Ukraine, the German two-year note yield was -0.36%. It settled last week at about -0.07%. It briefly traded positive for the first time since August 2014.

Although many claim to know what Putin is thinking or his intentions, we do not. Yet, assuming a rational actor still allows for reasonable analysis. We had expected Russia to have limited war aims to secure the entire regions claimed by the separatists. Until these are secured, negotiations seem to be a way to buy time.   The war is also altering fiscal policy in the EMU. Defense spending and new energy infrastructure expenditures will replace part of the public health spending.

In Japan, the BOJ mounted a rigorous defense of its Yield-Curve Control. This signaled a continuation of its monetary thrust and the fact that it is determined to lag behind the other major central banks. However, the Ministry of Finance seems less convinced by BOJ Governor Kuroda that the yen's weakness still benefits the Japanese economy. Higher energy and food prices are exacerbated by the yen's decline and are squeezing households. The government has begun putting together a package of measures that will ease the pressure. Prime Minister Kishida announced a one-month extension of subsidies to oil wholesalers to lower the price of retail gasoline until the end of April.

Where does that leave the dollar? 

Dollar Index:  For the past four weeks, the Dollar Index has been in a roughly 97.70-99.40 range. The jump in US rates and wider interest-rate differentials have not (yet) reignited the rally. It peaked on March 7. In the second half of last week, it tested the lower end of the range and reached 98.75 after the jobs report.   The rule of alternation suggests a test on the upper end of the range. SINCE MID-MARCH, the MACD has been trending lower but appears poised to turn higher. The Slow Stochastic has been trending down a bit longer, and it finished last week at its lowest level since the war began.

Euro: The euro reached a four-week high on the last trading day in March (~$1.185) before posting a key reversal by settling below the previous day's low. Follow-through selling ahead of the weekend pushed it slightly below $1.1030. The $1.0995 is the (50%) retracement of recovery from the $1.08-low on March 7. It is also where the March trendline is found. The next retracement (61.8%) is near $1.0950.  The MACD looks set to turn lower, while the Slow Stochastic is still gently rising. In the bigger picture, last month's price action looks corrective in nature, and that would imply scope for a new low below $1.08.

Japanese Yen: The greenback peaked on March 28 near JPY125.10. It retreated and found support ahead of the (38.2%) retracement objective of the rally March rally seen by JPY121.10. We often find the dollar-yen exchange rate to be a range-bound pair, and when it looks like it is trending, it is transitioning to a new range. The upper end of the range may extend a little above JPY125.00. The 2015 peak (the high since 2002) was closer to JPY125.85. The lower end of the range may be in the JPY119.50-JPY120.00 area. The MACD is at its highest level since 2016 and has begun flatlining. The Slow Stochastic turned down last week. The correlation between the change in the exchange rate and the difference in the US 10-year yield has softened to about 0.46 over the past 30 days. It peaked at over 0.70 in mid-March. The correlation between the changes in the exchange rate and the S&P 500 (as a proxy for risk) is below 0.15. The Q1 peak was set in early January, slightly above 0.60.

British Pound: Sterling has fallen in four of the past six weeks. Year to date, it is off about 3.1% and is the weakest currency of a major central bank that has begun lifting rates. The Swedish krona (~-3.35%) and the Japanese yen (~-6.1%) have fallen more than sterling. It traded in roughly a $1.3085-$1.3185 range in the middle of last week and remained in that range in the following two sessions. The MACD has trended higher since mid-March after sterling tested $1.30. It has begun flattening. The Slow Stochastic has already turned lower. The odds of a 50 bp rate hike at the next BOE meeting (May 5) have fallen to around 20% since the officials tempered their rhetoric in light of the greater uncertainty. The swaps market has about 140 bp of tightening discounted this year compared with a little more than 216 bp by the Fed. AS recently as early February, the UK and US two-year rates were almost identical. Now the US offers a premium of practically 110 bp. This is the most since the early days of the pandemic. A break of $1.30 could spur a move toward $1.2830, the (38.2%) retracement of the sterling's recovery from the March 2020 low near $1.1400.

Canadian Dollar: The US dollar's high for the year was recorded on March 8 at CAD1.29, and the low for the year was set on March 30 by CAD1.2430. It finished the month around CAD1.2505, which was below the February low (~CAD1.2635). This constitutes an outside down month, a bearish technical pattern. However, the near-term outlook seems more constructive for the greenback. The MACD is set to turn higher, and the Slow Stochastic already has turned up. A small bottoming pattern appears to have been forged last week, which projects toward CAD1.2630. The 200-day moving average is nearly CAD1.2620. For the first time since May 2021, the correlation between the changes in the exchange rate and the changes in oil prices turned positive last month. The correlation is typically inverse. On the other hand, the correlation between changes in the S&P 500 and the changes in the exchange rate remain deeply inverse (-0.63), suggesting risk appetites are a more important driver than crude oil.

Australian Dollar:  The Australian dollar slipped 0.25% last week, its first weekly loss in three. It was only the second weekly loss since the end of January. Its 3.2% gain year-to-date puts it at the top of the G10 currencies. The New Zealand dollar is in second place with an increase of a little less than half of the Aussie's. The Canadian dollar and Norwegian krone are next (~0.9% and 0.8%, respectively). For the past week and a half, the Australian dollar has been consolidating in a range between roughly $0.7460 and $0.7540. The MACD and Slow Stochastic remain overextended. Although they have stopped rising, they have not convincingly turned lower either. The central bank meets on April 6 in Sydney, and the failure to deliver a hawkish hold could see the Aussie breakdown. The $0.7400 area may be an initial target. It corresponds to the (38.2%) retracement objective since the March 15 low (~$0.7165) and the 20-day moving average.

Mexican Peso:  The peso is having a historic run. It has rallied for 15 of the past 16 sessions. During this run, the dollar has fallen by 5.2%. Ahead of the weekend, the dollar traded below MXN19.80 for the first time since last July. However, the move is getting stretched, and new downticks are difficult to sustain. The MACD is still falling, but the Slow Stochastic has flatlined and has not confirmed the new lows. Initial resistance is seen in the MXN19.97-MXN20.02 band. Mexico reports March CPI on April 7. It is expected to have edged higher to 7.35% (median from Bloomberg's survey) from 7.28%. The swaps market has 70 bp of tightening for the next three months and another 100 bp in the following six months.   The greenback's 2021 low was set in March near MXN19.60.

Chinese Yuan: The dollar slipped against the Chinese yuan last week to snap a four-week advance. Still, the exchange rate of the two largest economies appears to have found a new range:  CNY6.33-CNY6.38. Bad news could be good news for China in the sense that disappointing economic data bolsters the chances of a more significant policy response. In turn, this could spur fresh portfolio flows. It is not clear the significance of the momentum indicators on such a tightly controlled exchange rate, but the  MACD is stretched and, after pulling back a bit, looks ready to turn higher again. The Slow Stochastic has turned down more decisively.   Most emerging market currencies outside Latam (excluding Argentina) and South Africa have depreciated against the dollar this year. The Chinese yuan has by about 0.10%, making it the seventh-best performing emerging market currency.

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