Greenback’s Sell-off may Stall Ahead of Powell Tomorrow

by
Marc Chandler
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Overview: Don't fight the Fed went the manta as the market took the US two-year yield back up to 4.50% in the aftermath of the FOMC minutes last week, the highest in over a month. The minutes warned of a premature easing of financial conditions. And then bam, softer than expected hourly earnings and a weak service PMI and bonds and stocks rallied, and the dollar was sold. This is a key part of the backdrop for this week, for which several Fed officials will speak, including Chair Powell at a Riksbank event tomorrow, ahead of the US December CPI on Thursday. The US two-year yield is stabilizing after slipping through 4.25% before the weekend. The pre-weekend dollar losses have been extended, but the momentum appears to be stalling in the European morning, perhaps setting the stage for turnaround Tuesday tomorrow.

Meanwhile, investors continue to insist on looking past the current Covid disruption in China and instead are focusing on the new support for the property sector and aid for the broader economy.  Iron ore prices have rallied about 7.5% in the past two weeks, though traded a little heavier today. March copper futures are up more than 2% today, which, if sustained, would be the third consecutive gain of 2%. The Chinese yuan jumped today and the PBOC used to the fix to try to moderate its gains.

Asia Pacific

Over the weekend, China reported that the dollar value of its reserves rose by $10.2 bln to $3.13 trillion. The increase was less than the median in Bloomberg's survey suggest ($3.15 trillion). It appears valuation adjustments were key. The yen rose by 5.3% and the euro by 2.8% against the dollar, and other reserve currencies also appreciated. The Canadian dollar was the notable exception. It lost about 1%. Most observers regard the Canadian dollar as a minor reserve currency. At the end of Q3 22, the IMF's COFER reported estimated that central banks had about $265 bln worth of Canadian dollars in reserves. Consider, then, that it estimates central banks had about $298 bln worth of the Chinese yuan in reserves. While the FX adjustment would have lifted China's reserves, like other central bank, the PBOC holds foreign bonds and those took a hit last month. The BOJ surprise move lifted the 10-year JGB yield by 16 bp. The 10-year German Bund yield rose 64 bp and the 10-year US Treasury yield rose by 27 bp. Many pixels have been used talking about China diversifying away from the dollar toward gold. We have played this significance down. Its gold holdings did rise by about $5.5 bln to $117.2 bln or a little more than 5%. in December. This is a little more than the valuation adjustment (the price of gold increased slightly more than 3% in December. However, before getting too carried away, note that at the end of 2020, China's gold holdings were worth $118.2 bln. As a percentage of overall reserves, the share of gold was virtually unchanged over the two years at around 3.7%.

The futures market is pricing in about a 60% chance that the Reserve Bank of Australia lifts its cash target rate by 25 bp when it meets on February 7. We suspect the odds may rise on Wednesday after the release of November retail sales and CPI figures. After falling by 0.2% in October, the first decline this year retail sales likely rebounded. The median forecast in Bloomberg's survey is for a 0.6% increase. The new monthly CPI gauge eased in October to 6.9% from the cyclical peak of 7.3% in September. However, the risk that it returned to its peak in November. Higher oil and gas prices may be the primary culprit, but the trimmed mean reading may jump to a new cyclical high (5.5% vs. 5.3%). The more comprehensive quarterly figures will be reported before the RBA meets next month.

Tokyo markets were closed today (Coming-of-Age), but first thing tomorrow, Tokyo's December CPI will be reported. It offers good insight into the national figures, which are not due until January 19, the day after the BOJ meeting concludes. The yen is pulled between the weaker greenback and the rise in US yields. It is the only G10 currency that is trading heavier today. Initially, the US extended its pre-weekend loss, easing to almost JPY131.30 before recovering toward JPY132.60 in the European morning. However, overextended intraday momentum indicators warn not to chase it now. The Australian dollar extended its sharp pre-weekend gains and traded to almost $0.6950, its best level since last August. The next important resistance is near $0.7000. Optimism about China adds to the attractiveness of the Aussie. Support now is seen near $0.6880. The dollar gapped lower against the Chinese yuan, encouraged by investors continuing to look past the current Covid disruption and reports of further help for the property sector and support for the economy more broadly. The dollar's low before the weekend was around CNY6.8280 and today's high has been CNY6.8150. Like the Aussie, this is the best level for the yuan since last August. The PBOC set the dollar's reference rate stronger than expected at CNY6.8265 (vs. CNY6.8221) as it used its fix to lean against the sharp market move.

Europe

The softer than expected eurozone December CPI preliminary print did not change expectation for the trajectory of ECB policy. ECB President Lagarde has pre-committed to a 50 bp hike at the next meeting on February 2. More interesting the market leans strongly in favor of another 50 bp hike at the following meeting on March 16. The core measure inflation rose to a new cyclical high of 5.3%, giving more encouragement of the ECB to look past the tax break/subsidies for energy. Indeed, it looks like Germany's 1.2% drop in the headline rate explains the drop in the aggregate measure. The ECB's staff forecast headline CPI to fall to 6.3% this year from 9.2% in December. The IMF sees it at 5.7%. The swaps market sees the terminal rate between 3.25% and 3.50% in Q3. The ECB's Schnabel, and the governors of the Dutch and Spanish central banks will also speak at tomorrow's Riksbank function.

Germany November industrial production rose by 0.2% instead of the 0.3% projected and the October series was revised to show a 0.4% decline rather than the 0.1% initially reported. Many are still hopeful that a mild recession is still possible. The aggregate industrial production figure for the eurozone is due at the end of the week and a 0.5% gain is expected (median in Bloomberg's survey) after a 2.0% fall in October. Today, the eurozone reported that is unemployment rate in November was unchanged at the cyclical low of 6.5%. Recall that in December 2019, before Covid, the eurozone unemployment rate was 7.5%. 

The euro reached $1.07 in late Asian turnover and pulled back in the European morning to about $1.0660. The session low is near $1.0645, and the pre-weekend high was around $1.0650. The single currency reached almost $1.0715 on the last trading day in 2022 and had seen $1.0735 in mid-December. With the euro at the upper end of its range, the market may be reluctant to push it much higher without new incentives. Sterling gains have also been extended. The pound rose to almost $1.2175. The next technical hurdle is seen in the $1.2200-15 area ahead of the high last month near $1.2445. Here, too, euro, has, at least initially, be reluctant to extend sterling's gains. Support is seen in the $1.2080-$1.2100 area.

America

The combination of the softer US average hourly earnings data and the weakness of the services ISM saw the (Fed funds futures) downgrade the chances of a 50 bp hike on February 1 to about 28% from 44%. The strength of the Canadian jobs data spurred the market in the opposite direction. The swaps market boosts the chances of a 25 bp hike from about 66% to almost 81% on January 25. The median forecast in Bloomberg's survey was for Canada to have created 5k jobs last month. Instead, it created 104k, of which 84.5k were full-time positions. Hours worked ticked up for the third consecutive month, while aggregate hours worked in the US slipped for the second month in a row. Despite weakness in the US and Canada's housing market, it is striking that hiring in both construction sectors remain robust (28k in the US and 35k in Canada). Still, more than a little counter-intuitive, Canada's two-year yield slipped 6.5 bp ahead of the weekend, the biggest decline in about 3.5-weeks. Indeed, the explanation for the pre-weekend move and the larger (nearly 13 bp) decline on December 13, likely lies with the pull of the US rates. The US two-year yield fell 21 bp before the weekend and on December 13, in response to the softer than expected US CPI, the two-year yield shed almost 16 bp.

The US reports November consumer credit later today. It tends not to be a market mover. It is expected to have slowed to around $25 bln from slightly more than $27 bln in October. Through October, US consumer credit rose an average of nearly $30 bln a month. In the same period last year, it rose by an average of $19.1 bln. In the first ten months of 2019, consumer credit increased by an average of about $15.2 bln. The revolving credit component (credit cards) has averaged $12.95 bln through October and that compares with an average of $4.4 bln and $3.3 bln in the first 10 months of 2021 and 2019, respectively. Still, the market may be more interested in the Fed-speak ahead of the December CPI figures on January 12. Today, Atlanta Fed's Bostic and San Fran Fed's Daly are scheduled to speak. Neither has the vote this year on the FOMC, but they participate in the Summary of Economic Projections (dot plot), which seem to have been upgraded as policy tool since days that Bernanke and Yellen played them down. That said, there is much interest in whether Chair Powell who speaks at a Riksbank event tomorrow uses the opportunity to underscore the December minutes, which pushed back against the easing of financial conditions. Bank of Canada Governor Macklem also speaks at the Riksbank's symposium.

Last week, the US Treasury announced an increase in today's 3- and 6-month bill auctions by $3 bln to $57 bln and $48 bln, respectively. This is important for at least two reasons. First, increased bill issuance may attract funds that are now utilizing the Fed reverse repo facility. However, an underlying issue is that the reverse repos offer a higher yield than bills. Second, the US statutory debt ceiling is approaching, and bill issuance typically increases. The federal government is less than $80 bln away from its $31.4 trillion cap. The election of the new House speaker may make the negotiations to lift the cap more onerous. Still, this is the not the first time, and there is a "playbook" of extraordinary measures that can be taken that suggest the real crunch may be in Q3.

The reassessment of the outlook for the Bank of Canada later this month after the strong jobs data, the risk-on of rising equities, and the broad weakness of the greenback has seen the Canadian dollar rise to its best level since late November. The US dollar is fraying support around CAD1.34. The next near-term target is around CAD1.3320-45, while the mid-November low was about CAD1.3225. That said, the downside momentum is stalling, and a bounce may be seen in North America, but the CAD1.3450 should cap the corrective bounce. Similarly, the greenback fell to about MXN19.1025 before stabilizing. It is the lowest level since early last month. The downside momentum faded, and the US dollar bounced to record a new session high in the European morning near MXN19.1665. Above there, chart resistance is seen around MXN19.20. Mexico reports December CPI figures today.  The core rate is expected to ease (8.35% vs. 8.51%) but the headline rate may tick up to 7.84% from 7.80%, according to the median projections in Bloomberg's survey. After chaos in Brazil's capital yesterday, Bolsonaro's supporters have been routed and the reaction from the markets is awaited. There is some tentative indication that Brazil's equities may struggle. Bolsonaro did not support the "insurrection".