Market Hears Dovish Fed Hike and Sells Dollars

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Marc Chandler
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Overview:  The dollar remains under pressure following the Federal Reserve's rate hike. The market thinks it heard that the Fed was done hiking, even though Fed Chair Powell held out the possibility that "some additional firming may be necessary."  The Norwegian krone is the strongest of the G10 currencies today, up more than 1%, spurred by a 25 bp hike and a commitment to do more. The Dollar Index briefly traded below 102.00 for the first time since February 3. A close below 102.35 today would be the sixth decline in a row. The JP Morgan Emerging Market Currency Index is edging higher and trying to extend its advance for the fourth consecutive session. 

 Equities are mixed today. Hong Kong rallied 2.3% and its index of mainland shares jumped nearly 3% but most other large bourses outside of China and Taiwan fell. Europe's Stoxx 600 is snapping a three-day advance and is off nearly 0.75% in late morning turnover. The bank index is off nearly 2%. After a poor showing yesterday, US index futures are trading with a firmer bias. European bond yields are off mostly 4-6 bp. UK Gilts again are underperforming. The 10-year US Treasury yield is about four basis points firmer at 3.47%. Gold is firm and trading above yesterday's high near $1979. Recall that the high from Monday was a little shy of $2010. May WTI is consolidating near the upper end of yesterday's range and is hovering around $70.

Asia Pacific

Even if the new team at the Bank of Japan tweaks the monetary policy it is inheriting, there seems no alternative to the easy monetary and easy fiscal policy, which is a hallmark of LDP rule. Some of the unspent funds (JPY2 trillion or ~$15 bln) from the fiscal year that end on March 31 will be used to provide ease the squeeze from higher inflation. The new measures are targeted to low-income households and their children (JPY500 bln) and aim to subsidize the cost of liquified petroleum gas (~JPY700 bln), according to comments by the Economy Minister Goto. Additional spendings (JPY800 bln) was not specified.

Unlike the earlier subsidies, which went into effect last month and dampened price pressures, the aim of the new measures is to placate voters ahead of next month's local elections. The earlier fiscal measures did not include liquified petroleum gas, which is more commonly used in small cities and rural communities, and the government expected the package to dampen inflation by about 1.2 percentage points. The new measures may be worth a couple of tenths of a percentage point. Both efforts illustrate ways in which fiscal policy can be used to temper price pressures. Tomorrow, Japan report February CPI. It is expected to fall to around 3.3% from 4.3% and the core is seen falling to 3.1% from 4.2%. The flash March PMI will also be released. After dipping below the 50 boom/bust level in November and December, Japan's composite PMI rose back above it in January (50.7) and further in February (51.1). 

The Chinese yuan is simply not convertible, which is not a question of technology but policy. It is closely managed and purposefully opaque. Its capital markets are developing but are not sufficiently transparent. Including the yuan in the IMF’s Special Drawing Rights (2015) was supposed spark a growth in yuan reserves but as of the end of Q3 22, the yuan’s share of international reserves was about 2.75%. This will be updated for Q4 22 at the end of the month. The yuan’s share of SWIFT transactions briefly rose above 3% early last year, but last month, its share had stood at almost 2.2%. Russia may become more reliant on the yuan, but the rest of the world has not. If there is a yuan-bloc developing it is with Russia, North Korea, and Iran. Note that when India buys Russian oil, and it is Moscow's biggest customer now, it pays in UAE dirham (which is pegged to the dollar).

The dollar was sold to almost JPY130.40, its lowest level since mid-February, and may have spurred some position adjustment around the $980 mln of options expiring today at JPY130.50. It recovered to almost JPY131.25 in the European morning, stalling in front of chart resistance around JPY131.50. A break of JPY130 would be important from a technical perspective, but it seems unlikely in the very near-term. After a weak close yesterday, the Australian dollar has bounce back toward yesterday's high (almost $0.6760), where the 200-day moving average is found. The pullback in early European turnover found is likely to find support in the $0.6700-20 area. Despite the other G10 rate hikes over the past week, the market remains unconvinced that the Reserve Bank of Australia will join the latest round when it meets on April 4. Given the greenback's losses against the other major currencies, it is not a surprise that it was also sold against the Chinese yuan. The dollar gapped lower and traded to about CNY6.8170, it low since mid-February. The greenback is nursing its largest loss against the yuan in nearly two weeks. The PBOC set the dollar's reference rate at CNY6.8709 compared with the median forecast in Bloomberg's survey of CNY6.8714.

Europe

Three non-EU central banks meet today, and two, Norway's Norges Bank, and the Swiss National Bank have already hiked rates. Still to come is the Bank of England. After the acceleration of inflation last month, reported yesterday (10.4% vs. 10.1% in January and expectations for a small decline), the market has cast off any doubt that about today's rate decision. It has come around to accept a quarter-point hike. Norway hiked by 25 bp, lifting its deposit rate to 3.0%. Previously, the central bank saw 3.1% at the peak and now suggest the terminal rate will be closer to 3.6%. It raised its inflation forecast and signals that, barring fresh surprises, will hike rates when it meets against in May. The Swiss National Bank delivered a 50 bp hike, lifting its policy rate to 1.50%. The swaps market sees the terminal rate around 2.0%. A 25 bp hike will raise the UK base rate to 4.25%. The market anticipates one more hike with a modest risk (~33%) of another one after that.

The euro extended yesterday's gains and rose to $1.0930 in the Asia Pacific session before pulling back nearly half a cent in European morning. Support is seen near $1.0850, but the sold intraday momentum indicators suggest it will likely hold above. Position adjusting around the large expiring options (~955 mln euro today and 1.55 bln euros tomorrow) at $1.08 may have helped lift the single currency. Sterling is bid and has marginally taken out yesterday's high (~$1.2335) to edge up to $1.2345. It has been climbing on its five-day moving average this week, which is found today near $1.2250. The intraday momentum is flagging and initial support around $1.2280 looks to be tested. Recall that highs made last December and again in January were near $1.2450. While sterling may approach it, the momentum indicators suggest it will likely be over-extended. Lastly, Turkey's rate decision is still awaited. The one-week repo is at 8.50% and most expect it to be held steady. 

America

The Federal Reserve delivered a quarter-point hike, indicated further additional tightening may be necessary, and continued apace its quantitative tightening operations ($95 bln a month). Yet the market heard dovish sounds by dropping references to "ongoing increases" and replacing it with "some additional policy firming may be appropriate". The median dot (2023 year-end) was left at 5.1%. This also signals that the Fed is done or nearly done hiking rates. Chair Powell acknowledged that the tightening of financial conditions associated the banking stress. The magnitude and duration after that drag is not known, but Powell recognized that it may do some of the work for monetary policy. He did continue to push back against ideas of a rate cut this year, but the market paid little heed. The Fed funds futures imply a year end rate of about 4.20% compared with 4.37% at Tuesday's close. The Fed's decision was unanimous but the divergence with market expectations is significant. The market is also sensitive to the conflicting signals between Treasury Secretary Yellen who clearly told Congress that the US is not considering a blanket guarantee for all depositors while Powell said all depositors were safe.

Powell did not say it in so many words but the key to monetary policy is not the incoming macroeconomic data but an assessment of the impact of the banking stress. The Fed wants inflation to fall further, and the issue is how much tightening is being done for it. This makes today's high-frequency reports less interesting. Weekly jobless claims have been below 200k since early January with one exception. From the Fed's vantage point, the labor market robust and through wages or demand is driving up core non-shelter service prices that account for over half of the core PCE deflator. Weakness in new home sales, especially after the 7.2% surge in January also would not be surprising.

The Canadian dollar was an underperformer yesterday, unable to benefit from the broad weakness in the US dollar. However, after closing firmly, the greenback has slipped back toward yesterday's lows (~CAD1.3655). A push below CAD1.3640 could signal a test on CAD1.3600. The five-day moving average looks poised to push below the 20-day moving average today or tomorrow for the first time since mid-February. The US dollar peaked on Monday near MXN19.2320 and traded as low as MXN18.38 yesterday. It is consolidating today inside yesterday's range. Mexico reports January retail sales today (expected 0.8%) and inflation for the first half of March (expected to have accelerated slightly). The central bank meets next week and will likely match the Fed's quarter-point move. Although sensitive to the growing friction with the US and concerns about the domestic political situation, the recent setback has likely cleared some positioning. Between the attractive carry and the near-shoring/friend-shoring meme, we have a constructive near-term outlook. The MXN18.40 area offers support, and a break could see MXN18.20. Recall that the dollar's multi-year low was set in early March near MXN17.90.