Dollar Remains Under Pressure Ahead of FOMC

new fire

  • President Trump’s State of the Union speech offered no lifeline for the dollar
  • A hawkish hold is the most likely outcome from the FOMC meeting
  • The US Treasury will announce the details of the quarterly refunding
  • The BOJ increased its bond purchases at its regular operations for the first time since July
  • Australia Q4 headline CPI rose 1.9% y/y; China official January manufacturing PMI fell to 51.3 vs. 51.6 expected
  • Korea December IP was very weak; Brazil reports December consolidated budget data

The dollar is broadly weaker against the majors ahead of the FOMC decision and Treasury’s quarterly refunding announcement.  Stockie and Kiwi are outperforming, while the yen and sterling are underperforming.  EM currencies are broadly firmer.  ZAR and MXN are outperforming, while INR and PHP are underperforming.  MSCI Asia Pacific was down 0.2%, with the Nikkei falling 0.8%.  MSCI EM is up 0.5% on the day, with the Shanghai Composite falling 0.2%.  Euro Stoxx 600 is up 0.1% near midday, while S&P futures are pointing to a higher open.  The 10-year US yield is down 1 bp at 2.70%.  Commodity prices are mixed, with Brent oil down 0.7%, copper up 1.1%, and gold up 0.3%.

President Trump’s State of the Union speech offered no lifeline for the dollar.  He took the opportunity to focus on the strength of the US economy.  However, details of his proposed plan to boost infrastructure spending were lacking.  And while he talked of the need for greater bipartisanship ahead, Trump offered the Democrats very little in terms of possible compromises on the most contentious issues.

A hawkish hold is the most likely outcome from the FOMC meeting.  Growth impulses are stronger, even though headline Q4 GDP disappointed.  The part of the economy that is the most responsive to monetary policy, final domestic purchases, rose by a robust 4.8%.  The IMF recently raised its US growth forecasts, and we would expect the Fed to follow suit.

US inflation and market-based measures of inflation expectations have also risen.  In the first look at Q4 GDP, the core PCE deflator rose from 1.3% to 1.9%.  The 10-year breakeven rate (the difference between the yield of the conventional 10-year note and the 10-year TIPS) has risen by about 20 bp since the December FOMC meeting and is nearly 2.10%, where it finished last week and is at three-year highs.

The US Treasury will announce the details of the quarterly refunding.  Investors have already been put on notice that the size of the coupon offerings will increase, but the details will be very important.  Many participants still do not appear to appreciate that the government’s net issuance this year will be around twice last year’s $550 bln.  US yields have risen going into today’s announcement, and there still seems to be room on the upside.  Yet higher yields have done little for the dollar, which remains on its back foot.

During the North American session, there will be some data seen ahead of the FOMC decision.  ADP will report its jobs number for January.  A rise of 185k is expected.  Chicago PMI for January will also be reported, where a reading of 64.0 is expected, down from a revised 67.8 (was 67.6) in December.  Canada will report November GDP, with growth expected to remain steady at 3.4% y/y.

Germany reported December retail sales and January unemployment.  Sales dropped -1.9% m/m, almost five times the -0.4% drop that had been expected.  The y/y rate was -1.9% vs. +2.8% expected.  On the other hand, Germany saw a -25k drop in unemployment vs. -17k expected.  Coming on the heels of the weak CPI reading for January, investors are likely to accentuate the negative.

Indeed, the eurozone reported lower inflation in January from the 1.4% y/y reading in December.  This was not surprising after Germany’s CPI reading came in lower than expected.  However, higher than expected French inflation limited the slowdown to 1.3% y/y vs. 1.2% expected.  Yet soft European data this week has done little to impede the euro.

The BOJ increased its bond purchases at its regular operations for the first time since July.  It seems the central bank wants to make sure that the markets know that there has been no shift in its dovish policy stance.   It bought JPY330.5 bln of 3- to 5-year bonds, up about JPY30 bln from the last time.  This is natural in light of rising global yields, which will require more BOJ action under its yield curve targeting framework.

China official January manufacturing PMI fell to 51.3 vs. 51.6 expected and actual in December.  Caixin reports its manufacturing PMI Thursday.  While it is expected to remain steady at 51.5, the risk is now to the downside.  These are the first snapshots of the mainland economy for 2018, and data in Q1 certainly bear watching.  For now, markets appear comfortable with China’s macro outlook further slowing will negatively impact the regional outlook.

Australia Q4 headline CPI rose 1.9% y/y vs. 2.0% expected.  However, the trimmed mean came right at the expected 1.8%.  Private sector credit slowed to 4.8% y/y in December vs. 5.2% expected.  The data (from both Australia and China) should cool off any notions that the RBA is close to hiking rates.  It meets next Tuesday and no change is expected.  The Aussie has recovered back above .8000 after early selling, but it is underperforming within the majors.

Korea December IP was very weak, contracting -6% y/y vs. -1.5% expected and a revised -1.7% (was -1.6%) in November.  Korea reports January CPI and trade Thursday.  Inflation is expected at 1.3% y/y vs. 1.5% in December, while exports are seen rising 21.5% y/y and imports by 17.8% y/y.  Inflation seems likely to remain below the 2% target for much of this year.  Taken along with the soft real sector data, the BOK should be in no hurry to hike again after its 25 bp move in November.  Next policy meeting is February 27, no change is expected.

Brazil reports December consolidated budget data, where a primary deficit of -BRL30.8 bln is expected.  Earlier this week, the central government budget deficit was reported at -BRL21.2 vs. -BRL25.0 bln expected.  That 12-month total narrowed sharply to -BRL124.4 bln, the smallest since January 2016.  A similar dynamic is likely for the consolidated budget reading.  However, we warn that there are distortions from last year’s tax amnesty plan and we remain concerned about the fiscal trajectory in the absence of pension reform.