Dollar Rides High

Considering Portfolios In Times Of, Among Others, Inflation...

 $USDBank of CanadaBOEChinaCurrency MovementECBFederal ReserveItalyJapanUK

Overview: The more hawkish turn by the Federal Reserve continues to ripple through the capital markets.  Equity markets are struggling to stabilize.  Apple's earnings help its shares and ecosystem stabilize.  The MSCI Asia Pacific Index pared with week's losses helped by 2%+ gains in the Nikkei and Australia. Strong industrial production figures helped Korea's Kospi.  It pared its weekly loss to 6%, the most in the region.  All the sectors are trading lower in Europe's Stoxx 600 today as the finishing touches are put on the fourth consecutive weekly decline.  It is off around 1.5% near midday. US futures are narrowly mixed, with the NASDAQ faring best.  Benchmark 10-year yields are firm in Europe and the US.  European yields are 2-4 bp higher, and we note that for the week, the Italian premium over Germany narrowed is virutally unchanged with the basis point widening today.  The US 10-year yield is 1.83%-1.84% The 10-year JGB yield rose to 0.165%, testing the last couple years' high.  It has not been above 0.20% since 2016.  Foreign investors sold the most Japanese bonds last week since last September.  The Scandis and dollar bloc are bearing the brunt of the greenback's broad strength today.  The dollar's weekly gain ranges from around 1% against Norway to 2.7% against Sweden.  Most emerging market currencies are lower too.  Of note, today India, Russia and China are seeing small gains against the dollar.  The JP Morgan Emerging Market Currency Index is snapping a three-week advance.  Rising yields is sapping the appeal of gold.  It tested $1850 earlier this week and is now near $1786.  It looks set to test the month's low a little below $1783.  March WTI is quiet as it puts the finishing touches on its sixth consecutive weekly advance.  US natural gas went on a wild ride yesterday.  A powerful short squeeze saw the expiring February contract rise by over 70% yesterday.   The generic contract was up almost 46.5%, while it is off almost 30% today. Net-net, it is up around 11% for the week.  Europe's benchmark 2.5% higher on the day, which brings the weekly gain to about 17.5%.  Iron ore prices were virtually flat on the week before today's 6% advance.  Copper prices are heavy and now breaking below the 200-day moving average ($438). 

Asia Pacific

Mainland Chinese markets will be closed next week for the Lunar New Year celebration.  Over the weekend, the January PMI and Caixin manufacturing PMI will be reported, and are expected to have softened.  The lockdowns are taking a toll.  Recall that China reported stronger than expected growth in Q4 21 (1.6% vs. 1.2% expected and 0.2% in Q3).  Still, it is clear that officials are pushing different levers to induce stronger growth.  Separately, China approved AMD's $35 bln acquisition of Xilinx.  It won regulatory approval in the US and Europe.  China has rejected the last big chip merger a few years ago.  

Tokyo's January CPI was a little disappointing.  The headline pace slowed to 0.5% from 0.8% year-over-year.  The core measure, which excludes fresh food, slowed to 0.2% from 0.5% year.  The deflationary thrust can be seen when fresh food and energy are excluded. This measure stands at -0.7%, matching last year's low point, which was the lowest since 2013.  One key development will come in the few months when last year's cut in mobile phone fees drop out of the 12-month comparison.   

Rising US yields have eclipsed equities and is driving the dollar higher against the yen. Today is the fourth advance of the week.  Up until this week, the dollar had only risen against the yen four time this month.  The greenback finished last week slightly below JPY113.70 and is knocking on the JPY115.70 area now.  Some demand may be linked to the $1.6 bln option at JPY115.50 that expires today.  The five-year high was set on January 4 near JPY116.35.  The Australian dollar is break below key support near $0.7000.  It has scraped it before, but it has held on a closing basis since July 2020.  A convincing break could signal a medium-term move toward $0.6750, from a technical perspective.  We have seen a few false breaks this year already. Caution is advised ahead of next week's RBA meeting, which is expected to shift toward a less dovish bias.  The intraday momentum indicators are stretched.  After surging (relative concept) against the Chinese yuan yesterday, the greenback consolidated at slightly lower levels today.  Hopes of a cut in reserve requirements ahead of the Lunar holiday were unfilled.  Continued currency strength and soft incoming data may still get the PBOC to move.  The IMF is encouraging more fiscal support.  The dollar's reference rate was set at CNY6.3746.  The market (Bloomberg survey median) was for CNY6.3738. 


The divergence between the Fed and the ECB will be driven home next week and that is one of the reasons why are not particularly sympathetic to ideas that this is a false break like the upside move was earlier this month.  Consider that European businesses have a practice of cutting prices in January.  This pattern was broken for the first time in more than a decade last year.  However, it appears to be back in play this year.  A day before the ECB meets next week, the preliminary estimate of January CPI is expected to fall by around 0.8% on the month.  This would bring the year-over-year rate down toward 4.3% from 5.0%.  The core rate may ease below 2% from 2.6% at the end of last year.  This will allow President Lagarde to resist the pull of the hawks.  

Italy's president contest extends to the fifth round today.  We suspect that the longer it goes the less likely it is given to Draghi.  There does seem to be a reasonable recognition that if Draghi were to become president, the risk of political instability could return.  Of course, a compromise candidate, including having the current president begin another term, could simply extend the calm a year or so until next year's parliamentary elections move into the fore.  Without a political party, Draghi is unlikely to serve as PM again.  

The launching of a police investigation into "partygate" appears to be complicating the internal report conducted by Susan Gray.  Her "internal" report was expected this week, but now it appears that it could be stripped of key details at the request of the police.  Press reports say that the police have request Gray's report include only “minimal reference" to the parties.  The police apparently have not asked Gray to limit her inquiry into other events or to delay the report.  On balance and from afar, our best guess is that Johnson leads the Tories into the May elections before his political future is decided.

The euro's sell-off has been extended to almost $1.1120.  Recall that two weeks ago it was near $1.1485.  There is an option for 1.2 bln euros at $1.1150 that expires today.  It could come back into play as the intraday momentum indicators are stretched and Europe has not managed to push it below the lows seen in Asia.  This week's 1.8% loss (at $1.1135) is the largest since last June.  We continue to see potential toward $1.10 and will re-evaluate if/when it is approached.  Sterling is consolidating this week's 1.25% drop (at $1.3380).  The $1.3400 area, which it is hovering around, corresponds to the (61.8%) retracement objective of the rally from the December 20 low near $1.3175 to $1.3750 (January 13).  The next area of technical support is seen a little above $1.3300.  On the upside, the $1.3440 area offers initial resistance. The BOE is expected to hike next week and signal it is prepared to let the balance sheet begin shrinking too.    This may deflect some selling pressure away from it.  


Fed Chair Powell repeated a few times a mantra about how growth is robust (even though Covid-inspired weakness in Q1), labor market tight, and prices elevated.  In December and again this week, he mentioned labor costs.  Many liberal and neoliberal economists see core inflation driven by wage growth.  Profits are seen as a residual after cost are incurred.  While that may be helpful for analytic purposes, it is not clear that that it is factually true.  Many years ago, I was talking to the CFO of a large auto manufacturer.  I told him that I did not consistent effort to cut labor costs.  I noted that in the annual report, the company was very proud of being able to produce a car in less than 20 man-hours.  Assume labor costs and legacy costs (pensions, etc.) are $150 an hour that is $3000 of labor costs for a car that will cost me $30,000 to $35,000.  I said saving $100 or $200 in labor costs will have little meaningful impact on the price. The CFO criticized me for thinking like an economist instead of a businessperson.  He explained that the company could not control the price of capital or raw materials or other inputs, but labor.  Getting a $100 more from labor, doubles and sometimes more than doubles, the profit per vehicle. 

The US reports Q4 Employment Cost Index today.  Powell has specifically cited this time series.  Although it is not typically closely followed by market participants, it will likely draw more attention now that market participants know that the Fed is watching it closely.   The index is a broad measure of changes in compensation that include direct costs (ages, bonuses, in-kind benefits) and indirect costs (social security contributions, taxes, medical and other benefits).  It jumped 1.3% in Q3 21, which is the highest since least 2000.  It can be a volatile series.  The four-quarter moving average is 0.9%, the highest since Q4 04.  A 1.2% rise is projected for Q4 (median forecast Bloomberg survey), which would lift the four-quarter moving average above 1% for the first time since 2001. In Q3 21, total compensation rose 3.7% year-over-year, accelerating from 2.8% in Q2.   Private sector wages and salaries rose by 4.6%.  The market is pricing in roughly a 1-in-4 chance of a 50 bp rate hike, something the Fed has not delivered since May 2000.  Labor costs are of the variable move the proverbial needle.  The US also reports personal income and spending for last month.  While the deflators may draw attention, the activity was already included in the first estimate of Q4 GDP (6.9% annualized quarterly pace) released earlier this week.  Lastly, note that some 1700 west coast dock workers have tested positive for the virus, which fans fears of more supply disruptions. 


The Bank of Canada seemed as hawkish as the Fed.  A March rate hike is as much of a done deal as these things get and the balance sheet will likely be brought into play relatively quickly.  Still the Canadian dollar continue to be sold.  The greenback punched above CAD1.27 yesterday and is pushing near CAD1.28 today.  There is an option for almost $500 mln at CAD1.28 that expires today.   Note that the CAD1.2770 area corresponds to the (61.8%) retracement of the US dollar's retreat from the December 20 high (~CAD1.2965) to the January 20 low (~CAD1.2450).  Chart resistance above CAD1.2800 may be encountered around CAD1.2815-CAD1.2835. Meanwhile, the Mexican peso is weaker for the fifth consecutive session and eight of the last nine.  It continues to be a laggard in the region, with international asset managers seemingly drawn to Brazil.  Brazil's central bank has pre-committed to a 150 bp hike at next week's meeting.  The next target for the dollar is near MXN20.98, the halfway mark of the slide that began from MXN20.1550 late last November. A note of caution comes from push above the upper Bollinger Band (~MXN20.7960).  Lastly, Colombia is expected to hike its overnight lending rate by 75 bp to 3.75% later today.  



Considering Portfolios In Times Of, Among Others, Inflation...

Marc Chandler

Marc Chandler has been covering the global capital markets for more than 30 years, including stints as the global head of currency strategy for both HSBC and Brown Brothers Harriman. Chandler recently joined Bannockburn Global Forex as a Managing Director and Chief Market Strategist in 2018.

A prolific writer and speaker, Chandler appears regularly in the financial media. He is often quoted in the Financial Times, the Wall Street Journal, Barron’s, Bloomberg, and the Washington Post, among others. Marc also provides his insights and commentary on the markets on the most widely watched financial news channels, including CNBC, Bloomberg TV, CNN, and Fox Business.

Marc’s first book, Making Sense of the Dollar, was published by Bloomberg Press in 2009 and received a Bronze Award from Independent Publishers. Chandler's second book, Political Economy of Tomorrow, was published in February 2017.

Chandler is also an honorary fellow of the Foreign Policy Association and has been named a Business Visionary by Forbes.

Currently, Chandler teaches at New York University Center for Global Affairs, where he is an associate professor. He is also an honorary visiting professor at the Darden School of Business at the University of Virginia.

Though a Chicago native, and lifelong Cubs fan, Chandler currently resides in New York City with his wife, Jeannine, and son, Nathan.