FX Daily: USD in the driver’s seat

Cannot shake off Fed hike worries
Philip Wee16 Nov 2021
    Photo credit: Unsplash Photo

    DXY is eyeing 96.1 (50% Fibonacci retracement level) after closing above 94.5 (38.2% Fibo level) last week. The three major US stock indices – Dow, S&P500 and Nasdaq Composite – started Monday higher around 0.3-0.4% ahead of earnings reports by large US retailer and US President Joe Biden signing the USD1 trillion bipartisan infrastructure plan. However, US stocks ended the session flat as inflation fears lifted the US 10-year treasury yield by 5.3 bps to 1.615%, its highest level since 25 October. Former Fed President William Dudley (New York) and Jeffrey Lacker (Richmond) reckoned interest rates might need to increase to 3-4% to rein in inflation. This was well above the trajectory implied by Fed Funds Futures i.e., 0.64%, 1.37% and 1.79% towards the end of 2022, 2023 and 2024 respectively. However, the 5-year breakeven rate increased to 3.19%, well above the 2.91% high in March 2005. Back then, the Fed Funds Rate rose from 1% to 5.25% between mid-2004 and mid-2006. 

    In any case, past Fed hike cycles have coincided with rising US capacity utilization. Hence, we need to see capacity utilization rise again today to 75.9 (consensus) in October after 4 months of declines. Given the recent fall in consumer sentiment and confidence, October’s advance retail sales (1.5% MoM consensus vs 0.7% previous) will gauge the impact on consumer spending from higher inflation.

    EUR depreciated to 1.1368 after the critical support level at 1.1450 broke on monetary policy divergences between the Fed and the European Central Bank. ECB President Christine Lagarde continued to push back calls for rate hikes in 2022 but kept the door open for one in 2023. Lagarde will speak again on Wednesday and Friday and ECB Chief Economist Philip Lane will join on Thursday in pushing the ECB’s dovish stance. Even so, Germany might no longer tolerate the ECB’s transitory inflation stance. Deutsche Bank CEO has called on central banks to tighten monetary policy sooner rather than later against rising inflation. He is likely to be joined this Friday by outgoing Bundesbank President Jens Weidmann, a long-time critic of the ECB’s loose monetary policy. When he announced his decision to step down on 20 October, Weidmann told Bundesbank staff “not to lose sight of prospective inflationary dangers”. Weidmann flagged 5% inflation in July; CPI inflation has since risen to 4.1% YoY in October from 2.2%. Weidmann also warned that the ECB cannot protect governments from higher borrowing costs. Since late October, the 10-year spread between Italian and German yields increased to 115-130 bps from 100-110 bps in 3Q. 

    GBP was unchanged at around 1.34 for a third session with a downside bias. Bank of England Governor Andrew Bailey told the UK House of Commons Treasury Committee that the decision not to hike rates at the last meeting on 4 November was a close one. Although the BOE was very uncomfortable with above-target inflation, the monetary committee decided that it was prudent to assess the impact on the 1 million workers on the government’s furlough scheme that ended on 30 September. Hence, pay attention to today’s claimant count (unemployment) rate to see if it rises in October after six months of declines from 6.4% to 5.2% in September.

    Philip Wee

    Senior FX Strategist - G3 & Asia
    [email protected]

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