Dollar on front foot as robust U.S. data keep Fed hawks in control

Reuters: The dollar on the front foot on Monday, supported by a strong run of economic data out of the United States that traders bet will keep the Federal Reserve on its monetary policy tightening path for longer than initially expected.

US Dollar on front foot

The greenback advanced broadly in early Asia trade, sending sterling 0.12% lower to $1.2028 and the Aussie falling 0.18% to $0.6866. Against the Japanese yen, the dollar rose 0.14% to 134.32. Trading is likely to be thin on Monday, with U.S. markets closed for Presidents’ Day. A slew of data out of the world’s largest economy in recent weeks pointing to a still-tight labour market, sticky inflation, robust retail sales growth and higher monthly producer prices, have raised market expectations that the U.S. central bank has more to do in taming inflation, and that interest rates would have to go higher. “For the week ahead, the dollar can track higher given the recent run of economic data which supports the narrative of higher-for-longer interest rates,” said Carol Kong, a currency strategist at Commonwealth Bank of Australia (CBA).

Markets are now expecting the Fed funds rate to peak just under 5.3% by July. Hawkish comments from Fed officials have also underpinned the U.S. dollar, as they signalled that interest rates will need to go higher in order to successfully quash inflation. Similarly, two European Central Bank (ECB) policymakers said on Friday that interest rates in the euro zone still have some way to rise, pushing up market pricing for the peak ECB rate. That, however, did little to lift the euro, which was last 0.16% lower at $1.0677. “The hawkish ECB comments aren’t likely to support euro, given the dollar strength,” said Kong. Elsewhere, the U.S. dollar index rose 0.05% to 104.03, and is up nearly 2% for the month so far, keeping it on track for its first monthly gain since last September. The kiwi slipped 0.17% to $0.6232, with eyes on the Reserve Bank of New Zealand’s (RBNZ) interest rate decision on Wednesday.

The RBNZ is expected to scale down its tightening campaign only slightly, with a half-point interest rate hike to 4.75%. “With inflation so high … not staying the course could mean even higher interest rates are required down the track,” said analysts at ANZ. In Asia, focus is on China’s loan prime rate decision on Monday, with markets widely expecting its benchmark lending rates to be kept unchanged at the monthly fixing. “We don’t think there will be any changes made,” said CBA’s Kong. “Our view has been that the (Chinese) government should announce more easing measures to aid the Chinese recovery.” The offshore yuan was last marginally lower at 6.8783 per dollar.

British Pound

Reuters: Sterling dropped to a six-week low against a stronger dollar on Friday, even though January retail sales data showed British shoppers were out in force last month. The pound eased 0.1% against the euro to 89.03 pence , and was 0.4% lower against the dollar at $1.19360 having earlier fallen as far as $1.19150, its weakest since January 6. A stronger dollar was the main factor behind the drop on Friday, as the U.S. currency soared to a six-week high. “There is definitely a strong USD theme being seen at the moment, stemming from yesterday’s stronger PPI numbers which have seen the market now expecting the Fed to maintain its tightening bias for longer,” said Stuart Cole, head macro economist at Equiti Capital.

Data on Friday showed British consumers unexpectedly increased their shopping in January, as sales volumes rose by 0.5% from December for only the second month-on-month increase since August 2021. Economists polled by Reuters had expected a 0.3% fall. “From the prospects of the economy it is good news, as it suggests there is a headwind pushing against the risk of recession,” said Cole. “But for the BoE it may be less welcome news, as buoyant demand makes their task in bringing CPI back to target that much more difficult.” The market is currently pricing in an almost 75% chance of a 25 bp rate hike from the Bank of England at its March meeting.

The pound recorded its biggest daily drop against the single currency in two months on Wednesday when data showed UK consumer price inflation (CPI) cooled to 10.1% last month, the lowest reading since September. Close attention is being paid to developments around British Prime Minister Rishi Sunak’s visit to Northern Ireland as momentum builds towards a deal to revise the Northern Ireland protocol, the trade rules agreed to avoid a hard border with EU member Ireland when Britain left the bloc. Away from Westminster, UK lender Natwest (NWG.L) reported a leap in profit in 2022 on Friday that should have sent its shares soaring. But its results contained a stark warning about the rising interest-rate environment.

South African Rand

Reuters: South Africa’s rand on Friday recouped some losses from the previous session, when President Cyril Ramaphosa defended his decision to appoint a minister of electricity to try to end crippling power cuts. At 15:24 GMT on Friday, the rand traded at 18.0525 against the dollar, 0.7% stronger than its previous close. Ramaphosa’s responses in parliament have done very little to calm market fears, ETM Analytics said in a note. “It is difficult to argue with anyone suggesting that the rand’s performance reflects the country’s mood at the moment.”

Next week’s budget announcement by South Africa’s finance minister could offer clues on the government’s plans to take on a majority of the debt owed by beleaguered utility Eskom. Financial support to struggling state-owned enterprises and crimped growth from erratic power generation will mean more wide budget deficits to come, a Reuters poll found on Friday.

The Top 40 and the broader all-share indexes fell more than 1%. The South African government’s benchmark 2030 bond was weaker in afternoon deals, with the yield up 9 basis points to 10.115%.

World Markets

Reuters: Asian shares got off to a subdued start on Monday as a U.S. holiday made for slow trading ahead of minutes of the last Federal Reserve meeting and a reading on core inflation that could add to the risk of interest rates heading higher for longer. Geopolitical tensions were ever present with North Korea firing more missiles and talk of Russia ramping up attacks in Ukraine before Friday’s one- year anniversary of the invasion. There were reports the White House planned new sanctions on Russia, while Secretary of State Antony Blinken on Saturday warned Beijing of consequences should it provide material support, including weapons, to Moscow. All of which made for a cautious start and MSCI’s broadest index of Asia-Pacific shares outside Japan was largely flat, after sliding 2.2% last week. Japan’s Nikkei dipped 0.2% and South Korea 0.4%. S&P 500 futures eased 0.2%, while Nasdaq futures lost 0.3%. The S&P touched a two-week low on Friday as a run of strong U.S. economic news suggested the Fed might have more to do on interest rates even after hiking a huge 450 basis points in 11 months.

“It’s the most aggressive Fed tightening in decades and U.S. retail sales are at all-time highs; unemployment at 43-year lows; payrolls up over 500k in January and CPI/PPI inflation reaccelerating,” noted analysts at BofA. “That’s a Fed mission very much unaccomplished.” They warned the repeated failure of the S&P 500 to break resistance at 4,200, could unleash a retreat to 3,800 by March 8. Markets have steadily lifted the expected peak for Fed funds to 5.28%, while sharply scaling back rate cuts for later this year and next. Minutes of the Fed’s last meeting due on Wednesday should add colour on the deliberations, though they have been superseded somewhat by barnstorming numbers on January payrolls and retail sales. The latter means figures on U.S. personal consumption expenditures (PCE) due this Friday are expected to show a 1.3% jump in January, more than recovering from weakness in the prior two months. The Fed’s favoured inflation indicators, the core PCE index, is seen rising 0.4%, the biggest gain in five months, while the annual pace may have slowed just a fraction to 4.3%. There are also at least five Fed presidents speaking this week, to provide running commentary.

Earnings season continues this week with major retailers Walmart and Home Depot set to offer updates on the health of the consumer. Other companies reporting include chip company Nvidia , COVID-19 vaccine maker Moderna and e-commerce store front eBay. The prospect of more Fed hikes has lifted Treasury yields and generally supported the dollar, which hit a six-week top on a basket of currencies last week. The euro was stuck at $1.0676, having touched a six-week low of $1.0613 on Friday, while the dollar was just off a two-month top on the yen at 134.34. Investors are anxiously awaiting Friday’s testimony from the newly nominated head of the Bank of Japan, and his thinking on the future of yield curve control (YCC) and super-easy policy. Any hint of an early end to YCC could see yields spike globally and send the yen surging, so analysts assume Kazuo Ueda will be careful not to spook markets. Higher yields and a firmer dollar have not been good for gold, which was struggling at $1,837 an ounce and not far from a five-week low of $1,807. Oil prices were trying to steady after shedding around 4% last week amid signs of ample supply and concerns over future demand. Brent edged up 14 cents to $83.14 a barrel, while U.S. crude rose 15 cents to $76.49.

Published by the Mercury Team on 20 February 2023

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