Weekly analysis

Central bank policy in Japan and the United States captivated headlines this week but the dollar’s long-term position is under increasing threat from the erosion of real interest rates by inflation.

The USD/JPY rose moderately but remained below resistance at 109.30, as offsetting dovish outlooks from the Bank of Japan (BOJ) and the Federal Reserve left the pair without motive.
In Japan, the BOJ kept monetary policy unchanged as universally anticipated. Governor Haruhiko Kuroda said he is prepared to extend the pandemic relief programs beyond the September deadline. He did not expect inflation to reach its 2% target by the time of his retirement in early 2023.

Rising COVID-19 cases and a slow vaccination rollout have brought on a third state of emergency in Tokyo, Osaka and two other prefectures, inhibiting prospects for an economic recovery, though the BOJ did raise its quarterly growth forecast. The USD/JPY saw its largest one-day gain of the week after the BOJ meeting on Tuesday.

In the US, the central bank also left policy unaltered. Fed Chair Jerome Powell refused to speculate when or under what conditions the governors might reduce the $120 billion of monthly asset purchases that have pinned the short end of the Treasury yield curve.

The US economy expanded at a 6.4% annualized rate in the first quarter, slightly more than predicted. Initial Jobless Claims dropped to 553,000 in the latest week, the lowest level of the pandemic era. Inflation was stronger than projected in March with the headline Personal Consumption Expenditure Price Index (PCE) rising 2.3% on the year, outstripping the 1.6% forecast by a wide margin. Core PCE was 1.8% as expected.
The current bout of US inflation is temporary and largely due to the base effect from the steep decline in prices last year during the lockdown, as the Fed has asserted.

But behind the immediate rationale, fast-rising commodity prices, consumer demand and massive spending by the Federal government may be altering the general price structure.

If the basal inflation rate in the US does increase it will undermine the advantage that rising Treasury yields have provided the dollar this year.
In Japan, Retail Trade (sales) rose 5.2% for the year in March, the highest increase since last October and a strong reversal of April’s 1.5% decline. Industrial Production was also much more vibrant than forecast at 4% in March on a 0.0% forecast and 2% decrease in February.

Inflation was again a cause for BOJ concern as annual Tokyo CPI fell 0.6% in April, three times the -0.2% forecast.
The USD/JPY has been propelled this year by the increase in US interest rates and that advantage will continue to underpin the USD/JPY this week

Though the long-term dollar benefit of higher Treasury yields is under potential threat as rising US inflation reduces the currency's real interest rate margin, for the moment the trade impact on the USD/JPY is limited.

The 10-year Treasury yield has added over 70 basis points since the New Year and 10 this week. In the past month, US CPI has jumped from 1.7% to 2.6% and it is expected to rise further as the base index differential over last year increases.

American economic growth is easily outpacing Japan’s and the pandemic status in the US adds to the dollar’s advantage.

Treasury rates will rise despite the Feds obvious reluctance to sanction such, but the key for yields is inflation. Whether the increase in US inflation is transitory or not will not be known for several months. 

In December, European inflation reached a record high, up 5% over the year before. The US Federal Reserve has pointed to more aggressive measures to contain inflation.
There were a few surprises in the first week of 2022 for the EUR/USD pair, but it remained largely unchanged. Among the biggest shocks was when the American central bank released minutes of its December meeting, which showed policymakers were considering cutting their bonds.

According to the Fed, if the current improvements in the labor market persist, the conditions for a rate hike are likely to be met relatively soon. Next came the December nonfarm payroll report. The US created 199,000 new jobs in December, half of the market expected. On the other hand, the unemployment rate improved and fell to 3.9%. While the numbers were not impressive, market participants still considered them acceptable.
In December, the euro area’s inflation rate grew by 5%, a new record high after the last month at 4.9%. Also, German consumer prices rose 5.3% compared to the forecast of 5.2%. Inflation is pushing the European Central Bank to reconsider its conservative stance.

The hawkish FOMC minutes from Wednesday have so far proven not hawkish enough to trigger more than the one-off adjustment in the US dollar that seems to be fading quickly as we look toward today’s US December jobs report (more on that below). At the same time, risk sentiment remains broadly stable, speculative- and highly interest rate-sensitive US equities generally aside. This is intriguing as the implication is that as long as US yields and Fed expectations are able to march higher without spooking asset markets, the US dollar may fail to rally and could even weaken, though we need to get EURUSD up out of the sub-1.1400 range for a more interesting signal on that front.

Additionally, for the cycle we have to wonder if the Fed is the cart or the horse here, something that it may itself not understand, as it has already shared its lack of understanding on how its balance sheet affects the economy (though we seem to have a good idea how it affects financial markets – and the standing repo facility of some $1.5 trillion offers the Fed quite a large safety valve for how tapering and possibly a quick move to reducing the balance sheet will affect treasury market and asset market dynamics). Put another way, the economy will pull the Fed this way or that on interest rates more than Fed policy will impact the data, as policy moves only hit with a significant lag of 9-12 months.

Speaking of data, the next step for the USD and market is the December jobs report later today, with the market likely leaning now for quite a strong figure, given the six-month high ADP December private payrolls change number released on Wednesday at +807k. That puts the two-month total for the Nov-Dec ADP private payrolls change at over 1.3 million, while the official BLS nonfarm payrolls change total was a tepid +210k in November. Today’s December tally is expected to show about +450k of payrolls growths. But note: the “two-month net revision” number bears watching, as the US Bureau of Labor Statistics has had difficulty collecting data over the last year and has consistently underestimated the pace of jobs growth, with every month since July seeing growing positive revisions, from a +119k revision in August to a +235k revision in November.

After the economy slumped in Q3 due to a COVID-related lockdown, incoming data show a solid rebound from Q4 last year, as reflected in employment and retail spending data. Meanwhile, inflation pressures have also intensified, as the Q4 headline CPI firmed to 5.9% year-over-year with an acceleration also in underlying inflation as well as non-tradables inflation.”
Against this backdrop, we expect the RBNZ to continue its shift toward a less accommodative monetary policy stance at next week's policy meeting. At the same time, we favor a more measured 25 bps rate hike as opposed to a larger 50 bps increase, particularly after the central bank governor said late last year the RBNZ would take a “cautious” approach to tightening by moving in 25 bps increments “for now. 

As the EUR/USD currency pair hovered around 1.1300 for a fourth straight week, modest gains were posted before the weekend, but no future is apparent. During this time of year, volatility is hit hard by the vacation depression, and the decline towards the end of the year can lead to odd pricing.

The US Federal Reserve and European Central Bank announced their monetary policy decisions last week and released new inflation and growth forecasts. As the markets waited for the release of the results, both central banks responded to the gradual decline in prices, which did not result in any directional movements.

Beginning in January 2022, the Federal Reserve will increase its monthly bond purchases to $ 30 billion from $ 15 billion previously. As a result, the central bank will stop buying government bonds and mortgage-backed securities every month, which means a faster rate hike. The Fed’s scatter chart currently predicts three rate hikes in 2022 and three more in 2023.

Forecasts for 2021 and 2022 have been raised to 5.6% and 2.6%, respectively, from 4.2% and 2.2%. As a result, GDP will grow by 4% in 2022, up from 3.8% in September, while the economy is projected to grow by 0.2% in 2023, up from 2.5 % in September. 

In contrast, the ECB has confirmed that it will complete its pandemic emergency program in March 2022, as expected. Moreover, the governing council decided to increase its bond purchase program to €40 billion per month in the second quarter of 2022 and to €30 billion via PEPP in the third quarter.

Recent macroeconomic data confirmed inflation has reached an overheated level, and economic growth has slowed. The US PPI rose 9.6% year-over-year in November, while retail sales rose a modest 0.3%. Germany’s IFO business climate decreased to 94.7 in December, while the EU CPI rose 2.6% year-over-year. 

Trade accordingly with your risk.

At the week, Olli Rehn and Ignazio Visco of the ECB governing council tried to calm ECB rate hike expectations, with Rehn suggesting that a rate hike is not around the corner, but has gotten nearer. He also said that policy rates don’t impact energy prices and that wage rises have been subdued. The Banca d’Italia head Visco likewise noted the lack of pressure on wages. Lagarde is set to speak later today after she also tried to weigh in with dovish rhetoric last Thursday.
EUR/USD has suffered heavy losses late Friday and started the new week on the back foot. The souring market mood is making it difficult for the shared currency to find demand and the pair is likely to extend its slide unless risk flows return. The negative shift witnessed in market sentiment helped the greenback find demand ahead of the weekend and the US Dollar Index (DXY) managed to register weekly gains. 

Later in the session, European Central Bank President Christine Lagarde will deliver a speech. In an interview with Redaktionsnetzwerk Deutschland last week, Lagarde argued that raising rates would not solve the inflation problem and said that they don't want to "choke off the recovery." In case Lagarde sounds less hawkish than she did at the ECB's press conference on February 7, the pair could face additional bearish pressure.
The near-term technical outlook suggests that sellers dominate EUR/USD's action to start the week. The Relative Strength Index (RSI) indicator on the four-hour chart is now below 40 and the pair is trading below the 100-period. 

The weekly forecast for the USD/JPY remains mixed as the fundamental scenario is bullish bias, while technically, the retracement seems due after a bull run.
US credit markets and the Federal Reserve System hold USD/JPY hostage. US inflation cannot be contained in the short term unless US Treasury bonds rise. The Federal Reserve does not need to raise interest rates, as the credit market will do all the work
In contrast, the Bank of Japan is moving in the opposite direction. Prime Minister Fumio Kishida has pledged fiscal and monetary policies to stimulate the Japanese economy. A new budget for additional government spending will be proposed, and the Bank of Japan may increase purchases on the credit market. Japanese 10-year government bonds yielded 0.056% last week and 0.051% last week, largely flat.

Despite peaking at 1.764% on March 31, the US government bond yields have risen multiple times this year. The Fed may be willing to encourage higher Treasury and trading rates, but credit traders want proof, not rhetoric, after many false starts. 

Japanese data were mixed. Household spending declined from -1.9% to -0.6% in October, but it remains the third consecutive decline and the fourth over the past six months. In October, the rise in wages was 0.2%, which is within the forecast range of 0.7% and in line with September.  Producer prices rose by 0.6% month-over-month and 9% year-over-year in November, faster-than-expected. Japan is facing a deflationary environment.

Likewise, American data was different. In October, the trade deficit improved, and the number of initial jobless claims fell to 184,000, the lowest level in 52 years. In November, consumer inflation is expected to reach 6.8% in the headline, a 39-year record, and 4.9% in the core, also a three-year record, following 6.2% and 4.6% in October. After a 1.2% CPI increase in November last year, inflation jumped 5.6% last month, the fastest in 69 years.
The US Federal Reserve and Bank of Japan (BOJ), which meet on Wednesday and Thursday, will hold back and order markets. Expect quiet trading after the Fed announces and tightens rates at 2:00 pm ET. US interest rate hikes are almost certainly due to rising consumer prices and concerns expressed by the Fed itself.

Due to the differences in concerns and interest rate policies between the Federal Reserve and the Bank of Japan, the USD/JPY pair is expected to rise. The Fed’s willingness to take inflation seriously will determine how quickly and how far this goes. 

The USD/JPY price fell below the 20-day and 50-day SMAs while the volume is inclining. Such a condition usually forecasts a bearish scenario. On the downside, the 111.80 – 112.00 band may provide strong support amid the 100-day moving average and the round number effect.
On the upside, 114.00 remains a stiff resistance to break ahead of swing highs at 114.75 and 115.50. The path of least resistance lies on the downside. 

Trade accordingly with your risk.

The US dollar continues to blast higher with brutal momentum as key levels give way in major USD pairs. The momentum is impressive and could be set to continue if longer US yields also become unanchored and rise together with Fed rate hike expectations. But other central banks will be in focus next week as we look for whether hawkish surprises can offer any counterpoint to the strongest weekly surge in the US dollar since the panic phase of the pandemic outbreak.

The US dollar continues to track Fed rate hike expectations higher, with the USD back on an aggressive strengthening path today from the get-go, perhaps as long US treasury yields are back higher  an un-anchoring of long US yields and the yield curve steepening somewhat from here could take the USD move farther than if the long end of the US yield curve remains tame. In my portion of our quarterly outlook that was released this week and written some two weeks ago, Forecasted that the US dollar “could prove resilient for some of the early part of 2022 against the usual pro-cyclical currencies”, as assumed that risk sentiment could crater for a n extended period this quarter as asset markets continue to suffer under the weight of the Fed’s hawkish shift. Assessed that a “broad, aggravated extension of the [USD] strength we saw in late 2021” is unlikely on the assumption that those longer US treasury yields remain anchored. That is an important caveat, and long US treasury yields are creeping back toward the cycle highs. A quick move here significantly above 2.0% for the US 10-year treasury benchmark together with even higher Fed expectations could extend this USD move higher than I would have thought likely when writing the outlook or even after the FOMC meeting. If long yields stay tame, I have a hard time seeing the short end Fed expectations extending much further now that we have effectively already priced in five rate hikes for this calendar year.

Another important factor as 2022 wears on is that the US Federal Reserve is not the only central bank in town and if the Fed is moving in determined fashion to get ahead of inflation, we can expect other central banks to do the same  eventually even the ECB, especially as global prices are generally in US dollars and the price levels could rise even faster elsewhere. 

The RBA is certain to end its QE purchases as it has pinned the February meeting for a review of this stale policy after the embarrassing breaking of its prior commitment to the 3-year yield control. And after the hefty Q4 CPI surprise, together with ongoing inflationary risks that are aggravated by a weak currency, it is time for the RBA to wax far more hawkish, even though it has focused a considerable portion of its rhetoric on needing to see rising wage levels before raising rates. The market is looking for rate liftoff in April or May – this looks tardy and could be brought forward.
The AUDUSD has collapsed through 0.7000 and below the December pivot low just south of that level after the significant repricing of Fed expectations higher this week. Next week, we have the chance to witness the degree to which signals from other central banks are able to counter the USD strength, for example, if the RBA waxes far more hawkish than expected. This 0.7000 area is a major one and argue the last-ditch bull/bear line as we watch how the pair treats the RBA developments and the status of the USD rally next week. The next major downside area is perhaps the pre-pandemic major support zone near 0.6675.

The most consistent trending pair in G10 FX of late has been the slide in EURCHF, which has even slipped below the prior six-plus-year low near 1.0500 over the last week. Remarkably, the pair has maintained its consistent ride lower through some remarkable jolts in the background, including the more hawkish shift from the Fed and the omicron news. This may suggest that the move is not being driven by strong speculative flows  which might have shown significant volatility in line with other currency pairs recently, but rather by consistent flows as the Swiss National Bank has apparently stepped away from the assumed stout defense of the 1.0500 level. The last two weeks of sight deposit data have shown no growth, no signs that the SNB is leaning against this move after doing so the prior four weeks. Also, when inflation fears dominate as they have at times recently, CHF strength is an easy way to avoid importing inflation without rocking the boat with monetary policy signals, while CHF strength is also a natural safe haven play when volatility spikes as it has in recent weeks. The consistent trend may be set to extend here, with parity in EURCHF a natural target.

EURCHF has weakened steadily since mid September in line with the weakening in EURUSD, but far more steadily than the latter, as this trend has managed to sustain through recent volatility elsewhere and shifting focus. The technical situation is without remarkable variation and there are no signs that the SNB is leaning against the move of late. 

The USDCAD pair has gone far and fast to the downside since the crude oil market recovered swiftly from its December post-omicron breakout nadir and is now interacting with the psychologically significant 1.2500 area that slow happens to also be the 200-day moving average. Coming up next for the two currencies are signals from their respective central banks, with a hawkish raising of the bar from the Fed likely requiring, for example, calling an early end to QE already at the Jan 26 meeting and possibly indicating that “larger than 25 basis point” hike increments are under consideration.  The Fed is priced to hike to about 1.0% through the December meeting, depending on the barometer. The pricing for the Bank of Canada is less reliable, but it is certainly priced to lead the Fed in hiking this year by around two hikes even if the spread for 2-year yields between the two countries has been relatively flat for over a month, so little new has been priced in on a relative basis recently. On that account, the move lower in USDCAD looks a bit over-extended without new signals from respective central banks. Other factors influencing the exchange rate will include whether oil continues to march to new highs or corrects and risk sentiment, where I suspect extended weakness will begin to offer more safe haven support for the US dollar if long US yields are also on the rise.

The decision to reappoint Powell was made easier by Quarles stepping down from the Fed Board of Governors ahead of schedule after his position of Fed Vice Chair for banking supervision ended in October. It allows Lael Brainard, who the progressives had favored for Fed chair, to step into that vice-chair role and roll back some of the changes introduced by Quarles without the awkwardness of him sitting across the table.
This decision also removes uncertainty with Powell’s current term ending in February. Had there been any delay in appointing a new Chair due to a lack of political support this could have caused significant financial market nervousness, particularly if we are right and the economy is soaring, inflation is above 6% and the Fed is still stimulating the economy with QE.
The Fed will still taper, and will likely hike in 2022 and the rates market will remains in a state of anticipation for tighter policy and a higher rates environment generally.

Moreover, with two vacancies on the Fed Board of Governors now that Quarles is departing, Biden has the opportunity to shape the Fed further to ensure that monetary policy is truly focused on achieving the “broad-based and inclusive” goals as set out in the updated Fed’s 2020 policy framework. 

In US treasuries, this has mean a sharp drop along the entire US yield curve, giving the euro and the yen a strong boost, as the euro in particular was headed south and fast on the policy divergence theme of the ECB seen likely to maintain zero rates and even some level of QE out over the horizon while the market had priced in three full Fed rate hikes by the end of next year before this sudden reversal. On the weak side, while the US dollar has fallen within the G3 and is approximately flat against sterling, the smaller currencies are sharply lower against all of the above, and EM.