by Marc Chandler
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US yields and the dollar softened after the release of the November CPI figures before the weekend. The data were in line with expectations showing the headline rate accelerated to 6.8% and the core rate to 4.9%. The price action likely reflected positioning rather than a reassessment of the outlook for next week's FOMC meeting. Nearly everyone recognizes the likelihood that the pace of tapering is quickened, and the individual forecasts reflect a more aggressive tightening path than anticipated in September.
With the diverging monetary policy impulses are evident in the shifting two-year interest rate differentials in the US favor, it is increasingly expensive to resist a stronger greenback. A critical part of the backdrop is that market participants feel more comfortable that the Omicron variant may not be as disruptive as feared in Europe and the US (where the current surge is notable in its own right). As a result, those major currencies that tend to do well when risk appetites are strong, namely the dollar bloc and Scandis, are outperforming. At the same time, the traditional funding currencies, the yen, and Swiss franc, were out of favor. The euro falls in the latter camp. A return to working from home, the evaporation of speculation that the BOE would raise rates in the week ahead, and a disappointing October GDP report pinned sterling in its trough.
It is difficult to see the market getting significantly more aggressive about the next year's outlook for the Fed. The futures market is pricing in two hikes entirely and around two-thirds of a third hike. A similar logic has turned us more cautious about the Canadian dollar. There the market has discounted 125 bp of hikes over the next 12-months, which seems too aggressive.
Dollar Index: The Dollar Index has been moving broadly sideways, though it rose for the seventh consecutive week. For the first eight sessions of December, it has traded within the range set on November 30 (~95.50-96.65). The momentum indicators have trended lower but appear to be stabilizing near mid-range. The next big target is slightly below 97.75, which is the high from June-July 2020, and the (61.8%) retracement target of the decline since the March 2020 high near 103.00.
Euro: The single currency briefly traded below the November 30 low (~$1.1235) last Tuesday before short-covering lifted it to the week's high ($1.1355) the following day. It finished the week on a firm note after wobbling initially after the US CPI report. With a brief exception, the euro has chopped between $1.12 and $1.14 since mid-November. The broad sideways movement has seen the momentum indicators correct from over-extended territory. Since November 10, when the US reported the jump in CPI to 6.2%, the US 2-year premium over Germany rose by roughly 18 bp to 1.40%, to set the year's high. It stalled. The consolidative phase may continue ahead of the FOMC meeting. Given what the market is pricing in, it may be difficult for the Fed to get ahead of market expectations for next year when it meets on December 15.
Japanese Yen: After testing support near JPY112.55 to start last week, the dollar recovered to almost JPY114.00 in the middle of the week before moving sideways. It continued to track the movement of US 10-year yields. As yields rose in the first part of the week, the dollar traded higher against the yen, and when yields slipped min the second half of the week, so did the greenback. The MACD has flatlined, while the Slow Stochastic is trending higher. A break of JPY113.00 retargets the lows. On the topside, the JPY114.00-JPY114.30 area offers nearby resistance.
British Pound: Little is going sterling way. Support for the Prime Minister has fallen, and polls show Labour opening its largest lead in years. It has opted for "Plan B," with people returning to working from home, though no new government support was offered. The economic growth slowed more than expected in October, which was before the Covid wave intensified and the Omicron variant was detected. The rate hike that looked so likely in November now seems off the table until at least February. Meanwhile, the fishing row and the attempt to change the Northern Ireland Agreement remain unresolved but causing enough consternation to deter the US from lifting the steel and aluminum tariffs that Trump imposed, let alone discussing a free-trade agreement. Sterling made a marginal new low for the year last week (slightly below $1.3165, which met the (38.2%) retracement objective of the rally from the March 2020 low. The next retracement (50%) is around $1.2830. The momentum indicators are not generating a strong signal presently. It finished last week on a firm note but a move above $1.3300-$1.13350 is needed to signal anything important.
Canadian Dollar: The Canadian dollar's recovery fizzled after the central bank failed to provide fresh encouragement to the market, with 125 bp of hikes priced into the swaps market over the next 12 months. The US dollar, which had rallied and closed above CAD1.28 on December 3 despite the diverging jobs reports, fell nearly CAD1.26 before catching a good bid. Ahead of the weekend, it had recovered to the middle of the week's range (~CAD1.2730). A move above the CAD1.2760 area could signal another run at the highs. The MACD pulled back, but it looks like it may try turning higher, while the Slow Stochastic is still falling. The five-day moving average is set to slip below the 20-day moving average for the first time in a month. Canada reports November CPI figures on December 15, and the year-over-year pace is set to accelerate from the 4.7% 12-month clip seen in October. Inflation is also likely rising even faster this month.
Australian Dollar: The Australian dollar rose almost 2.5% last week to end a five-week slide that shook a nickel from it. The Aussie recovered from the year's low slightly below $0.7000 (December 3), the measuring objective of the potential head and shoulder pattern traced out in H1 21. However, the recovery stalled shy of $0.7190. The initial retracement of the leg lower that began in late October was closer to $0.7210. Still, the anticipation of a strong employment report (December 15) could help underpin the Aussie. Provided it holds above the $0.7120 area, the Australian dollar can work its way higher. The MACD and Slow Stochastic are trending higher.
Mexican Peso: While the Australian dollar was the strongest of the major currencies, the Mexican peso led the emerging market currencies a nearly 2% gain. Last week, Latam provided three of the four strongest emerging market currencies (Colombian peso +1.25%) and the Brazilian real (0.95%). The Thai baht was in third place with a 1.25% gain. Banixco meets on December 16. It is widely expected to hike by another 25 bp. The central bank of Chile meets on December 14 and is expected to hike 125 bp to 4.0%. The last move in October was also for 125 bp. The Colombian central bank meets on December 17. Most anticipate a 50 bp hike to 3.0% after initiating the tightening cycle with a 75 bp move in October. Mexico's central bank appears to be a laggard in this cycle, but the peso's 4.5% loss this year makes it the top performer in the region. The US dollar fell to a new three-week low slightly below MXN20.85 before the weekend. The momentum indicators are trending lower, and the five-day moving average crossed below the 20-day for the first time since mid-November. Initial support is seen in the MXBN20.70-MXN20.75 band.
Chinese Yuan: Chinese officials have delivered verbal warnings and cautioned banks and businesses to adopt good foreign exchange hedging practices and avoid a one-way market. It signaled displeasure as the yuan rose to new three-year highs against the dollar by setting the daily reference rate. It cut reserve requirements ahead of the expected FOMC decision next week to accelerate its tapering and bring forward its first rate hike. The PBOC also raised the reserve requirement for foreign currency deposits. Yet, the yuan rose in all but one session last week and eked a small gain on the week. This month, the dollar's high was set ahead of the weekend near CNY6.3835, but the positive greenback momentum was not sustained. The dollar finished around CNY6.3700. In the grand scheme of things, these are small moves, yet this is where the lines are being drawn. Some observers have argued that state-owned banks in China have operated on behalf of the central bank (stealth intervention). If this is true, one must ask what happened to them now or why is that channel not working? Still, with policy divergence on the PBOC's side, the risk-reward does not seem to favor fighting it now. If the PBOC wants to drive home its message, the dollar needs to rise above CNY6.40. Portfolio inflows and the large trade surplus need to be offset by increased capital outflows if officials want to remove the upside pressure on the currency. That said, if there is an escalation ladder here, officials dominate nearly every rung. In the long game, officials cannot be seen as losing, and if the carrots do not work, the will appears to be there to use the stick.
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