Dollar Bears Will Have to Be Patient

Overview:

Last night's release of the February FOMC minutes provided little comfort to dollar bears who were looking for signs that the Fed was increasingly buying into the disinflation/slowdown narrative. Yet the subsequent rise in US yields and strengthening of the dollar has been quite muted. It's a quiet day for data in the G10 space, but EM FX is interesting.

USD: FOMC minutes can keep the dollar supported

Despite Federal Reserve Chair Jerome Powell sounding quite relaxed at the 1 February press conference and declaring that the 'disinflation process has started', the minutes of that meeting were largely hawkish. The consensus agreed that further rate increases were needed, and that inflation remained unacceptably high.

There were no hints of a pause and very little to divert market pricing of three more 25bp hikes from the Fed over the March, May, and June meetings.

This backdrop can keep the dollar supported in the near term and potentially into the 22 March FOMC meeting, where the debate will focus on whether the Fed Dot Plots will retain a median view of a 100bp easing cycle in 2024.

For dollar bears, both activity and price data will have to soften over the coming weeks to make an impact on an otherwise hawkish Fed.

The next set of meaningful US data is today (midnight) core PCE data for January - but even that is likely to see the core month-on-month reading rising to 0.4% from 0.3%.

And for today, the market should not take too much notice of revisions to the strong fourth quarter GDP data - driven by an inventory build and weaker imports.

My first quarter game plan is that DXY does not hold onto these gains. But for the time being, it looks like DXY wants to probe higher to the 105.00 area with outside risks this quarter to the 106.00/106.50 area.

EUR: PMIs drowned out by hawkish Fed

The better run of European PMIs earlier this week has rather been drowned out by the hawkish Fed. And actually, the German Ifo proved something of a reality check, where the current assessment of business conditions continued to deteriorate.

The good news for EUR/USD is that the re-pricing of the European Central Bank cycle has nearly matched that of the Fed - meaning that the two-year EUR:USD swap differential has not substantially widened in favour of the dollar. In fact, it was interesting to read in the FOMC minutes - under the market developments section - that the Fed felt it was interest rate differentials and the improved Rest of World growth prospects that had been weighing on the dollar into January.

For the short term, EUR/USD remains soggy, and it is hard to rule out a break under 1.0600 towards the 1.05 area. My game plan remains that 1.04/1.05 could now be some of the lowest EUR/USD levels of the year - but it feels like EUR/USD could trade on the offered side for a few weeks yet.

GBP: BoE's Mann speaks today

Sterling is just about holding onto Tuesday's gains when strong PMI data triggered a sharp re-pricing of the Bank of England curve.

Markets now price a further 50bp of BoE hikes by June - taking the Bank Rate to 4.50% - and the policy rate being kept there until early 2024.

In addition I think EUR/GBP probably traces out a 0.8750-0.9000 range for the first half of the year, while cable should find support under 1.20. Also - whisper it. Sterling offers quite attractive risk-adjusted yields in the G10 space.

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