Dollar Remains Soft Post-FOMC, But Losses Limited Today

  • The Fed delivered an extremely dovish hold; US rates have responded accordingly
  • Today, some of the delayed US data will start to trickle out
  • Eurozone Q4 GDP data was reported; Germany reported simply awful December retail sales
  • China reported official January PMI
  • The Fed gave EM a gift yesterday with its dovish messaging
  • Colombia central bank is expected to keep rates steady at 4.25%

The dollar is broadly weaker against the majors in the wake of the dovish FOMC decision.  However, today’s losses have so far been very limited.  Aussie and yen are outperforming, while the euro and Loonie are underperforming.  EM currencies are broadly firmer.  IDR and CLP are outperforming, while MXN and HUF are underperforming.  MSCI Asia Pacific was up 1.2%, with the Nikkei rising 1.1%.  MSCI EM is up 1.1% so far today, with the Shanghai Composite rising 0.4%.  Euro Stoxx 600 is flat near midday, while US equity futures are pointing to a flat open.  10-year UST yields are down 2 bp at 2.66%.  Commodity prices are mostly higher, with Brent oil up 0.3%, copper up 0.5%, and gold up 0.3%.

The Fed delivered an extremely dovish hold.  For an in-depth look at the FOMC decision, please see our recent piece (99 Problems But The Fed Ain’t One).  We were shocked at how dovish Powell was, especially since equity markets had calmed from the Fed’s “patience” and “flexibility” message since the December FOMC meeting.

US rates have responded accordingly.  The 2-year yield has sunk back below 2.50% to levels not seen since January 7, while the 10-year yield has fallen to 2.66%.  The implied yield on the January 2020 Fed Funds futures contract has fallen to 2.38%, also the lowest since January 7.  That means the market is back to pricing in a potential rate cut this year.  Lastly, WIRP shows odds of a May or June hike dropping sharply to 2% from near 20% before the FOMC meeting.

We fear that the Fed has given in too much to the market and its tantrums.  To put it bluntly, recent Fed messaging leaves a lot to be desired.  As such, we see the likelihood of further volatility and swings in market sentiment if this current round of Fed messaging turns out to be too dovish, as we suspect.  For now, however, markets have been given the green light to buy equities and sell the dollar.

How far can this trade go?  Much will depend on the data.  While one data point won’t change the market’s ultra-dovish take on the Fed, this Friday’s jobs data takes on even greater importance.  If we get a weak number, then this equity rally and dollar sell-off should intensify.  If we get a strong number, we think we should see some profit-taking at the very least.

Today, some of the delayed US data will start to trickle out.  US reports January Challenger job cuts, Q4 employment cost index, weekly jobless claims, January Chicago PMI, November new home sales, and TIC data.  None of these are market-moving, though Chicago PMI (61.5 expected) could set the table for tomorrow’s ISM manufacturing PMI (54.0 expected).

Eurozone Q4 GDP data was reported.  Growth slowed as expected to 1.2% y/y from 1.6% in Q3.  France reported yesterday, with growth slowing as expected to 0.9% y/y from 1.4% in Q3.  Spain (2.4% y/y) and Italy (0.1% y/y) reported earlier today.  Of note, Italy’s GDP contracted q/q for the second straight quarter.  Tomorrow, final January PMI readings will be reported.

Germany reported simply awful December retail sales.  Sales contracted -4.3% m/m vs. -0.6% expected, dragging the y/y down to -2.1% y/y from a revised +1.9% (was +1.1%) in November.  Yesterday, Germany reported softer than expected January CPI readings.  It’s clear that the Q3 slowdown was not temporary and it has intensified in Q4 and Q1.

Because of the weak eurozone data, the euro’s gains have been tempered today.  After trading above $1.15 earlier today, the single currency is now at the lows of the day.  As bad as things may be in the US, it would seem even worse in Europe.  Likewise, sterling is having trouble extending its rally due to ongoing Brexit uncertainty.  Indeed, dollar bears should be disappointed that the post-FOMC sell-off has not really been extended today.

China reported official January PMI.  Manufacturing PMI rose a tick to 49.5, while non-manufacturing jumped to 54.7 from 53.8 in December.  Caixin PMI will be reported tonight, which is expected to drop a tick to 49.67.  Despite the positive impact of stimulus measures already taken, we believe there are still downside risks to the economy until the trade war with the US has been resolved.

US-China trade talks will wrap up today.  While some progress may be reported, we think the two sides remain far apart in the areas of intellectual property and structural reforms.  As such, we think we must get closer to the March 1 deadline when higher US tariffs kick in before the two sides make a face-saving deal.

The Fed gave EM a gift yesterday with its dovish messaging.  The prospect of steady US rates is certainly good news for EM FX, but this is offset by the backdrop of slower global growth.  As such, EM bulls should temper their enthusiasm about the asset class in the coming weeks.

Colombia central bank is expected to keep rates steady at 4.25%.  CPI rose 3.2% y/y in December, well within the 2-4% target range.  The bank has not moved since the last 25 bp cut last April.  Markets see the first 25 bp hike in Q2, followed by one each in Q3 and Q4.  This strikes us as too aggressive, but much will depend on global factors this year.