September 09, 2022 | 13:43
Long to Reign Over US
Is King Dollar finally close to a top? After bottoming out in the spring of 2021, the U.S. dollar has risen by nearly 20% to a 20-year high on a trade-weighted basis against a basket of seven other major currencies. That prolonged bout of strength was mostly accompanied by persistent gains in commodity prices as well—at least up until the past few months. Combined, a strong dollar and strong commodity prices have acted as a powerful one-two punch for inflationary forces in many overseas economies. But a broad reversal in resource prices (aside from European natural gas, of course) has at least taken some edge off inflation pressures. And, now, there are some indications that the dollar’s long rocket ride may be nearing a crest as well.
First, the ECB signalled that it had finally truly joined the inflation fight with this week’s aggressive 75 bp rate hike. While hardly surprising, the move marked a notable step up for a central bank that had dragged its heels on rates, and only began to hike in July. Prior to that belated step, we had the odd combination of 9% inflation and zero interest rates, pretty much the definition of “behind the curve”. As well, press reports suggest that the ECB will begin discussions on reducing its balance sheet as soon as next month. The hawkish turn by the ECB has finally stabilized the euro at around the parity mark. Recall that the currency was north of US$1.20 as recently as 15 months ago.
Next, Japanese authorities are finally beginning to signal some unease with the relentless drop in the yen. The dollar pushed up to almost ¥145 this week, its strongest level since the summer of 1998—the depths of the Asian financial crisis. Little more than six months ago, or just prior to the Fed’s initial rate hike, the exchange rate was still dancing around ¥115. That 20% depreciation of the yen in half a year has nudged up Japan’s headline inflation rate to 2.6%. Yet, until recently, the Bank of Japan has been steadfast in its dovishness, pushing back on any talk of rate hikes. The latest surge in the dollar seems to have hit a nerve, however, with officials finally murmuring concern. BoJ Governor Kuroda, for one, intoned that “sudden moves in foreign exchange rates are undesirable”. While not exactly earth-shaking, the modest verbal intervention is a hint that the top may be nearing for the dollar.
The U.K. certainly had a lot more news to focus on this week beyond the pound, between a new Prime Minister and the passing of the monarch. Still, Sterling’s dip to below $1.15, its lowest ebb since the record dive in early 1985, was notable. The currency bounced back towards $1.16 on a broad U.S. dollar pullback on Friday but is still down 14% since the start of the year (a bit of a deeper drop than the 11% sag in the euro over the same period). PM Truss’ huge energy price relief package, weighing in at potentially 4% of GDP, rattled the pound. While there was some talk that it would prompt an even more aggressive Bank of England rate-hike campaign, that’s not at all obviously the case. The huge dollop of borrowing will simply shield households from an even more dire outcome, and can’t be viewed as traditional “stimulus”. Still, with headline inflation already raging at more than 10%, there’s plenty of reason to believe that the BoE will remain aggressive in the months to come and could easily match the Fed’s terminal rate.
The Australian dollar also found a touch of support, nudging back above 68 cents. Unlike many of the other majors, the Aussie is down only moderately this year (about 6%) and is only back to around pre-pandemic levels. Australia’s heavy commodity weight has offered some economic support, partly shielding its currency. However, China’s soggy trade statistics for August point to a challenging export outlook. Even so, after a delayed start, the RBA has kicked its tightening campaign into second gear with four consecutive months of 50 bp hikes. Unlike many other central banks, the RBA meets monthly, so it has managed to make up for lost time with its rapid series of hikes. The cumulative 225 bps of hikes this year matches the Fed and the RBNZ.
The most aggressive hiker of them all this year, at least among the advanced world central banks, was back in action this week. The Bank of Canada’s 75 bp hike left it with both the biggest cumulative rate hike this year (300 bps) and the highest overnight policy rate (3.25%). While the latest step was precisely in line with expectations, the verbiage in the accompanying statement was moderately on the hawkish side. Swatting away talk that this could be the last hike, the Bank bluntly stated that there was still a need for further moves. There was also commentary that “we will be assessing how much higher interest rates need to go”. Suggesting that the end may be coming into view, the August jobs report landed with all the grace of an overfed hippo—replete with a third straight heavy job loss and a hefty 0.5 percentage point upswing in the unemployment rate.
The Bank of Canada’s challenge was clear to see in the messy jobs release. Even amid a sustained retreat in employment over the summer, wage pressures continue to mount amid a still-tight market. Average hourly wages rose two ticks to 5.4% y/y, and other measures of labour compensation have also moved into this zone. Productivity is doing little to dull the inflation impact; although output per hour nudged up in Q2, it’s still down from pre-pandemic levels. As a result, unit labour costs have risen at a steamy 6.6% y/y in the private sector. Meantime, public sector wages are starting to stir, with the largest B.C. union securing a three-year deal of well into double digits. (In fairness, even if inflation somehow miraculously fades to around 2% over the next two years, the big burst this year will leave the three-year price increase at above 11%.)
Thus, even with a string of job declines over the summer, we still look for the Bank of Canada to hike by a further 50 bps by the end of the year (leaning to all of that arriving in the October meeting). That’s up 25 bps from our prior view, and pretty much in line with current market pricing, as it happens. The ongoing “need” (BoC’s word) for further rate hikes meant that the dollar barely blinked at the clunker of a jobs report—the loonie managed to edge higher this week, even with crude skidding to around $82 (ending closer to $86). As a result, the Canadian dollar is now down only about 2% versus the high-flying greenback since the start of 2022 and is nearing all-time highs against the pound, for one. This relative firmness in the currency has somewhat shielded Canada from the harshest inflation gales seen in much of the rest of the world.
Overall, it may be too early to call a peak on the U.S. dollar. But, it’s also clear that the Fed is by no means any kind of outlier on the tightening trail, with most other central banks in the club or catching up. Looking ahead, next week’s big release is the U.S. August CPI, which could both lock in a 75 bp move by the Fed later this month (Sep. 21) but also determine the near-term fate of the dollar. The consensus looks for the big drop in gasoline prices to clip headline prices by 0.1%, which will shave the headline rate four ticks to 8.1%, down a full point from June’s peak. However, core inflation will increasingly dominate the conversation, and underlying prices are expected to rise 0.3%, lifting the annual pace to 6.0%. (We are two ticks higher on both headline and core measures, for the record.) While no doubt still beyond problematic levels, that’s probably not strong enough to power the dollar, not with European inflation taking due aim at double digits.
Only those well into their 70s or beyond have ever known any other British monarch than Queen Elizabeth II (a point also made by 75-year old Elton John last night). It is beyond remarkable that any person would be in the same role and tirelessly/effectively doing the same job for more than 70 years. The only person that springs to mind is, perhaps, a Tony Bennett or Betty White. Suffice it to say that the participation rate for those over 75 (at least in the U.S.) is a mere 8%. King Charles III now ascends to the throne at the sprightly age of 73 (74 in November)—the participation rate for that age bracket (70-74) is a bit higher. But at around 18%, that would still leave the new monarch in a distinct minority, let alone the rarity of just starting a position in that age group. Long live the King.