Dollar Mixed as Markets Await Fresh Drivers

• Fed tightening expectations remain elevated despite the mixed jobs report; markets for now believe that the Fed has things under control
  
• The German economy continues to soften; South African rand is outperforming as more positive evidence emerges that the omicron variant is less severe than first thought
• PBOC delivered a 50 bp RRR cut; Hang Seng Tech index fell 3.3% to its lowest level ever; Bitcoin had a flash crash over the weekend, falling some 20% but recovering about half of that since
  

The dollar is mixed as markets await fresh drivers in the wake of the mixed jobs data. DXY traded as high as 96.38 today and a break above 96.40 is needed to set up a test of the November cycle high near 96.938. It is currently near the middle of last week's trading range. The euro still feels heavy after being unable to break above $1.14 last week and is currently near $1.13, while sterling is edging higher after finding ongoing support near $1.32. With market sentiment improving, USD/JPY is trading back above 113, while EUR/CHF is trading back above 1.04 after trading at a new low for this move near 1.0374. We believe the underlying trend for a stronger dollar remains intact as the Fed is moving closer and closer to liftoff sooner than markets previously thought.

AMERICAS

Markets are starting the week searching for some near-term direction. There are no U.S. data reports today, nor are there any Fed speakers due to the media blackout. That said, market sentiment has improved on some positive signs emerging from South Africa (see below). This has helped push global bond yields higher, along with global equity markets. A RRR cut from PBOC (see below) helped boost sentiment as well. The major currencies are mixed, with the yen and Swissie weaker and the Scandies and dollar bloc largely firmer. EM FX is also mixed, with ZAR putting in a strong performance and TRY continuing to weaken. When all is said and done, we believe recent developments continue to favor the dollar.

Fed tightening expectations remain elevated despite the mixed jobs report. WIRP suggests Q2 liftoff is nearly fully priced in, with another 1-2 hikes priced in by end-2022. Looking further out, swaps market is pricing in a little over 50 bp of Fed tightening over the next 12 months and about 125 bp over the next 2-3 years. A terminal Fed Funds rate of 1.5% seems too low to us if the labor market is getting as tight as we fear. Obviously, a lot depends on omicron and other possible variants that pose downside risks to the economy. However, the market seems a bit complacent about Fed tightening. If we had to pick a side, we think the risks are tilted for a terminal rate above 1.5%, not below. Of note, Fed Funds peaked at 2.25-2.50% back in 2019 before the mid-cycle correction saw three cuts that year to 1.50-1.75%, while the Dot Plots show the median long-term rate at 2.5%.

Markets for now believe that the Fed has things under control. The 10-year yield traded as low as 1.33% Friday, the lowest since late September, but is trading back near 1.40% today. Elsewhere, the 10-year breakeven inflation rate is trading around 2.44%, the lowest since early October. On the other hand, the 2-year yield traded at a new cycle high of 0.65% Friday, reflecting heightened Fed tightening expectations. The U.S. 2-year traded today near 0.63% and the differentials with Germany, U.K., and Japan should continue to rise in the dollar's favor. Of note, the 2- to 10-yrear curve at 77 bp is the flattest since December 2020, while the 3-month to 10-year curve at 133 bp is the flattest since September.

EUROPE/MIDDLE EAST/AFRICA

The German economy continues to soften. October factory orders were expected at -0.3% m/m but instead plunged -6.9% vs. a revised 1.8% (was 1.3%) in September. German October IP (1.0% expected) and December ZEW survey will be reported tomorrow and there are clear downside risks. German data have been weakening in Q4 even before the omicron variant surfaced, and so the headwinds are building. The slump in the forward-looking orders data points to even greater weakness in the economy as we move into 2022.

The South African rand is outperforming as more positive evidence emerges that the omicron variant is less severe than first thought. While very contagious, the symptoms seem to far milder, as seen by recent hospital data from South Africa. That said, it's too early to sound the all clear. With another week or two likely needed to determine its impact, South Africa policymakers are in a holding pattern. SARB started the tightening cycle last month with a 25 bp hike to 3.75%, which in hindsight looks premature. 2022, suggesting further tightening ahead. Next policy meeting is December 22 and another large hike is expected. South Africa reports Q3 GDP data tomorrow and is expected to have contracted -0.8% q/q vs. 1.2% growth in Q2. This is of course old news as the omicron variant has made the economic outlook cloudier.

ASIA

Chinese Premier Li Keqiang confirmed last week that RRR cuts are on the way "in a timely way," and the PBOC delivered a 50 bp move today. According to the Premier, the stated goal of this forthcoming move is to "support the real economy, especially small and micro firms." It's nice to get confirmation, but a RRR cut was universally expected so it shouldn't make much market impact. That said, with the PBOC still in easing mode and we remain surprised that the yuan remains so firm given 1) broad EM weakness and 2) growing monetary policy divergence. We like USD/CNY higher. We also expect imminent further support - directly or indirectly - for the real estate sector given how developers are again under pressure. Indeed, Evergrande is down 17% to new record lows amid heightened anxiety about its debt restructuring. The embattled firm plans to "actively engage" with offshore creditors on the restructuring plan. 

Separately, the Hang Seng Tech index fell 3.3% to its lowest level ever. Note that the index was launched in July 2020 and includes the likes of Alibaba, JD.com, and Baidu. The immediate trigger was Didi Global's delisting, which caused more worries about stocks with dual listing in China and the U.S. Increased regulatory scrutiny from both sides probably means that pressure on the sector will continue as foreign investors become more reluctant to maintain their exposure. The Hang Seng Tech index is off 32% on the year, compare to modest gains for the Shanghai and Shenzhen indices.

ALTERNATIVE INVESTMENTS

Bitcoin had a flash crash over the weekend, falling some 20% but recovering about half of that since. The crypto currency fell to near $42,000 on Saturday and it's now at around $48,200. There didn't seem to be a clear trigger for the move, except for the hack of the medium size exchange Bitmart. As usual, elevated leverage was one of the big factors for the outsized move. By some estimates, $2.5 bln of positions were liquidated on the day, the largest such event since September.

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