Dollar Flat Ahead of FOMC Decision

• U.S. yields remain elevated ahead of the FOMC decision; the Fed is expected to hike rates 50 bp to 1.0% and announce QT; April ISM services PMI will be the data highlight; ADP reports its private sector jobs data; Treasury makes its quarterly refunding announcement; Brazil is expected to hike rates 100 bp to 12.75%.
  
• The EU will announce another round of Russian sanctions; ECB officials continue to tilt hawkish; yet ECB tightening expectations remain subdued; final eurozone April services and composite PMIs were reported
  
• Australia reported firm March retail sales; India delivered a surprise intra-meeting hike

The dollar is basically flat ahead of the FOMC decision. DXY is trading near 103.412 but we expect a test of last week's cycle high near 103.928. The euro remains heavy near $1.0530 and should soon test last week's cycle low near $1.0470. We still look for an eventual test of the January 2017 low near $1.0340. USD/JPY remains stuck near 130 but we continue to look for a test of the 2002 high near 135.15. Sterling is stuck in the middle of recent trading ranges near $1.25 but we look for an eventual test of last week's cycle low near $1.2410. Between lingering risk-off impulses and the recovery in U.S. yields, we believe the dollar uptrend remains intact. Any post-FOMC profit-taking in the dollar should be viewed as a buying opportunity.

AMERICAS

U.S. yields remain elevated ahead of the FOMC decision. The 10-year yield hit a new cycle high this week near 3.01%, the highest since December 2018, and is currently trading near 2.95%. The real 10-year yield has risen to 0.12%, the highest since December 2019. Similarly, the 2-year yield traded at new cycle high near 2.81%, also the highest since December 2018, and is currently trading near 2.78%. Of note, the 2-year interest rate differentials have swung back in the dollar's favor after a brief corrective phase last week. In particular, the spreads with Japan (283 bp) and the U.K. (112 bp) continue to make new cycle highs, while the spread with Germany (249 bp) is lagging a bit. This uptrend in rates is likely to continue as U.S. inflation continues to run hot and the Fed continues its aggressive tightening cycle (see below).

The Fed is expected to hike rates 50 bp to 1.0%. It's possible that Bullard dissents again in favor of a larger hike, as he did at the March meeting. There will be no new forecasts until the June 14-15 FOMC meeting, when another 50 bp hike is widely expected. Indeed, WIRP suggests over 50% odds of a 75 bp hike next month. Looking further out, the swaps market is pricing in 300 bp of tightening over the next 12 months that would see the Fed Funds rate peak near 3.5%. As always, Chair Powell's post-decision press conference will be key. If he shows any hints of dovishness, markets will take yields and the dollar lower. That said, we see no reason for Powell to hedge his bets right now and so we expect full speed ahead from the Fed. Afterwards, Fed speakers will fan out to spread the word. Williams, Bostic, Bullard, Waller, and Daly all speak Friday.

The Fed is also likely to announce Quantitative Tightening. Recall that the minutes to March FOMC meeting set out a likely scenario for balance sheet runoff, with a $95 bln monthly cap seen as appropriate. This cap would be split $60 bln for USTs and $35 bln for MBS. Furthermore, the appropriate phase-in period for this cap was seen at three months or "modestly longer if market conditions warrant." While the details may be tweaked, the pace of QT will be much faster this time around. Back in 2017, the phase-in period was 12 months and the final monthly caps were $30 bln for UST and $20 bln for MBS. The March minutes also showed that "the Committee was well placed to begin the process of reducing the size of the balance sheet as early as after the conclusion of its upcoming meeting in May." If the Fed stays true to form, then a plan close to the one outlined here will be announced Wednesday and implemented on May 15.

April ISM services PMI will be the data highlight. Headline is expected at 58.5 vs. 58.3 in March. Of note, April Chicago PMI came in last week at 56.4 vs. 62.9 in March and so there are downside risks to the ISM readings. We saw this with ISM manufacturing PMI Monday, which came in at 55.4 vs. 57.6 expected and 57.1 in March. While markets will be sensitive to signs of weakness in the U.S. economy, we are not yet concerned. March trade data (-$107.0 bln expected) will also be reported. Canada also reports March trade data.

ADP reports its private sector jobs data. Jobs are expected to rise 383k vs. 455k in March. However, with the U.S. pretty much at full employment, the jobs data Friday no longer has that much impact on Fed policy. That said, consensus stands at 385k vs. 431k in March, with the unemployment rate expected to fall a tick to anew cycle low of 3.5%. Average hourly earnings are expected to ease a tick to 5.5%, while average weekly hours are expected to rise a tick to 34.7.

The U.S. Treasury makes its quarterly refunding announcement. Dealers are reportedly looking for another cut in planned sales. At the last announcement February 2, Treasury cut its sales of long-term debt for a second straight quarter to $110 bln, down $10 bln from the November announcement. This week's decision is made all the more difficult because it comes just as the Fed is about to undertake QT. In the February announcement, the Treasury Borrowing Advisory Committee (TBAC) estimated that the Fed's balance sheet runoff could create about $1.6 trln in additional new financing needs over the next three years.

Brazil COPOM is expected to hike rates 100 bp to 12.75%. At the last meeting March 16, it delivered the expected 100 bp hike to 11.75% and signaled that this May hike could be the last one. Since then, inflation has surprised to the upside and so markets believe the tightening cycle will have to be extended. The swaps market is pricing in another 175 bp of tightening over the next 3 months that would see the policy rate peak near 13.5%.

EUROPE/MIDDLE EAST/AFRICA

The European Union will announce another round of Russian sanctions. Reports suggest the EU will ban purchases of Russian crude oil over the next six months and refined fuels by the end of the year. Hungary and Slovakia, which are most reliant on Russia, had opposed a sudden ban and so they will be given until the end of 2023 to enforce the sanctions. European Commission President von der Leyen stressed "This will be a complete import ban on all Russian oil, seaborne and pipeline, crude and refined. We will make sure that we phase out Russian oil in an orderly fashion, in a way that allows us and our partners to secure alternative supply routes and minimizes the impact on global markets." The EU is also planning to cut off Sberbank and two other Russian banks from the SWIFT payment system. The EU's 27 member states will reportedly meet today to debate and potentially approve the sanctions, which will require a unanimous vote. It seems clear that the exemptions were given to achieve unanimity and that the EU would not have leaked news of the sanctions without first getting assurances of support from Hungary and Slovakia.

European Central Bank officials continue to tilt hawkish. Yesterday, Schnabel said a rate hike may come as early as July. She stressed in a Handelsblatt interview that "It's not enough to talk now -- we have to act. From today's perspective, I think a rate hike in July is possible." Schnabel is considered one of the more dovish members of the Governing Council and so her shift is noteworthy. Today, it was Muller's turn, who said the ECB should consider raising rates as soon as July as inflation continues to accelerate.

Yet ECB tightening expectations remain subdued. WIRP suggests odds of liftoff June 9 are now around 25% vs. 30% at the start of this week and 40% at the start of last week, while liftoff July 21 remains fully priced in. The swaps market is now pricing in 150 bp of tightening over the next 12 months, with another 50 bp (vs. 75 bp) of tightening priced in over the following 12 months that would see the deposit rate peak near 1.5% vs. 1.75% at the start of last week. While this still seems too aggressive to us, at least markets are recognizing that 1) eurozone inflation may be peaking and 2) the risks to growth are mounting.

Final eurozone April services and composite PMIs were reported. Headline readings were unchanged from preliminary at 57.7 and 55.8, respectively. German composite was revised down two ticks to 54.3, while the French composite was revised up a tick to 57.6. Italy and Spain were reported for the first time and both composite PMIs rose over two full points from March to 54.5 and 55.7, respectively. March eurozone retail sales were also reported and came in at -0.4% m/m vs -0.3% expected and a revised 0.4% (was 0.3%) in February.

ASIA

Australia reported firm March retail sales. Sales rose 1.6% m/m vs. 0.5% expected and 1.8% in February. It was the third straight monthly gain to a new record high, and underscores the underlying strength of the consumer as parts of the nation recover from the floods early this year. RBA tightening expectations are still adjusting. WIRP suggests another 25 bp hike at the June 7 meeting is fully priced in, with nearly 50% odds of a larger 50 bp move. The swaps market is now pricing in 350 bp of further tightening over the next 12 months followed by almost 75 bp over the following 12 months that would see the policy rate peak near 4.5%, up from 3.5% at the start of this week and 3.25% at the start of last week. AUD jumped as high as .7150 yesterday after the hawkish surprise but is already trading back near the .7100 level. As we saw after the recent hawkish surprised from the Riksbank, the initial boost to the currency will eventually be overwhelmed by the more hawkish Fed outlook.

Reserve Bank of India delivered a surprise intra-meeting hike. It hiked its key repo rate by 40 bp to 4.40% as Governor Das warned that persistent inflation pressures are becoming more acute. He added that there is a risk prices stay high for "too long" and lead to expectations becoming unanchored. Das stressed that "Inflation must be tamed in order to keep the Indian economy resolute on its course to sustained and inclusive growth." The RBI also increased the cash reserve ratio by 50 bp to 4.5%, which Das said would drain INR870 bln of liquidity from the banking system. The bank has signaled that a tightening cycle would be needed this year but the timing for liftoff was a surprise as most expected a hike at the next scheduled meeting June 8. Given this hawkish pivot, another hike next month is very likely.

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