Dollar and U.S. Yields Continue to Rise

August 14, 2023

Win Thin

The dollar and U.S. yields continue to rise; recent data out of the U.S. suggest that a September skip seems more and more likely; Chile central bank releases its minutes
Market expectations for ECB policy remain subdued
The yen continues to weaken; concerns about China’s financial system are mounting; India reports July CPI

The dollar is starting the week off on a firm footing. DXY traded above 103 for the first time since July 7 and is on track to test the July 6 high near 103.572. The euro is trading flat near $1.0950 and remains on track to test the July low near $1.0835. Sterling is trading higher near $1.2710 but remains on track to test the late June low near $1.2590. USD/JPY traded above 145 for the first time but there has been little follow-through. We look for further upside in this pair. Despite the recent jobs and CPI data, we believe the relative fundamental story should continue to move in favor of the greenback. As we expected, the recent FOMC, ECB, and BOJ decisions as well as the ongoing economic data underscore the divergence theme and so further dollar gains seem likely.

AMERICAS

Despite fairly benign CPI and PPI data, the dollar and U.S. yields continue to rise. The 10-year yield traded near 4.18% today after ending last week near 4.15% and is just shy of the 4.20% high for this move, while the 30-year yield traded near 4.28% today after ending last week near 4.26% and is just shy of the 4.32% high for this move. Even the 2-year yield took part as it trade near 4.92% after ending last week near 4.90% and is just shy of the 4.94% August high. As a result, the 2-year differentials continue to move in the dollar’s favor and DXY traded above 103 today for the first time since July 7 after ending last week near 102.842. These gains are impressive given the softish data but these trends should continue this week.

Indeed, recent data out of the U.S. suggest that a September skip seems more and more likely. However, there are clearly some underlying inflation concerns and so we still don't think the Fed is done hiking. The market seems to agree with us as WIRP suggests 10% odds of a hike in September, rising to nearly 40% in November. Those odds will rise and fall with the data.

Chile central bank releases its minutes. At that July 28 meeting, the bank delivered a dovish surprise and cut rates 100 bp to 10.25% vs. 75 bp expected. The decision was unanimous and the bank warned that “The board estimates that, in the short term, the MPR will accumulate a somewhat stronger reduction than was considered in the Monetary Policy Report’s central scenario, in line with the results of the surveys conducted prior to this meeting.” Next meeting is September 5 and another 100 bp cut seems likely. The swaps market is pricing in 150 bp of easing over the next three months followed by another 175 bp of easing over the subsequent three months.

EUROPE/MIDDLE EAST/AFRICA

Market expectations for ECB policy remain subdued. WIRP suggest odds of a 25 bp hike stand near 40% September 14, rise to 60% October 26 and top out near 70% December 14. These odds will rise and fall with the data but Madame Lagarde clearly accentuated the negative last week and that’s what markets should focus on. What’s very interesting to us is that the ECB may stop hiking before the Fed does and we don't think the markets have priced this risk in yet.

ASIA

The yen continues to weaken. USD/JPY traded at the highest since November near 145.20 and sets up a test of the October 31 high near 148.85 and then the October 21 cycle high near 152. With the BOJ remaining very dovish, we believe the pair will revisit these highs from last fall. There may be some official jawboning if yen weakness continues but we do not expect actual FX intervention anytime soon.

Concerns about China’s financial system are mounting. Reports have emerged that banking regulators set up a task force last month to examine risks after a major private wealth manager missed payments on multiple high-yield investment products. The National Financial Regulatory Administration established a task force to examine outstanding debt obligations and the risks involved at one of the main financing arms of Zhongzhi, which holds more than CNY1 trln ($138 bln) of assets. Of note, real estate accounts for over 10% of its assets and the news comes just days after real estate developer Country Garden missed coupon payments on two of its dollar-denominated bonds. With a debt/GDP ratio approaching 300%, we suspect there will eventually be major bailouts and debt restructurings in both the property and finance sectors, as the two have become inextricably intertwined.

India reports July CPI. CPI is expected at 6.50% y/y vs. 4.81% in June. If so, it would be the second straight month of acceleration to the highest since February and back above the 2-6% target range. WPI was reported earlier today at -1.36% y/y vs. -2.50% expected and -4.12% in June. The Reserve Bank of India just left rates steady at 6.5% last week but maintained a hawkish bias. Like the last policy meeting June 8, the vote to hold was unanimous and the bank kept its bias towards “removal of accommodation” by a 5-1 vote. Governor Das stressed that ““The MPC is prepared to act if the situation so warrants. Bringing headline inflation within the tolerance band is not enough. We need to remain firmly focused on bringing inflation within the 4% target.” Next policy meeting is October 6 and no change is expected then.

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