Dollar Rallies and Treasuries Sell-Off

October 23, 2024

Dollar Rallies and Treasuries Sell-Off

  • USD and Treasury yields are breaking higher reflecting the strong U.S. economy and financial markets positioning for a Trump win.
  • The Bank of Canada is expected to slash the policy rate 50 bp to 3.75%. CAD can come under further downside pressure.
  • USD/JPY retraced all its losses triggered by the BOJ hawkish surprise on July 31.

USD and Treasury yields continue to edge higher reflecting in large part the strong U.S. economy. In fact, the IMF raised U.S. real GDP growth projections to 2.8% (+0.2pts) and 2.2% (+0.3pts) for 2024 and 2025, respectively. Meanwhile, the Atlanta Fed GDPNow model is tracking Q3 annualized growth of 3.4%, which is above the pre-pandemic average annual growth rate of 2%.

The IMF also forecasts U.S. growth to outpace its international peers. Eurozone real GDP growth forecasts were lowered to 0.8% (-0.1pts) and 1.2% (-0.3pts) for 2024 and 2025, respectively. U.K. real GDP growth forecast was raised for 2024 to 1.1% (+0.4pts) and kept unchanged at 1.5% for 2025. Japan real GDP growth forecast was slashed for 2024 to 0.3% (-0.4pts) and raised to 1.1% (+0.1pts) for 2025. Other major economies real GDP growth forecast was raised for 2024 to 2.1% (+0.1pts) and kept unchanged at 2.2% for 2025.

Moreover, the rising likelihood former President Donald Trump returns to the White House is supporting a higher USD and long-term Treasury yields. Polls show Trump has a narrow lead in most of the seven key battleground states (here and here) while betting odds are heavily skewed in favor of Trump.

The logic is that fiscal and trade policies under a Trump presidency are inflationary. This could force the Fed to keep the policy rate restrictive for longer underpinning a firmer USD and Treasury yields. Additionally, the U.S. fiscal outlook is expected to worsen under a Trump presidency raising the compensation investors require for holding long-dated Treasuries (the term premium). Indeed, the term premium on 10-year Treasury yields implied by the ACM model has risen throughout October and nearing a one year high of 0.215%.

The Fed Beige Book is today’s highlight (7:00pm London). Given the recent data, we see risks that the Beige Book points to some modest improvements in U.S. economic sentiment. As a background, the September Beige Book painted a mixed picture of labor market conditions and economic activity. “Five Districts saw slight or modest increases in overall headcounts, but a few Districts reported that firms reduced shifts and hours, left advertised positions unfilled, or reduced headcounts through attrition—though accounts of layoffs remained rare.” The Beige Book further noted that more Districts (9 vs. 5 previously) reported flat or declining economic activity than in the prior reporting period. However, “District contacts generally expected economic activity to remain stable or to improve somewhat in the coming months”.

CAD faces additional downside risk. The Bank of Canada (BOC) is expected to slash the policy rate 50 bp to 3.75% (2:45pm London). The swaps market implies 74% probability of a 50 bp rate cut while 14 of the 24 analysts polled by Bloomberg have 50 bp of easing penciled-in. We expect the BOC to deliver a 50 bp cut and signal a faster return towards its nominal neutral interest rate estimate of 2¼% to 3¼%. Inflation in Canada is undershooting the BOC’s projection while business conditions and consumer sentiment remain subdued. New sets of macro forecasts will be published in the Monetary Policy Report.

EUR/USD is trading heavy under 1.0800 weighed down by dovish ECB comments. Yesterday, President Lagarde declined to rule out larger rate cuts noting that while the moves since June had been “sensible,” that didn't mean the ECB was bound to continue with quarter-point cuts. Similarly, Governing Council member Centeno said it was important for monetary policy to continue easing and left the door open for a 50 bp rate cut. Finally, Governing council member Holzmann said that more rate cuts will follow, and Governing Council member Rehn warned that “the growth outlook has weakened quite clearly in the past few months, which could also increase disinflationary pressures.” In our view, the bar for additional ECB easing is low and an ongoing drag for EUR. The Eurozone economy is stagnating, and inflation is undershooting the ECB’s 2% target.

JPY is underperforming against all major currencies and USD/JPY surged to the highest since the Bank of Japan hawkish surprise on July 31. Widening U.S.-Japan 10-year bond yield spreads is turbocharging USD/JPY.

Central bank speakers today include: Fed Governor Michelle Bowman (2:00pm London), Richmond Fed President Tom Barkin (voter) (5:00pm London), ECB President Lagarde and ECB Chief Economist Lane (both at 3:00pm London), BOE Deputy Governor Sarah Breeden (2:00pm London), BOE Governor Andrew Bailey (7:45pm London), RBNZ Governor Adrian Orr (6:00pm London).

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