Dollar Steady as U.S. Yields Move Higher

August 26, 2021

All eyes are on the Kansas City Fed’s Jackson Hole Symposium as it begins today; U.S. stocks continue to make new highs and now it's time for yields to play some catch-up; regional Fed manufacturing surveys for August will continue to roll out; weekly jobless claims data will be very important; Brazil August IPCA inflation accelerated by more than expected to 9.30% y/y
Germany reported weak September GfK consumer confidence; July eurozone M3 growth continues to soften; ECB Chief Economist Lane pledged to respond to any market disruptions that stem from Fed tapering
Australia is extending its lockdowns as virus numbers continue to rise; Korea surprised with a 25 bp rate hike

The dollar is getting some traction as U.S. yields rise. DXY is stabilizing just below 93 after four straight down days. The euro is edging higher but is likely to run into stiff resistance around $1.18, while sterling is lagging after having trouble trading much above $1.3750. USD/JPY is trading just above 110 and a clean break of 110.15 would set up a test of the August 12 high near 110.80. While we remain positive on the dollar, this period of consolidation is likely to persist ahead of Powell’s Jackson Hole keynote speech Friday morning.

AMERICAS

All eyes are on the Kansas City Fed’s Jackson Hole Symposium as it begins today. This year’s topic is "Macroeconomic Policy in an Uneven Economy" and the full agenda will be made available at www.kansascityfed.org at 7 PM CT/8 PM ET tonight. Last year’s symposium was all virtual and the topic was "Navigating the Decade Ahead: Implications for Monetary Policy." Please see our Jackson Hole preview here.

U.S. stocks continue to make new highs and now it's time for yields to play some catch-up. The 10-year yield is trading near 1.36%, the highest since August 13 and on track to test the August 12 high near 1.38%. After that is the July 14 high near 1.42% and then the June 25 high near 1.54%. Despite the rise in U.S. yields, the dollar remains stuck in recent ranges but we think that at some point soon, it too will play catch-up and follow yields higher. With 10-year breakeven rates around 2.35%, the real U.S. yield has risen to -1.0% and is the highest since mid-July. If the U.S. data remain firm as we expect, allowing the Fed to move forward with tapering, then we see further upside for U.S. yields.

The U.S. 5-year auction yesterday saw fairly strong demand. Indirect bidders took 62.7% of the $61 bln offered vs. 58.1% previously, while the bid-to-cover ratio was 2.35 vs. 2.36 previously. After the strong 2-year auction Tuesday, all that’s left of this week’s coupon issuance is the 7-year auction today. At the last 7-year auction, indirect bidders took 58.4% and the bid-to-cover ratio was 2.23, leading to a yield of 1.05%.

Regional Fed manufacturing surveys for August will continue to roll out. Kansas City Fed is expected at 25 vs. 30 in July. So far, Richmond Fed came in at 9 vs. 27 in July, Empire survey came in at 18.3 vs. 43.0 in July, and Philly Fed came in at 19.4 vs. 21.9 in July. Virtually all the survey and PMI readings were at or near record highs and so some moderation is to be expected from these lofty levels. This does not mean the manufacturing sector is slowing sharply. Of note, IP came in much stronger than expected in July, up 0.9% m/m vs. 0.5% expected, driven by continued strength in manufacturing production (1.4% m/m vs. 0.7% expected).

Weekly jobless claims data will be very important. That is because the continuing claims data are for the BLS survey week containing the 12th of the month. Initial claims are expected at 350k vs. 348k the previous week, while continuing claims are expected at 2.772 mln vs. 2.82 mln the previous week. Last week’s readings were both new cycle lows for the pandemic and the signs so far point to another strong jobs report for August. Consensus is currently 800k vs. 943k in July but this will obviously change as we get more clues. Of note, JOLTS job openings rose to a record 10.1 mln in June, which shows continued strength in labor demand. As such, it’s no surprise that average hourly earnings continue to move higher, hitting 4.0% y/y in July.

We get another look at Q2 GDP. Growth is expected to be revised up two ticks to 6.7% SAAR. Yet this is old news and markets are already looking ahead to Q3 and Q4. The Atlanta Fed GDPNow model shows 5.7% SAAR vs. 6.1% previously. That's down slightly from Q2 but is still well above the NY Fed's Nowcast reading of 3.48% SAAR for Q3 vs. 3.79% previously. Of note, BBG consensus is 6.9% SAAR in Q3, 5.6% in Q4, 3.8% in Q1, and 3.0% in Q2.

Brazil August IPCA inflation accelerated by more than expected to 9.30% y/y, justifying the BCB’s hawkish stance. The surprise was largely due to a 5% increase in electricity costs, though other headline items such as fuel also contributed. The bank has already delivered 325 bp of tightening to the current level of 5.25% and at least another 75 bp is coming at the next COPOM meeting September 22, with risks of a 100 bp move. BRL was stronger again yesterday, up over 3% in the last two sessions and yields were up a few basis points across the curve.

EUROPE/MIDDLE EAST/AFRICA

Germany reported weak September GfK consumer confidence. It came in at -1.2 vs. -0.5 vs. -0.3 in August. This comes a day after Germany reported weak August IFO business climate survey, where the headline reading came in at 99.4 vs. 100.4 expected and a revised 100.7 (was 100.8) in July. The current assessment rose a full point to 101.4, but expectations fell a whopping 3.5 points from July Wednesday, which is expected at 100.4 vs. 100.8 in July. France also reported August business and manufacturing confidence and the readings were mixed. Business confidence fell to 110 from 113 in July while manufacturing rose to 110 from a revised 109 (was 110) in July. Tomorrow, France reports consumer confidence while Italy reports manufacturing and consumer confidence. All are expected to ease from July.

July eurozone M3 growth continues to soften. Money growth slowed as expected to 7.6% y/y vs. 8.3% in June. This is the slowest pace since March 2020 and is extremely disappointing in light of ongoing ECB asset purchases. The bank aims to keep financing conditions loose for the foreseeable future, but this will not do much for the economy if the transmission mechanism breaks down.

ECB Chief Economist Lane pledged to respond to any market disruptions that stem from Fed tapering. Lane stressed that “The ECB is not a passive bystander. If there are spillovers to euro-area financing conditions, we are willing and able to move as appropriate, as we have already demonstrated.” He added that “The autumn and the winter will give us further information on what happens to the pandemic, so we should use the autumn to think about these issues.” The bank is expected to discuss changes to its asset purchases at the next meeting September 9 but a consensus is unlikely to be reached until the December 16 meeting.

ASIA

Australia is extending its lockdowns as virus numbers continue to rise. Sydney is the epicenter and so the state of New South Wales will extend stay-at-home orders until at least September 10. The Reserve Bank of Australia meets September 7 and is likely to push forward with its plans to taper next month. Some banks are calling for a delay but we believe that to be very unlikely after the bank just reaffirmed its intent to taper at the August 3 meeting. This AUD bounce is running out of steam near .7280, which is the 62% retracement objective of the late August drop. A break above would set up a test of the August 11 high near .7390.

Bank of Korea surprised with a 25 bp rate hike, pulling ahead of the tightening cycle in Asia. The 25 bp hike to 0.75% went against consensus forecasts (and our expectations) for officials to follow the RBNZ in delaying tightening in light of greater uncertainty from the Delta variant. However, this wasn’t enough to push the balance against long-standing BOK concerns about high leverage in the financial system, especially in the household and real estate sectors. Our best guess is that tightening will continue but at a gradual place, perhaps skipping next meeting October 12. Note that one MPC member dissented in favor of a hold. There wasn’t much reaction in Korea’s asset prices with the won slightly weaker and the Kospi down 0.6%, roughly in line with moves elsewhere in the region. Yields at the very short end of the rates curve were higher, as one would expect, but the belly of the curve was a few basis points lower.

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