Dollar Firm as U.S. Rates Continue to Move Higher

April 05, 2022
  • U.S. yields continue moving in the dollar’s favor; the U.S. 2- to 10-year curve remains inverted; March ISM services PMI is the main highlight
  • Default risk has risen after the Treasury Department banned Russia from making any debt payments through U.S. banks; reports suggest the EU is also considering tougher sanctions on Russia; we suspect the upcoming French presidential election is also playing a part in recent euro weakness; final eurozone March services and composite PMI readings came in firm; BOE Deputy Governor Cunliffe remains at the dovish end of the spectrum
  • BOJ Governor Kuroda added his voice to official concerns about the weak yen; Japan reported February cash earnings and household spending; RBA kept rates steady at 0.10% but tweaked its forward guidance; the hawkish tilt helped AUD to trade at new cycle highs; Korea reported March CPI

The dollar is firm as U.S. rates continue to move higher. DXY is up for the fourth straight day and is trading just above 99. Last month’s cycle high near 99.418 should eventually be tested. The euro remains heavy due to Russia exposure and French political risk (see below) and has broken support near $1.10. Last week's low near $1.0945 is up next and break below would set up a test of the March 7 low near $1.0805. That this is happening despite heightened ECB tightening expectations will be disappointing for any euro bulls out there. The relentless rise in USD/JPY is taking a pause after Kuroda’s comments and is steady near 123. Despite rising official concerns (see below), we look for further yen weakness as it should eventually test last week’s high near 125.10. Sterling remains stuck just above $1.31. We still look for an eventual test of last month’s cycle low near $1.30 as BOE messaging has tilted more dovish of late. Between the likely return of risk-off impulses and the even more hawkish Fed outlook for tightening, we believe the dollar uptrend remains intact.


U.S. yields continue moving in the dollar’s favor. The 2-year yield is trading just below 2.50% and this has led the 2-year differentials with Germany, Japan, and the U.K. to also make new cycle highs. This of course argues for further dollar strength against the euro, yen, and sterling. Elsewhere, the 10-year yield is moving higher and trading near 2.47%, up from last week’s low near 2.31% and just shy of the 2.55% cycle high from March 28. However, the real 10-year yield has risen to -0.34%, the highest since March 2020. Brainard and Williams speak today.

The U.S. 2- to 10-year curve remains inverted. That curve is now around -3 bp, joining the 3- and 5-year curves in inverting. The more widely followed 3-month to 10-year curve is trading near 185 bp, just below the March 25 peak near 195 bp. Please see our recent piece here to see why we are not yet concerned about yield curve inversion in the U.S. Until the 3-month to 10-year curve moves remotely close to inverting, the U.S. economy is likely to avoid recession.

March ISM services PMI is the main highlight. Headline is expected at 58.5 vs.56.5 in February. Keep an eye on the employment and prices paid components, which stood at 48.5 and 83.1 in February, respectively. Last week’s manufacturing PMI suggest price pressures remain strong as prices paid jumped to 87.1 vs. 75.6 in February. In that same report, supplier deliveries fell to 65.4 vs. 66.1 in February and backlog of orders fell to 60.0 vs. 65.0 in February. The lower these numbers are, the lower the strains in the supply chains for the manufacturing sector. The fact that prices paid increased sharply to 87.1 vs. 75.6 in February despite improvement in the supply chain suggests price pressures are spreading beyond just the supply chain issues. This supports aggressive Fed tightening and is bond-negative, to state the obvious. Both the U.S. and Canada report February trade data today.


Default risk has risen after the Treasury Department banned Russia from making any debt payments through U.S. banks. President Biden said President Putin could face a war crimes trial and said the U.S. would also impose additional sanctions on Russia and so some action was to be expected. However, this latest move is a risky one. While Russia has so far remained current on its external debt, this move will make it harder to continue doing so. Russia has several choices: use existing onshore reserves to make payments, use incoming foreign currency revenues to make payments, or halt payments altogether. Like a cornered animal, Russia’s reaction is impossible to predict and the odds of default are not insignificant.
Reports suggest the EU is also considering tougher sanctions on Russia. These are said to possibly included Russia’s energy and maritime sectors, which would of course hit the eurozone economy the hardest. The EU said that work is already under way on additional sanctions due to what appear to be war crimes in Ukraine and that it regards sanctions “as a matter of urgency.”

We also suspect the upcoming French presidential election is playing a part in recent euro weakness. Polls suggest neither Macron nor Le Pen will win outright in the first round this Sunday and so a runoff April 24 will likely be needed. Polls suggest a close race in the runoff: Harris has Macron winning 51.5-48.5%, Ifop has Macron winning 53-47%, and Ipsos has Macron winning 54-46%. The race is probably even tighter than this as opinion polls typically understate support for the more controversial candidate, something now known as the Bradley effect. If Le Pen were to win, it would be very euro-negative.

Final eurozone March services and composite PMI readings came in firm. Headline services came in at 55.6 vs. 54.8 preliminary and the composite came in at 54.9 vs. 54.5 preliminary. The stronger readings are a bit of surprise given the ongoing impact of the Ukraine crisis. Looking at the country breakdown for the composite, Germany came in at 55.1 vs. 54.6 preliminary and France came in at 56.3 vs. 56.2 preliminary. Italy and Spain were reported for the first time. Italy came in as expected at 52.1 vs. 53.6 in February, while Spain came in at 53.1 vs. 53.9 expected and 56.5 in February. French February IP was also reported and came in at -0.9% m/m vs. -0.4% expected.

Bank of England Deputy Governor Cunliffe remains at the dovish end of the spectrum. He said that “While I recognize the risk of second-round effects and that further tightening of monetary policy might be necessary, I am not at present convinced that we will inevitably have to lean heavily and constantly against an embedding of an inflationary psychology as we progress through this challenging period and as the impact of higher commodity prices on real household incomes depresses activity.” Cunliffe was the lone dissent last month in favor of steady rates so his comments shouldn't be too surprising. WIRP suggests another 25 bp hike to 1.0% is fully priced in at the next meeting May 5. Final services and composite PMI readings for March were reported. Headline services came in at 62.6 vs. 61.0 preliminary and the composite came in at 60.9 vs. 59.7 preliminary. The strength is certainly welcome but April is likely to show significant weakness as payroll tax and household energy caps are raised.


Bank of Japan Governor Kuroda added his voice to official concerns about the weak yen. He noted that “If you look at moves in foreign exchange rates over the longer term such as the past decade, fluctuations have gotten smaller but as pointed out, the recent moves in foreign exchange rates seem somewhat rapid.” Still, it’s clear that it’s more about the pace than the level, as last week’s spike above 125 proved unsettling. If the pace of weakness remains modest and controlled, we do not think policymakers would be as concerned. As we noted yesterday, Japan cannot have an independent monetary policy and free capital movement and then expect to be able to control the exchange rate as well. Because of the so-called “Impossible Trinity,” the Bank of Japan would have to change its monetary policy stance (tighten) if it wants to prevent a weaker yen. Otherwise, the monetary policy divergence with the Fed will continue to weaken the yen.

Japan reported February cash earnings and household spending. Nominal earning came in at 1.2% y/y vs. 0.6% expected and a revised 1.1% (was 0.9%) in January, while real earnings came in flat y/y vs. -0.7% expected and a revised 0.5% (was 0.4%) in January. BOJ officials have recently been stressing the need to see higher wages as well as inflation near the 2% target before the bank will consider tightening and so these readings are noteworthy if the upside trend is sustained. However, spending came in at 1.1% y/y vs. 2.7% expected and 6.9% in January, suggesting households are saving the higher earnings rather than spending. Again, this bears watching. Final services and composite PMI readings for March were also reported. Services came in at 49.4 vs. 48.7 in February and helped drag the composite PMI up to 50.3 for the first reading above 50 since December.

Reserve Bank of Australia kept rates steady at 0.10% but tweaked its forward guidance. The bank dropped its reference to remaining “patient” on policy and instead moved to being data dependent. Governor Lowe said the bank will assess upcoming inflation and wage data as it “sets policy to support full employment in Australia and inflation outcomes consistent with the target.” This shift would seem to validate market expectations for liftoff coming sooner rather than later. As such, RBA tightening expectations continue to rise. WIRP suggests liftoff now fully priced in for the June 7 meeting; at the beginning of March, liftoff was priced in for the August 2 meeting. Swaps market sees 250 bp of tightening over the next 12 months and another 90 bp over the following 12 months that would see the policy rate peak near 3.5%. Final March services and composite PMI readings were also reported.

The hawkish tilt helped AUD to trade a new cycle highs. It is trading at the highest since June 2021 and the clean break above .7540 sets up a test of the May 2021 high near .7890. AUD is the best performing major YTD. Similar to what we’re seeing in EM FX, the best performing majors YTD (AUD,NZD, CAD, and NOK) are all benefiting from high commodity prices and rising interest rates. This trend should continue in Q2.

Korea reported March CPI. Headline came in at 4.1% y/y vs. 4.0% expected and 3.7% in February, while core came in as expected at 3.3% y/y vs. 3.2% in February. This is the highest headline reading since December 2011 and further above the 2% target. At the last policy meeting February 24, the central bank delivered a hawkish hold as it raised its inflation forecast for 2022 to 3.1% vs. 2.0% previously and for 2023 to 2.0% vs. 1.7% previously. That was Lee’s last meeting as Governor and so it will be up to his successor to follow through with the next hike. Swaps market sees the policy rating peaking around 3.0% over the next 12 months. Next BOK policy meeting is April 14 and another 25 bp hike to 1.5% seems likely then.  

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