Inflation data and a hawkish Fed are keeping upward pressure on U.S. yields; Fed tightening expectations remain relatively robust
Markets are still digesting the dovish surprise from the ECB last week; ECB hawks continue to undermine Lagarde
Official concern with the weak yen is intensifying; China reported mixed March retail sales, IP, and Q1 GDP data
The dollar remains firm as U.S. rates continue to adjust. DXY is up for the third straight day and tested last week’s new cycle high near 100.761. With the clean break of the psychological 100 level, the March 2020 high near 103 is the next big target. The euro remains heavy just below $1.08 and is likely to test last week’s new cycle low near $1.0760. Break below would set up a test of the March 2020 low near $1.0635. The relentless rise in USD/JPY continues as it is up for the twelfth straight day and traded at a marginal new cycle high near 126.80. There are no significant chart points until the 2002 high near 135.15. With the BOJ so far unwilling to change its ultra-dovish stance, the yen is likely to continue weakening despite rising official concerns (see below). Sterling remains heavy just above $1.30 and is likely to test last week’s new cycle low $1.2975. Break below would set up a test of the November 2020 low near $1.2855 and then possibly the September 2020 low near $1.2675. Between the likely return of risk-off impulses and the hawkish Fed outlook, we believe the dollar uptrend remains intact.
Inflation data and a hawkish Fed are keeping upward pressure on U.S. yields. The U.S. Treasury market was closed Friday but has picked up today where it left off last Thursday. US 10-year yield traded near 2.88% Thursday, a new cycle high. The 2-year continues to lag and traded near 2.51% Thursday, not yet close to matching the 2.60% cycle high from earlier this month. That said, the recent price action in the rates markets supports the notion that the last week’s sharp bond rally was really all about short-covering and positioning. As a result, U.S. yields and USD should continue to move higher. With inflation expectations remaining fairly steady, the real 10-year yield traded at -0.03%, the highest since March 2020 and poised to move into positive territory for the first time since the pandemic began.
Fed tightening expectations remain relatively robust. WIRP suggests a 50 bp hike at the May 3-4 meeting is fully priced in, while odds of another 50 bp hike at the June 14-15 FOMC meeting are nearly 85%. Looking ahead, swaps market is pricing in 250 bp of tightening over the next 12 months that would see the policy rate peak near 3.0%, down from 3.25% at the start of last week. We continue to see room for the expected terminal rate to move higher again if inflation proves to be even more stubborn than expected. Bullard speaks today.
Markets are still digesting the dovish surprise from the ECB last week. Here are the key takeaways from the dovish ECB narrative: 1) APP is likely to end in Q3 followed by likely liftoff in Q4; 2) the June 9 meeting will provide key forward guidance on the end of APP and potential liftoff but for now, the ECB appears to be in no hurry to hike rates; 3) the weak euro does not seem to be a concern; 4) inflation is still seen as an energy issue, with wage growth remaining muted; and 5) there will be no firm commitment yet on how soon rates will be hiked after APP ends.
ECB hawks continue to undermine Lagarde. Holzmann said “Given where we stand, it would be well advised to hike rates in the fall” and get to 0% in the deposit facility rate. This echoes remarks from back in late March, when he called for the ECB to hike rates twice this year to increase its room to maneuver should inflation outstrip projections. Then, Holzmann said two 25 bp hikes would broaden its future policy options and help avoid the need to make steeper increases in borrowing costs later on. He note that if by year-end “the deposit rate wasn’t already at 0%, it would be too late. If inflation doesn’t prove to be higher than expected, we could simply stay at 0%.” On Friday, Simkus said he sees “no reason why we shouldn’t consider an interest-rate increase” in Q3 after ending APP.
Official concern with the weak yen is intensifying. The relentless rise in USD/JPY continues as it is up for the twelfth straight day as the pair trades at a marginal new cycle high near 126.80. Looking ahead, there are no significant chart points until the 2002 high near 135.15. BOJ Governor Kuroda reiterated his concerns, noting “Recent yen moves have been very rapid. That can cause trouble for companies when they make their business plans and we will need to take into account negative factors like these.” Finance Minister Suzuki also expressed concern, reiterating that excessive and disorderly swings in the yen can be negative for Japan. Despite rising concerns, we see low risk of FX intervention. Until the BOJ changes its ultra-dovish stance, the monetary policy divergence argues for continued yen weakness and intervention would likely have little lasting impact.
China reported mixed March retail sales, IP, and Q1 GDP data. Sales came in at -3.5% y/y vs. -3.0% expected and 6.7% in the January-February period, while IP came in 5.0% y/y vs. 4.0% expected and 7.5% in the January-February period. GDP growth came in at 4.8% y/y vs. 4.2% expected and 4.0% in Q4, while the q/q rate is expected at 1.3% vs. 0.7% expected and 1.6% in Q4. We must admit that it’s hard to explain where the firm Q1 growth is coming from. The retail sales most likely gives the truest read on the economy, as the IP and GDP most likely overstate strength in an economy that’s being overrun by rising virus numbers and lockdowns. Note that PMI readings, both official and Caixin, suggest the economy is contracting now. Commercial banks set their 1- and 5-year Loan Prime Rates Wednesday and are expected to cut them 5-10 bp. Last week, the PBOC kept its 1-year MLF rate steady at 2.85% but instead cut the RRR by 50 bp for large banks and 100 bp for small banks. More needs to be done, however, as the growth target for this year of “around 5.5%” is looking increasingly unlikely despite firm Q1 growth.