Dollar Resilient in Wake of Weak Jobs Report

February 08, 2021

• The US curve continues to steepen to new highs; market appetite will be tested this week with heavy UST supply; inflation expectations continue to rise in the US
• Mario Draghi’s chances of assembling a workable coalition for Italy are looking good; Germany reported soft December IP; BOE Governor Bailey speaks today and Wednesday and we look for some damage control; UK truckers report that exports to the EU have fallen nearly 70% since Brexit
• The Lunar New Year holiday will be observed across much of Asia this week; China-Australia relations remain tense; Taiwan reported strong January trade data; Brent crude breached the $60 per barrel for the first time since January last year

The dollar is stabilizing after Friday’s rout. We had an outside down day for DXY Friday whereby it made a new high but then reversed to close below the previous day’s low. This pattern suggests further losses near-term though for now, DXY is holding above Friday’s low. The euro is holding above $1.20 while sterling is trading near $1.37. USD/JPY is once again testing its 200-day moving average near 105.55 after failing to make a clean break Friday. While we are getting increasingly confident that the dollar can carve out a bottom in Q1, its recovery won’t be a straight line as the US data are likely to remain weak near-term. That said, the vaccine rollout here continues and should allow the US economy (and the dollar) to outperform in the coming months.

AMERICAS

The US curve continues to steepen to new highs. Our favored metric (3-month to 10-year) has risen to 117 bp, the highest since last March and nearing that month’s peak near 120 bp. The 2- to 10-year spread has risen to 109 bp vs. 80 bp at the start of this year and 0 bp in August 2019, and is the highest since April 2017 and nearing the December 2016 high near 134 bp. The steepening has so far not been disruptive as equity markets power higher and spread product continue to narrow. It would appear that the steepening is due to the “right” reasons (improved US economic outlook) than ”wrong” (excessive debt issuance).

Market appetite will be tested this week with heavy UST supply. US Treasury will sell $126 bln in total coupon debt this week, starting with $58 bln of three-year notes tomorrow. The last time we had a combination of heavy UST issuance and a steep yield curve was back in mid-January. That issuance was easily absorbed and US yields fell for several weeks, helped by strong foreign demand. Let’s see if history repeats. It will be a bit tougher given the growing momentum of the global reflation trade as vaccine roll-outs continue.

Inflation expectations continue to rise in the US. The 10-year TIPS breakeven inflation rate has risen to over 2.20%, reaching the highest since 2015. Treasury Secretary Yellen is doing her part, making the argument for a larger stimulus package to bring the economy back towards full employment. There are no US data reports today. Cleveland Fed President Mester speaks but she is not a voting member of the FOMC in 2021.

EUROPE/MIDDLE EAST/AFRICA

Mario Draghi’s chances of assembling a workable coalition for Italy are looking good. Reports suggest that he is getting ready to announce his potential cabinet and a confidence vote will take place soon after. Of note, Draghi will meet with business groups and trade unions to shore up their support. He has already received substantial support from major Italian parties from both sides, including the Lega on the right and Five Star on the left. Italian spreads are responding on cue, extending their dramatic narrowing against equivalent German bunds, with the 10-year spread falling to multi-year lows.

Germany reported soft December IP. It was flat m/m vs. 0.3% expected and a revised 1.5% (was 0.9%) gain in November. Eurozone IP will be reported next week and is expected to fall -0.5% m/m vs. a 2.5% gain in November. Given the lockdowns, we know that January data will be even worse.
Bank of England Governor Bailey speaks today and Wednesday and we look for some damage control. The 10-year Gilt yield rose 16 bp last week as the BOE pushed back against negative rates and started talking about tapering this year, and are up another 4 bp today. Sterling also gained against the euro last week. We think that was the wrong message to send to the markets right now. Yes, the UK vaccine rollout is going very well but the UK economy is still facing a hangover from Brexit (see below) on top of the current lockdowns.

UK truckers report that exports to the EU have fallen nearly 70% since Brexit. Road Haulage Association chief Burnett stressed “The current situation should not be considered a consequence of Covid. If anything, the absence of the pandemic would have made it worse, because volumes would be greater.” Burnett also said the number of customs brokers in place (so far an estimated 10k) are only about a fifth of the total needed to help UK firms with extra checks. Reports also suggest that 65-75% of the UK trucks returning from the EU are returning empty due to lack of goods to transport.

ASIA

The Lunar New Year holiday will be observed across much of Asia this week. China markets will close February 11 and reopen February 18. Taiwan will close February 10 and reopen February 17. Hong Kong will close February 12 and reopen February 16. Korea will close February 11 and reopen February 15. Singapore, Indonesia, Malaysia, Philippines, and Thailand will only close February 12.

China-Australia relations remain tense. The latest salvo was the formal arrest of an Australian TV anchor on espionage charges after months of detention. China’s Foreign Ministry said judicial authorities had concluded Cheng had “conducted illegal activities on supplying state secrets overseas” and so approved her arrest. So far, the economic impact has been limited as China has for the most part left its imports of Australian iron ore untouched by tariffs, focusing instead on agricultural goods that are of much lower value. In related news, China allowed some Australian coal stranded offshore to unload. However, officials stressed that the move was to allow crew members to disembark rather than to signal any loosening of its coal import curbs.

Taiwan reported January trade data. Exports jumped 36.8% y/y 25.1% expected and 12.0% in December, while imports jumped 29.9%% y/y vs. 24.3% expected and 0.9% in December. The y/y comparisons were flattered due to the timing of the Lunar New Year holiday, which fell in January last year. This means this February’s y/y comparisons will be distorted lower. That said, the underlying signal is one of solid growth, as export orders point to strong shipments into H2.

COMMODITIES AND ALTERNATIVE INVESTMENTS

Brent crude breached the $60 per barrel for the first time since January last year, despite the plot twist of a strengthening dollar. This is a clear sign that the cyclical reflation trade is re-instating itself and a testament to the dual engines of vaccine rollout and fiscal stimulus. It’s encouraging to see that risky asset prices (especially commodities and EM) can look through the dollar’s appreciation. The rally in oil is also being driven by declining global, and especially Chinese, stockpiles. Of note, the backwardation in the Brent curve continues to deepen, meaning that longer-dated futures are cheaper than shorter ones.

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