Dollar Soft as Reflation Trade Returns

February 09, 2021
  • Reports suggest President Biden is likely to push through much of his aid proposal without Republican support; high yield corporate bonds are extending their rally; US Treasury will sell $58 bln of three-year notes; Mexico reports January CPI; Brazil reports January IPCA consumer inflation
  • ECB President Lagarde warned of growing downside risks; Germany reported December trade and current account data
  • Japan reported December real cash earnings and January machine tool orders; China’s aggregate financing numbers surprised on the upside; Bitcoin continues to rally to all-time highs

The dollar is giving up some of its recent gains as the reflation trade gets reinvigorated. The DXY is still holding above 90.5 but is well below the 91.6 high from last week. It has retraced nearly half of this year’s rally and a break below 90.123 would signal a move back to the January low near 89.209. In the G10 space, the Australian dollar and Norwegian krone have been outperforming with the commodity rally, while the euro and yen have been lagging. The euro is taking a peek above $1.21 while sterling continues its relentless rally to a new multi-year high near $1.38. USD/JPY is down nearly a full yen at 104.65 after failing yesterday to break above its 200-day moving average near 105.55. While we are increasingly confident that the dollar can carve out a bottom in Q1, this week’s price action suggests its recovery won’t be a straight line.


Reports suggest President Biden is likely to push through much of his aid proposal without Republican support. Comments from senior officials suggest they view the stimulus negotiations during the financial crisis as a cautionary tale. That aid is now widely considered to have been too small due to the concessions made in order to get some Republicans on board. However, it’s worth noting that the reconciliation process is nothing new. Indeed, the Republican-led Congress did the same thing to push through President Trump’s tax cuts back in 2017. Bottom line: the next relief bill is likely to be closer to $2 trln than it is to $1 trln and that may be one of the factors behind the recent resurgence in the Blue Wave reflation trade.

High yield corporate bonds are extending their rally, with the Bloomberg Barclays index now falling below 4% for the first time ever. The backdrop couldn’t be more favorable for this sector, with low rates everywhere fueling a global reach for yield along with official support from the Fed. According to Bloomberg, the sector had a record bond issuance in January, amounting to $52 bln, with the year to date volume at around $60 bln.

The US Treasury will sell $58 bln of three-year notes as part of $126 bln in total coupon debt this week. At the last 3-year auction in January, the bid to cover ratio was 2.52, 52.2% went to indirect bidders (representing foreign demand), and the yield was 0.234%. This will be followed by $41 bln of 10-year notes to be sold tomorrow and $27 bln of 30-year bonds to be sold Thursday. The last time the market had to absorb such a big slug of issuance was the large reopening during the week of January 11, which also happened to coincide with the last bout of US curve steepening. Back then, $58 bln of 3-year notes, $38 bln of 10-year notes, and $24 bln of 30-year bonds were easily absorbed by the market, with larger and larger chunks going to indirect bidders as the week progressed. Long rates subsequently fell and the curve flattened until just recently. Let’s see if history repeats.

Otherwise, it’s a quiet day in the US. December JOLTS job openings will be the only data reported and are expected at 6400 vs. 6527 in November. St. Louis Fed President Bullard speaks but he is not a voting member of the FOMC in 2021.

Mexico reports January CPI. Headline inflation is expected at 3.46% y/y vs. 3.15% in December. If so, it would be the highest since October but still within the central bank’s 2-4% target range. Banco de Mexico meets Thursday and is expected to cut rates 25 bp to 4.0%. Many see this as the end of the easing cycle but we are not convinced. December IP will also be reported Thursday and is expected to fall -2.2% y/y vs. -3.7% in November.

Brazil reports January IPCA consumer inflation. Headline inflation is expected at 4.61% y/y vs. 4.52% in December. If so, it would be the highest since May 2019 and moving closer to the top of the central bank’s 2.25-5.25% target range. The central bank opened the door for a tightening cycle at its January meeting and is likely to hike rates 25-50 bp at the next COPOM meeting March 17. December retail sales will be reported Wednesday and are expected to rise 5.5% y/y vs. 3.4% in November.


ECB President Lagarde warned of growing downside risks. She noted “The renewed surge in Covid-19 cases, the mutations in the virus and the strict containment measures are a significant downside risk to euro-area economic activity.” She added that “It remains crucial that monetary and fiscal policy continue to work hand in hand. Fiscal policy -– both at the national and at the European level -– remains crucial to bolster the recovery.” Next ECB meeting is March 11, when new macro projections will be released. These will most likely be marked down substantially due to the region’s failed vaccine rollout and subsequent lockdowns. While many believe the ECB is done adding stimulus, we are not yet convinced given the growing downside risks.

Germany reported December trade and current account data. Exports rose 0.1% m/m vs. -0.6% expected while imports fell -0.1% m/m vs. -2.0% expected. This was a pleasant surprise, as December real sector data so far for Germany had surprised to the downside. Perhaps the strong external data reflects strength in Germany’s major trading partners, while domestic data such as retail sales and confidence are lagging.


Japan reported December real cash earnings and January machine tool orders. Earnings fell -1.9% y/y vs. -3.4% expected and a revised -0.7% (was -1.1%) in November. Orders rose 9.7% y/y vs. 9.9% in December and was the third straight month of y/y gains. The orders data was a pleasant surprise, though y/y comparisons will be flattered this year by the low base from last year. For now, the Bank of Japan is on hold though markets await the results of its policy review at the March 18-19 meeting. The bank may have painted itself into a corner as it tries to tweak its programs without signaling premature withdrawal of stimulus. When all is said and done, we expect little of substance to emerge from the review.

China’s aggregate financing numbers surprised on the upside. The broad measure increased by CNY5.17 trln vs. CNY4.6 trln expected, while new loans rose by CNY3.58 trln vs. CNY3.5 trln expected. Both measures were nearly triple the December readings but due in part to seasonal factors. On the other hand, M2 growth is decelerating, falling from 10.1% y/y in December to 9.4% in January. With vaccines gaining traction, we expect the PBOC to start to pare back on its credit-fueled stimulus efforts. Indeed, the PBOC just warned that “The expansion of consumption should not rely on the development of consumer finance.” The bank should also continue its policy of allowing the yuan to appreciate and gently curbing credit to system, especially when directed towards real-estate and financial assets.


Bitcoin continues to rally to all-time highs. This most recent jump was prompted by yesterday’s news that Tesla has invested $1.5 bln in the crypto currency. It will also start accepting bitcoin as a form of payment for its cars. This follows CEO Elon Musk changing his twitter profile to include the Bitcoin symbol a few days back. But other factors remain supportive of demand for the asset as a store of value, especially concerns of rising inflation and debasement of the dollar.

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