Dollar Firms Modestly as Risk-Off Impulses Build

February 23, 2021
  • The main event will be Fed Chair Powell’s semi-annual testimony before the Senate Banking Committee; Fed manufacturing surveys for February will continue to roll out; the rise in US yields hasn’t yet had a significant impact on the corporate bond market, but outflows from high-yield ETFs are picking up; Brazil asset prices continue to suffer from the repercussion of President Bolsonaro’s decision to fire Petrobras’ CEO
  • ECB President Lagarde made an unusual comment about the yield curve; UK reported weak labor market data; Chancellor Sunak is under great pressure to deliver more relief for labor and small businesses in his March 3 budget; Hungary is expected to keep rates steady at 0.6%.
  • Japan may end the state of emergency in six prefectures at month-end; 3-year Australian government bond yields remain above the 0.10% target; Australia reported weak preliminary January merchandise trade data

The dollar is getting some limited traction as risk-off impulses pick up. DXY is up modestly today after three straight down days and trading at a new cycle low near 89.943. The clean break below 90.123 yesterday sets up a test of the January low near 89.209. The euro broke above last week’s high near $1.2170 to trade at the highest level since January 25, while sterling made a new high for this move near $1.41 and remains on track to test the April 2018 high near $1.4375. However, both moves have stalled out. USD/JPY traded below 105 and remains heavy. The break below 105.10 sets up a test of the February 10 low near 104.40. We are still confident that the dollar is carving out a bottom in Q1, but recent price action suggests its recovery path won’t be a straight line.

AMERICAS

The main event will be Fed Chair Powell’s semi-annual testimony before the Senate Banking Committee. While typically a ho-hum affair, we think recent events will put Powell under great pressure to try and soothe markets. There's no doubt that yield curve steepening worldwide is starting to spill over into other asset markets and the last thing we need right now is a full-blown bond and equity market sell-off. Markets are nervous, with equities mostly lower this week. We expect Powell to underscore the Fed’s current messaging. That is, the recovery continues, risks remain, higher inflation is temporary, and any talk of withdrawing accommodation would be premature. He appears before the House Financial Services Committee tomorrow.

Fed manufacturing surveys for February will continue to roll out. Richmond Fed is expected at 16 vs. 14 in January, while Kansas City reports Thursday and is expected at 15 vs. 17 in January. So far, Dallas Fed came in at 17.2 vs. 7.0 in January, Philly Fed came in at 23.1 vs. 26.5 in January, and Empire survey came in at 12.1 vs. 6.0 in January, all stronger than expected. The strong US data continue to roll in with little benefit to the dollar. At some point, stronger growth and higher yields should help the dollar but we're not there yet, it seems. December S&P CoreLogic house prices and February Conference Board consumer confidence (90.0 expected) will also be reported today.

The rise in US yields hasn’t yet had a significant impact on the corporate bond market, but outflows from high-yield ETFs are picking up. The yield on the HY index is still hovering around the 4% level, with higher risk segments such as energy holding up well. However, the sector’s main ETFs have seen huge outflows of about $1 bln (worth 10%) over the last few days, according to Bloomberg. Similarly, the IG ETF LQD saw an outflow of $7.4 bln (from a $46 bln market cap) over the last six weeks.

Brazil asset prices continue to suffer from the repercussions of President Bolsonaro’s decision to fire Petrobras’ CEO. The move implies a turn away from the reform agenda that markets (and we) hoped would be enacted after the race for the lower house speaker position was completed. With his popularity once again falling after the Covid bounce, it seems as if Bolsonaro is taking a sharp turn towards populism and interventionist policies. We expected this to occur as his re-election approached, but not this early. The impact has been widespread, including a 20% decline in Petrobras stock price, a steepening of the local yield curve, a weaker BRL, and a move higher in Brazil’s sovereign CDS.

EUROPE/MIDDLE EAST/AFRICA

ECB President Lagarde made an unusual comment about the yield curve yesterday. She said the ECB is “closely monitoring” the government bond market. This goes without saying, but the implication here is a greater risk of intervention to keep yields from rising. At this point, jawboning is all that we’ll see as we believe the bar is very high (though not as high as in the FX market) for any overt action to suppress longer-dated yields. We doubt policies such as yield curve control would be implemented without evidence that higher rates are being transmitted to consumers and banks. Indeed, YCC is really QE on steroids and we know ECB policymakers are very much split on the need for more QE. Also, if the yield curve is steepening due to rising inflation expectations, isn’t that a good thing for a region that has been battling deflation for years and years?

UK reported weak labor market data. Employment for the three months ending in December slumped -114k vs. -30k expected and-88k previously. This pushed the unemployment rate up a tick to 5.1%, the highest rate since March 2016. The weakness comes despite aggressive government measures to support the labor market. CBI also released the results of its distributive trades survey for February, with retailing reported sales at -45 vs. -40 expected and -50 in January.

Chancellor Sunak is under great pressure to deliver more relief for labor and small businesses in his March 3 budget. Recent data is likely to prove supportive. Sunak said “At the budget next week I will set out the next stage of our plan for jobs, and the support we’ll provide through the remainder of the pandemic and our recovery.” He clearly recognizes that support will be needed even after the UK reopens. Prime Minister Johnson yesterday outlined a four-step plan that gradually lifts restrictions. Sunak’s plan is likely to follow a similar step-wise process so that there are no cliff-edge risks.

National Bank of Hungary is expected to keep rates steady at 0.6%. CPI rose 2.7% y/y in January, remaining at the cycle lows and in the bottom half of the 2-4% target range. However, the bank has warned that inflation may temporarily rise above target in H1. This suggests the bank is unlikely to tighten policy in reaction to this acceleration unless it turns into something more than temporary.

ASIA

Japan may end the state of emergency in six prefectures at month-end. With virus numbers falling, this would allow them to reopen a week earlier than the planned March 7. Governors from the Tokyo area said they were concerned that improvements in the numbers had slowed and so they will not end the state of emergency early. However, Kyoto, Osaka, Hyogo, and Aichi are among those that may see the state of emergency end early. A final decision is expected by this Friday. While obviously good news, the extended lockdowns mean that Q1 is basically a lost quarter for the economy. Blomberg consensus sees a -5.1% q/q contraction, followed by 6.1% q/q growth in Q2.

3-year Australian government bond yields remain above the 0.10% target. Yet the RBA was absent from the market after buying bonds yesterday for the first time since early December. It is only a matter of time before the bank comes in again. The RBA just boosted its QE program by AUD100 bln at this month’s meeting and extended it to September. Since the February 2 meeting, the Australian yield curve has steepened sharply, with 20- and 30-year yields up nearly 40 bp and 12- and 15-year yields up nearly 45 bp. Furthermore, AUD has been the top performing major currency over the same period, up nearly 4% vs. USD. Next meeting is March 2 and the RBA will likely have to push back stronger against these curve steepening and AUD strengthening trends.

Australia reported weak preliminary January merchandise trade data. Exports fell 9% m/m, driven largely by a 10% drop in iron ore shipments. The ABS noted that “Despite the decline, exports of metalliferous ores are the second highest on record behind December 2020.” A 39% drop in meat shipments and an 8% fall in coal exports also drove the overall export decline. Imports of goods slumped 10% in January. We know that the strong AUD is very much on the RBA’s radar screen, and it has acknowledged that keeping rates low via QE is helping to prevent further strength.  

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