Dollar Firm as Central Banks Fight Rising Yields

February 26, 2021
• The Fed’s nonchalance regarding rising yields is noteworthy; indeed, markets are now pricing in odds of the first Fed hike coming in Q4 2022February Chicago PMI will be the data highlight; we got our second look at Q4 GDP yesterday; weekly jobless claims are worth discussing
• The ECB continues to jawbone rising yields; if actual bond purchases can’t stop yields from rising, mere jawboning will have little lasting impact; France and Spain gave us the first snapshots for February CPI
• Japan data came in better than expected; BOJ Governor Kuroda stressed steady policy to parliament; Australia yields continued to rise despite RBA intervention; BOK also joined in the bond purchase action to stabilize rising yields; India reports Q4 GDP data

Measures of implied volatility have started to rise quickly, especially in the US Treasury market. The MOVE index is at 74, a level not seen since last April. The VIX is back to its 1-year average, though the EuroStoxx equivalent index (V2X), hasn’t risen as much. G10 FX volatility is also picking up but remains comparatively more subdued.

Global fixed income markets remain at center stage, though yields have subsided a touch this morning in most major markets. The US 10-year yield reached a high of just over 1.6% yesterday, though it has fallen back below 1.50% at the time of this writing. German 10-year yields are at -0.25% and those in the UK at 0.82%. Australia was the exception, where yields continued to rise despite central bank intervention (see below). In the 10-year space, Australia is the worst performing major this week at +30 bp. New Zealand is close behind at +28 bp and Canada at +23 bp. Japan has held up the best at +3 bp, followed by Switzerland at +8 bp and Germany at +9 bp.

EM fixed income markets are also starting to feel the heat of rising global yields. Both local and hard currency debt are selling off. Using the Bloomberg-Barclays indices, the aggregate yield on local currency bonds are starting to move higher, now nearing 4%. In the 10-year space, Turkey is the worst performing in EM this week at +35 bp, followed by Brazil at +34 bp. Peru has held up the best at -25 bp, followed by Colombia at -9 bp and Indonesia at -5 bp. A similar dynamic goes for USD-based bonds, but current levels remain nowhere near what we had seen during the pandemic.

In the equity space, no major market has been spared. EM and the Nasdaq have been the greatest causalities, down about 7% and 5% over the last five sessions, respectively. As expected, the washout has hit crowed trades especially hard; Tesla’s stock, for example, was down 8% yesterday after substantial declines earlier in the week.

The dollar is getting some traction. It’s unclear how much of the recovery is being driven by risk off impulses and how much by rising expectations of Fed tightening (see below). Whatever it is, we are still confident that the dollar is carving out a bottom in Q1. DXY traded at a new low for this move near 89.692 yesterday but is seeing its biggest one day gain of 0.61% (so far) today since December 22. It is on track to test the February 17 high near 91.056 and a break above 90.869 would set up a test of the February 5 high near 91.602. The euro is on track to test the February 17 low near $1.2025, while sterling is on track to test that same day’s low near $1.3830. USD/JPY has recovered from its brief time below 105 and is trading at the highest level since August near 106.50. It is on track to test that month’s high near 107.05.



The Fed’s nonchalance regarding rising yields is noteworthy. Virtually every other central bank is pushing back both verbally and concretely. What makes the Fed so confident that the US economy can weather this move higher? For one, the vaccination program in the US, for all its problems, is still outstripping much of the world. This underpins a more optimistic growth outlook. The Fed keep saying that inflation is temporary but we sense some growing market skepticism. The upcoming March 16-17 is taking on much greater significance now, as it will allow the Fed to reset is messaging if bond markets force their hand.

Indeed, markets are now pricing in odds of the first Fed hike coming in Q4 2022. Previously, 2023 was penciled in. If that timetable continues to accelerate, the Fed may have to push back more forcefully on notions of tightening sooner rather than later. At the margin, enhanced Fed tightening expectations should help boost the dollar, as other central banks are likely to follow the Fed much, much later. 

February Chicago PMI will be the data highlight today. It is expected at 61.0 vs. 63.8 in January. So far, the regional Fed manufacturing indices have come in firm for this month. January advance goods trade (-$83.0 bln expected), wholesale and retail inventories, personal income (9.5% m/m expected) and spending (2.5% m/m expected), core PCE deflator (1.4% y/y expected), and final January University of Michigan sentiment (76.5 expected) will also be reported today. In particular, a softer core PCE reading would go a long way in helping to calm the bond market.

We got our second look at Q4 GDP yesterday. The economy grew 4.1% SAAR vs. 4.2% expected and 4.0% preliminary. However, this is old news and markets are already looking ahead to 2021. The Atlanta Fed’s GDPNow model suggests Q1 growth is 9.6% SAAR, while the New York Fed’s Nowcast model suggests Q1 growth is 8.3% SAAR. Both models will be updated today. Of note, Bloomberg consensus for Q1 is currently at 3.5% SAAR. 

Weekly jobless claims are worth discussing. Regular initial claims of 730k are the lowest since late November, while regular plus PUA initial claims are the lowest since December. Regular continuing claims of 4.419 mln are the lowest since March and are for the survey week containing the 12th of the month. So far, so good. The only negative is that emergency continuing claims edged up by nearly 1 mln to 12.58 mln but are for the week prior to the BLS survey week. All in all, the labor market is back on track to healing, albeit slowly. Consensus for NFP next Friday is 120k but more clues to come.



The ECB continues to jawbone rising yields. Today, Executive Board member Schnabel reiterated her recent comments that “A rise in real long-term rates at the early stages of the recovery, even if reflecting improved growth prospects, may withdraw vital policy support too early and too abruptly given the still fragile state of the economy. Policy will then have to step up its level of support.” Yesterday, Chief Economist Lane said the bank is keeping a close eye on yields and will use its asset purchases to counter any unwarranted tightening of financial conditions. Earlier in the week, President Lagarde said the ECB was “closely monitoring” nominal bond yields. Eurozone yields are modestly lower today.

If actual bond purchases in Korea and Australia (see below) can’t stop yields from rising, mere jawboning will have little lasting impact. If eurozone yields continue to rise, the ECB may have to step up its purchases and eventually increase the so-called envelope for PEPP again. At the December meeting, PEPP was increased by EUR500 bln and extended through at least March 2022. The March 11 meeting seems too soon for another increase but the ECB could set the table withs its updated macro projections.

France and Spain gave us the first snapshots for February CPI. In EU Harmonized terms, the former fell a tick to 0.7% y/y vs. 0.5% expected and the latter fell half a percentage point to -0.1% y/y vs. 0.5% expected. Germany reports CPI next Monday, where a steady reading of 1.6% y/y is expected. The eurozone reading comes out next Tuesday, which is expected to rise a tick to 1.0% y/y. Of note, France also reported weak January consumer spending today of -4.6% m/m vs. -4.0% expected.



Japan data came in better than expected.  January retail sales fell -0.5% m/m vs. -1.2% expected and -0.7% in December.  January IP, housing starts, construction orders, and February Tokyo CPI were also reported.  Both headline and core (ex-fresh food) inflation were expected at -0.4% y/y vs. -0.5% in January, and both came in at -0.3%.  IP rose 4.2% m/m vs. 3.8% expected and -1.0% in December.  There are no policy implications from the data.Indeed, Bank of Japan Governor Kuroda stressed steady policy to parliament.  He said today that “It’s important to keep the entire yield curve low and stable now as the pandemic deals a blow to the economy.  I want you to understand that we aren’t aiming to raise our target from around 0%.”  Speculation has been swirling that the bank could widen its target band for the 10-year JGB, but this month’s global bond rout should put that one to bed.  Widening the band now would simply invite more JGB selling and we do not think that is what the BOJ really wants right now.
Australia yields continued to rise despite central bank intervention. The RBA launched an unscheduled bond purchase worth AUD3 bln at the short end of the curve to maintain its 0.1% target for the 3-year yield.  The yield remains above the target even after the purchases while the long end of the curve exploded,  with the 30-year up 16 bp to nearly 3% and the 10-year up 17 bp to nearly 2% 
Bank of Korea also joined in the bond purchase action to stabilize rising yields. The BOK will buy the equivalent of $6.2 bln of government bonds through the first half of the year.  Still, local bond yields finished higher on the day.  At this week’s policy meeting, Governor Lee flagged the possibility of some action to help limit bond market volatility but stressed that it should not be considered QE.  If this is a one-off action, then Lee may have a point.  However, if the BOK is forced to lean continuously against the tide of rising yields, then that signals a stronger policy stance than just limiting volatility.  Only time will tell. 
India reports Q4 GDP data.  Growth is expected at 0.6% y/y vs. -7.5% in  Q3.  For 2020 as a whole, a contraction of -7.0% is expected vs. 4.0% growth in 2019.  After the massive fiscal stimulus package announced for the upcoming fiscal year, growth should pick up significantly.  At some point this year, we believe the RBI will add some more monetary stimulus too.  Next policy meeting is April 7 and a cut is possible if inflation continues to ease.  CPI rose 4.06% y/y in January, the lowest since September 2019 and near the middle of the 2-6% target range.   

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