Dollar Builds on Gains as Markets Calm

March 01, 2021
All eyes are on the US bond market this week; the dollar is the missing piece of the reflation trade as it builds on its Friday turnround; this week offers Fed officials a final opportunity to hone their message to the markets; February ISM manufacturing PMI will be the data highlight

• The ECB releases details of its bond-buying operations for last week; Germany reports February CPI; firm final eurozone February manufacturing PMI readings were reported

• BOJ stand ready to maintain YCC ahead of the policy meeting March 18-19; RBA announced a substantial increase of its YCC efforts by increasing the amounts and maturities of its purchases; the drama comes ahead of the RBA meeting tomorrow; Caixin reported softer China manufacturing PM; IHong Kong’s Hang Seng Index is overhauling its weightings and composition; Korea reported firm February trade data; crypto currencies have had a wild ride over the last few sessions

The dollar is building on its gains. DXY is trading at the highest level since February 8 and is on track to test 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 last week and is trading at the highest level since August near 106.75 and is on track to test that month’s high near 107.05.

All eyes are on the US bond market this week. The meltdown Thursday appears to have been exaggerated by some forced liquidation of bond positions. USTs came roaring back Friday, with 10-year yields closing the week at 1.40% vs. the 1.61% high Thursday and 30-year yields closing the week at 2.15% vs. the 2.39% high Thursday. However, those yields are higher today at 1.45% and 2.22%, respectively, while global equity markets are clawing back some of Friday’s losses. Bottom line: we believe much of the reflation trade remain intact, including higher equities and lower bonds. 
The dollar is the missing piece of the reflation trade as it builds on its Friday turnround . That 0.83% daily gain in DXY was the largest since March 30. 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). That may become clearer this week but whatever it is, we are still confident that the dollar is carving out a bottom in Q1. 
This week offers Fed officials a final opportunity to hone their message to the markets. With the March 16-17 FOMC meeting approaching, the Fed media embargo goes into effect at midnight Friday, after which there will be nearly two weeks of radio silence. Williams, Brainard, Bostic, Mester, and Kashkari speak today. So far, the “what, me worry?” mantra has not been taken well by the markets and we think it needs to be refined if this current calm in the bond markets is to be maintained. Of note, markets are now pricing in odds of the first Fed hike coming in Q4 2022. This compares to the Fed Dot Plot that suggests steady rates through 2023.
February ISM manufacturing PMI will be the data highlight today. It is expected at 58.6 vs. 58.7 in January. ISM services PMI then comes out Wednesday and is expected at 58.6 vs. 58.7 in January. The employment components for both will be watched closely for clues to NFP, where consensus has steadily crept up to 180k currently. January construction spending will also be reported today and is expected to rise 0.7% m/m. Elsewhere, Canada reports Q4 current account data and February Markit manufacturing PMI.

The ECB releases details of its bond-buying operations for last week. Of note, the ECB bought EUR17.2 bln for the week ending February 19, around the same amount that it’s been buying for some time now. Bank officials continue to jawbone rising yields. However, if actual ECB bond purchases picked up last week, it would signal a much stronger commitment to maintain low yields. If eurozone yields continue to rise, the ECB will have little choice but to step up its purchases. This would support our ling-standing call that the ECB will 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 is clearly too soon for another increase but the ECB could set the table withs its updated macro projections. Guindos, Makhlouf, and Villeroy speak today and we expect more jawboning this week if eurozone yields remain elevated.

Germany reports February CPI. A steady EU Harmonized reading of 1.6% y/y is expected. However, the state readings seen so far today suggest some upside risks to the national number. The eurozone reading comes out tomorrow, which is expected to remain steady at 0.9% y/y. Of note, France and Spain reported their CPI readings last week. 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. The ECB has already signaled that it sees any acceleration in inflation as temporary and thus will have no policy implications. 

Firm final eurozone February manufacturing PMI readings were reported. The headline PMI rose a couple of ticks from the preliminary to 57.9. France improved sharply to 56.1 from 55.0 preliminary, while Germany rose a tick to 60.7. Spain and Italy improved significantly from January to 52.9 and 56.9, respectively. Final eurozone services and composite PMIs will be reported Wednesday. Elsewhere, the final UK manufacturing PMI rose a couple of ticks to 55.1.

Bank of Japan officials reportedly stand ready to maintain YCC ahead of the policy meeting March 18-19. Focus has turned to the BOJ during this period of rising global yields, even though the 10-year JGB yield is trading just below the top of the -0.2% to +0.2% target range. Reports suggest officials are prepared to act even before the target is breached, noting that action depends on the speed of the rise in rates, the level of rates, the reasons behind the rise, and the state of global financial markets. Although the economy is likely to contract in Q1, the Bank of Japan is likely on hold for now. Simply put, the bank is in a bind and cannot tinker with its YCC program when long rates are rising. Neither can it cut rates more negative and so we are left expecting superficial changes to its policies. 
The RBA announced a substantial increase of its YCC efforts by increasing the amounts and maturities of its purchases. The bank can now spend AUD4 bln (double the original amount) in purchases between maturities of 2024 to 2028. In other words, the RBA is moving fast towards a broader yield curve control policy, and the eyes of the finance world are upon it. The RBA seems to have won this latest round, with yields falling sharply across the curve, though still not far from their cycle highs. After peaking above .80 last week, AUD reversed sharply Friday to trade at the weakest level since February 8. Despite today’s bounce, the currency appears on track to test the February low near .7565 and we believe that the RBA will be quite content with recent weakness.

The drama comes ahead of the Reserve Bank of Australia meeting tomorrow. With today’s announcement, the RBA is clearly pushing back harder at the continued rise in interest rates. However, it could outline its plan more forcefully by officially targeting longer maturities beyond 3-year bonds currently. The RBA will likely pledge stronger action to maintain YCC and promise to increase QE as needed in the coming months. One extreme possibility is that the RBA does what the BOJ did and simply drop any numerical limits on QE. Under pure YCC, purchases should be flexible and open-ended, not numerically limited. This would be a much stronger statement from the bank, though it will not really involve any operational changes to the YCC program. 
Caixin reported softer China manufacturing PMI. It is expected at 51.4 vs. 51.5 in January. China reported softer official February PMI readings over the weekend. Manufacturing came in at 50.6 vs. 51.0 expected and 51.3 in January, while non-manufacturing came in at 51.4 vs. 52.0 expected and 52.4 in January. As a result, the composite fell to 51.6 from 52.8, the lowest since February. Caixin services and composite PMI readings will be reported Wednesday, with services expected at 51.5 vs. 52.0 in January. For now, we regard this as a healthy cooling off for the accelerated post-pandemic recovery, removing some pressure from the PBOC to start reining in liquidity.

Hong Kong’s benchmark Hang Seng Index is overhauling its weightings and composition. The index will now increase the number of companies by 28 to 80 and will limit each constituent’s weight to 8% from 10% currently. The review and implementation will start as early as May and will go on through mid-2022. The changes will reduce the relative weights of property and financial sector stocks and will lead to some forced selling.

Korea reported firm February trade data. Exports rose 9.5% y/y vs. 10.9% expected and 11.4% in January, while imports rose 13.9% y/y vs. 15.1% expected and 3.6% in January. As we’ve noted before, the strength is noteworthy as the timing of the Lunar New Year holiday will boost y/y readings for January and depress those for February. Both months were strong and this bodes well for regional trade and activity.

Crypto currencies have had a wild ride over the last few sessions. After making a high of over $58K on February 21, bitcoin fell to low of $43K over the weekend before recovering to just over $47K now. The downdraft led the gigantic Grayscale bitcoin trust to trade with a discount to NAV for the first time, compared to its usual premium of around 20%. The short term volatility seems to be linked in part to the broader risk-off move, especially in tech stocks. Several observers have argued that crypto currencies share part of its investor base with participants in high volatility equity sectors such as Tesla and the ARK funds. That said, reports on chain fundamentals remain supportive for Bitcoin, as well as the hugely successful launch of an ETF in Canada and the narrative of growing corporate adoption. Lastly, investors also got some positive news from the favorable settlement of Bitfinex and Tether with the office of the NY Attorney General last week for a relatively small fine of $18.5 mln and the requirement of greater transparency in managing its reserves.

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