Dollar Marches Higher as US Economic Momentum Builds

March 02, 2021

The US economy is gathering momentum in Q1; Democratic lawmakers are moving ahead with a relief package that does not contain a minimum wage provision; Senator Warren unveiled her proposal for a wealth tax
ECB released details of its bond-buying operations; Villeroy expressed concerns but without any concrete action, they ring hollow; eurozone reported February CPI; Germany reported very weak January retail sales and February unemployment; reports suggest that Germany will extend a broad lockdown until March 28
RBA kept all policy settings unchanged, as expected; without a stronger official commitment to YCC, we think markets will continue to test the RBA; RBNZ reminded us of its dovish credentials too; the risk-on mood was tempered in part by comments from China’s regulators about the risk of bubbles in financial markets

The dollar continues to gain.  DXY is trading at the highest level since February 5 and is on track to test that day’s high near 91.602.  Break above that would set up a test of the November 23 high near 92.80.  The euro traded below $1.20 for the first time since February 5 and is on track to test that day’s low near $1.1950.  Sterling is holding up a bit better but is on track to test the February 17 low near $1.3830.  Break below that would set up a test of the February 4 low near $1.3565.  USD/JPY continues its march higher and is trading at the highest level since August near 106.95, just below that month’s high near 107.05.  After that comes the July high near 108.15.


The volatility in the US Treasury market seem to be subsiding but the yield curve is still very steep. The 10-year yield is up a bit over the last two sessions, but only by a few bp to 1.44% and well below last week’s high near 1.61%.  The 3-month to 10-year curve is at 142 bp vs. last week’s high near 1.49 bp, while the 2- to 10-year curve is at 132 bp and is nearing last week’s high near 135 bp.  US futures are showing a modestly lower open, while European stock markets are mostly higher near midday.

The US economy is gathering momentum in Q1.  February ISM manufacturing PMI came in at 60.8 vs. 58.9 expected and 58.7 in January and was the highest since May 2004.  The   employment sub-index rose to 54.4 vs. 52.6 in January and is another positive clue for Friday’s jobs data.  Other details were strong, with new orders rising to 64.8 from 61.1 in January and prices paid rising to 86.0 from 82.1 in January, the highest since 2008.  ISM services PMI comes out Wednesday and is  expected at 58.6 vs. 58.7 in January.  Of note, the Atlanta Fed’s GDPNow model suggests Q1 growth is 8.8% SAAR, while the New York Fed’s Nowcast model suggests Q1 growth is 8.68% SAAR.

Today is a quiet day for the US. Only February auto sales will be reported and are expected at a 16.0 mln annual rate vs. 16.63 mln in January.  Brainard and Daly speak. For now, Fed officials are sticking with their “what, me worry?” stance and markets have calmed a bit. However, this drama is by no means over and we fully expect volatility to pick up again in the coming days.  If we get a solid jobs report Friday (consensus is 188k), the long end of the US curve will likely sell off again and this will come just as the Fed media embargo kicks in for the March 16-17 FOMC meeting.  Elsewhere, Canada reports December and Q4 GDP data and are expected at -3.0% y/y and +7.3% annualized, respectively. 

Democratic lawmakers are moving ahead with a relief package that does not contain a minimum wage provision.  The House passed the measure over the weekend and it now goes to the Senate.  Majority Leader Schumer said the chamber will take up the matter after confirmation hearings for Biden’s cabinet picks are held Monday and Tuesday, and aims to pass it by March 14.  Last week, the Senate parliamentarian ruled that a minimum wage provision could not be passed under so-called budget reconciliation, meaning it would need 60 votes to pass.    

Elsewhere, Senator Warren unveiled her proposal for a wealth tax.  The so-called Ultra-Millionaire Tax Act would levy a 2% annual tax on households and trusts worth between $50 mln and $1 bln.  All net worth over $1 bln would be taxed 3% annually.  Warren claims the tax would generate at least $3 trln in revenues over ten years, citing a study by two economists from UC-Berkeley.  The plan is highly unlikely to pass but perhaps serves as a marker for Warren and the progressive wing of the Democratic Party.  Of note, President Biden has not endorsed a wealth tax.


The ECB released details of its bond-buying operations.  Despite expressing concerns about rising yields, the ECB slowed its pace of bond buying last week.  PEPP purchases totaled EUR12 bln vs. EUR17.2 bln the previous week and EUR17.1 bln the week before that.  The ECB said that the drop in net purchases was due to higher redemption, but the reason really doesn’t matter to us.  Jawboning needs to be backed up with action and we got inaction.  We fully expect the market to test the ECB's resolve by taking yields higher in the coming days.  Indeed, 10-year eurozone yields are higher on the day, with Italy leading the pack, up 5 bp.

ECB Governing Council member Villeroy expressed concerns but without any concrete action, they ring hollow.  Yesterday, he said the ECB “can and must react” to any tightening of eurozone financial conditions and should take advantage of the PEPP’s flexibility.  He added that the ECB could possibly lower its deposit rate, currently at -0.5%.  However, a quick glance at WIRP shows the market really doesn’t see this as a likely option. 

The eurozone reported February CPI.  Headline remained steady at 0.9% y/y while core eased to 1.1% y/y vs. 1.4% in January, both as expected.  The headline reading remains the highest since last February and could move higher as energy prices remain elevated.  However, the ECB has already signaled that it sees any acceleration in inflation as temporary and so today’s CPI data really had no policy implications either way. Indeed, the bank is very likely alarmed by further signs of weakness in the real sector (see below), as the pandemic continues to weigh in activity.
Germany reported very weak January retail sales and February unemployment.  Sales were expected to rise 0.3% m/m vs. -9.1% in December, but instead plunged -4.5% m/m.  Unemployment was expected to fall -10k vs. a revised -37k (was -41k) in January, but instead rose 9k.  Eurozone retail sales will be reported Thursday and are expected at -1.3% m/m vs. 2.0% in December.  There are clear downside risks here, as France reported weak January consumer spending last week of -4.6% m/m vs. -4.0% expected.   

Reports suggest that Germany will extend a broad lockdown until March 28.  Chancellor Merkel and the 16 state premiers will hold talks today to lay out the path towards reopening and reports are coming from the draft proposals to be considered.  Some restrictions on household gatherings may be partially eased, but restaurants, gyms, and non-essential stores would remain closed.  This means that Q1 will most certainly be a lost quarter in terms of growth for Germany as well as the eurozone.  In turn, this underscores our view that the US dollar and US economy will likely outperform in Q1 and Q2.


Japan reported January jobs data.  The jobless rate remained steady at 2.9% instead of rising to 3.0% consensus, while the jobs-to-applicant ratio jumped to 1.10 vs. the 1.06 consensus.  That ratio is the highest since last June.  Q4 capital spending and company profits data were also reported, with the former coming in at -4.8% y/y vs. -10.6% in Q3 and the latter coming in at -0.7% y/y vs. -28.4% in Q3.  While capital spending was better than expected, it’s the third straight quarter of contraction and four of the past five.  This bodes ill for growth and although the economy is likely to contract in Q1, the Bank of Japan is likely on hold for now. 

The RBA kept all policy settings unchanged, as expected.  The bank still thinks rate hikes won’t be  seen until 2024 “at the earliest” given subdued wage pressures are offsetting the impact of the recovery. Governor Lowe said “The bank is prepared to make further adjustments to its purchases in response to market conditions.”  We thought it was possible that the RBA would officially extend its YCC beyond the 3-year space today but it appears that it wants to maintain a more flexible approach and buy longer-dated bonds opportunistically.  Either way, the RBA will very likely have to expand and extend QE again, just as it did at the February meeting.  One extreme possibility going forward 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 is a much stronger statement from the bank, though it would not really involve any change to the YCC program. 

Without a stronger official commitment to YCC, we think markets will continue to test the RBA.  Indeed, markets resumed putting  upward pressure on longer-dated yields today, with the 10-year up 5 bp to 1.70% and the 30-year up 6 bp to 2.65%.  While far short of last week’s highs, the upward creep in longer-dated yields will lead the RBA to come in again in the coming days or weeks.  Of note, the 3-year yield remains below the target of 0.1%. The Australian dollar has depreciated nearly 2% over the last five sessions, underperforming most other major currencies.
Reserve Bank of New Zealand reminded us of its dovish credentials too. Assistant Governor Hawkesby said the bank can cut the cash rate further if needed.  He also noted “pockets of dysfunction” in the local bond market last week and can increase its weekly bond purchases if needed to keep yields low. He said the recovery is stronger than many others are experiencing and yet it remains uneven and fragile while the outlook is muted.  Lastly and perhaps most importantly, Hawkesby stressed that its policy remains focused on inflation and employment, noting that the government’s request that the RBNZ consider “the impact on housing when making monetary and financial policy decisions” simply underscores that macroprudential policy will be the bank’s main instrument to do so.  Next policy meeting is not until April and we need to see how local bonds are trading beforemaking any call.

The risk-on mood was tempered in part by comments from China’s regulators about the risk of bubbles in financial markets. The chairman of the China Banking and Insurance Regulatory Commission said he was “very worried” that major economies could face a correction “sooner or later.”  He added that “From a banking and insurance industry’s perspective, the first step is to reduce the high leverage within the financial system.”  The comments support our view that PBOC will normalize policy sooner rather than later in order to address bubble risks locally and helped reverse earlier gains for the EM Asia indices, which closed today’s session mixed.

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