Dollar Marches Higher, US Curve Steepens Ahead of Heavy Supply

March 08, 2021

The US curve continues to steepen to new highs; near-term inflation expecations in the US contiue to rise, but longer-dated measures have been lagging, which can be seen as a positive sign for the Fed; US bond market faces some serious challenges this week; President Biden’s stimulus plan enters the final stretch
The ECB releases details of its bond-buying operations; purchases have taken on more significance ahead of the ECB meeting Thursday; Germany reported weak January IP; BOE Governor Bailey sounded a cautious note; Bailey’s comments represent some belated pushback to the market reaction after its last meeting
JGB yields rose today; the selloff in Asian stocks continued with steep drops in Chinese indices; an attack on an oil export terminal in Saudi Arabia led to a spike in oil prices

The dollar continues to gain.  DXY traded today at the highest level since November 25 near 92.30 and is on track to test the November 23 high near 92.80 and then the November 11 high near 93.208.  The euro remains heavy near $1.1870 after the break below the February 5 low near $1.1950, which sets up a test of the November 23 low near $1.18 and then the November 11 low near $1.1745.  Sterling has found some support near $1.38 but remains heavy, and a break below that would set up a test of the February 4 low near $1.3565.  USD/JPY continues its march higher, trading at the highest level since last June near 108.65 and on track to test the June 5 high near 109.85.


The US curve continues to steepen to new highs.  Our favored metric (3-month to 10-year) has risen to 155 bp, the highest since 2017 and on track to test the December 2016 near 210 bp.  The 2- to 10-year spread has risen to 144 bp and is the highest since 2015 and on track to test the June 2015 near 176 bp.  The steepening has so far not been very disruptive as US equity markets remain near record highs and spread product hold up relatively well.  That said, EM as an asset class has suffered this most during this curve steepening and may end up being the canary in a coalmine for a wider sell-off in risk assets.  Stay tuned.

Near-term inflation expecations in the US contiue to rise, but longer-dated measures have been lagging, which can be seen as a positive sign for the Fed. Looking at breakeven rates, the 5-years continues to climb, now at 2.5% from about 1.9% at the start of the year. The 10-year and 30-year rates, however, are still hovering aroudn the 2.15-2.25% range, which is consistent with the Fed’s long-term inflation target. One way to look at this is to infer the market is buying into the notion of Average Inflation Targenting (AIT), by which the Fed will let inflation run hot for a while to compensate for the time in which it was below target. Eventually, all will be well and we will return to a stable level of inflation of around 2%.  This is how the Fed envisions it working but it remains to be seen whether markets go along quietly.
The US bond market faces some serious challenges this week.  Due to the media embargo, there are no Fed speakers today.  Indeed, there will be no speakers until Chair Powell’s post-decision press conference March 17.  In a sense, the markets are flying through potentially stormy weather with little guidance from air traffic control.  With a huge slug of new issuance coming this week along with February US inflation data that are expected to show accelerating inflation, there is potential for a perfect storm of rising UST yields that could spill over into global financial markets.  Today, only January wholesale trade sales and inventories will be reported.  

President Biden’s stimulus plan enters the final stretch.  After a full reading of the bill last week, the Senate began debate Friday and passed it over the weekend by a 50-49 vote.  It goes back to the House this week.  House Majority Leader Hoyer said it will be taken up Tuesday and House Speaker Pelosi said it will be passed.  Despite some income limits, $1400 checks will be sent to millions of Americans.  State and local governments will receive $350 bln in aid, extra $300 per week unemployment benefits will be paid through September 6, and healthcare access will be expanded.  Needless to say, this stimulus will goose the US economy even more but at a cost of heavier UST issuance in the coming months.


The ECB releases details of its bond-buying operations.  Bank officials continued to jawbone rising yields, though Weidmann took the other side and expressed little sense of urgency.  The previous week’s net purchases of EUR12 bln were the lowest since early January.  Even taking out the EUR4.9 bln in redemptions, gross purchases of EUR16.9 bln were the lowest since late January.  If ECB bond purchases picked up last week, then it would signal a stronger commitment to maintaining low yields.  Mere jawboning will have little lasting impact and so if eurozone yields continue to rise, the ECB will have to step up its purchases and eventually increase the so-called envelope for PEPP again. 

Bond purchases have taken on more significance ahead of the ECB meeting Thursday.  While it is expected to keep policy unchanged, the bank will have to address the issue of rising yields.  At the last meeting January 21, the bank sounded a bit more upbeat and that will have to be adjusted this week.  Official comments over the past couple of weeks have been at two ends of the spectrum and reflect ongoing dissension over what to do about rising yields.  Given the wide range of views on the need to take action, the bank will do what it usually does under these circumstances and that is….nothing.  We think it will take much more market pressure to get the ECB to pivot towards adding more stimulus.  However, the ECB could help set the table for a move later this year with a more bearish outlook.

Germany reported weak January IP.  It was expected to fall -0.4% m/m but instead plunged -2.5%.  December was revised to a 1.9% m/m gain from a flat reading previously.  Italy reports IP Tuesday (0.8% m/m expected), followed by France Wednesday (0.6% m/m expected).  Eurozone IP will be reported Friday and is expected to rise 0.3% m/m vs. -1.6% in December.  However, there are clear downside risks after the German data.

Bank of England Governor Bailey sounded a cautious note.  He warned that risks to the UK economy remain tilted to the downside.  Bailey stressed that the bank doesn’t intend to tighten monetary policy until there’s clear evidence the economy is absorbing excess capacity, and added that unemployment is likely to rise and remain higher a year from now.  Bailey noted “There is a growing sense of economic optimism in markets and in consumer and business measures.  A note of realism though. Our latest forecast painted a picture of an economy that starts at a lower level of activity.” The comments are noteworthy ahead of the BOE meeting next week. 

Indeed, we think Bailey’s comments represent some belated pushback to the market reaction after its last meeting.  At the February 4, the bank delivered a less dovish than expected hold.  It pushed back against the need for negative rates whilst presenting an upbeat growth outlook.  Deputy Governor Ramsden went so far as to say he envisions slowing the pace of QE later this year.  The threat of negative rates had helped keep the UK curve flat and the market perceived that as being off the table.  Now it's stuck with a steeper yield curve (up 30-50 bp across the curve) and firmer sterling (1.5% vs. USD nearly 3% vs. EUR) and that's going to be a headwind for the economy. 


JGB yields rose today.  The 10-year yield rose 3 bp to 0.12% while the 30-year rose 3 bp to 0.69%.  After BOJ Governor Kuroda seemingly shot down any notions of adjusting its YCC, JGB yields sank sharply last week.  It appears that the market may the bank’s resolve ahead of its meeting March 18-19.  That said, policymakers should be very happy with the recent yen weakness that has come along with the flatter curve, so why rock the boat now?  We are becoming more and more convinced that markets are waiting for what is likely to be a largely toothless policy review that maintains the status quo.  Japan reported an adjusted JPY1.5 trln surplus in January vs. JPY2.2 trln expected.

The selloff in Asian stocks continued with steep drops in Chinese indices. The tech heavy ChiNext index fell 5% and the CSI300 fell 3% and has now erased the gains for the year. The moves are in part following the global trend lower in the more crowded growth equity plays, including the US tech sector.  However, the selloff also reflects continued warnings by Chinese regulators about the froth in local assets and parts of the property sector.  Lastly, the diplomatic tensions between the US and China are starting to rise again. Chinese officials made some strong comments about the US approach to Taiwan, saying the new administration was “crossing lines and playing with fire.”
China’s annual NPC meeting started on Friday and set a comparatively low growth target of “above 6%.” Contrary to some observers, we don’t draw any negative inference from this as the 6% figure represents a floor in the growth target. It’s more conservative than many expected, but the message on employment is still robust enough. We maintain our view that tapering of stimulus is in the works and it will be gentle so as not to be disruptive to domestic and global growth.


An attack on an oil export terminal in Saudi Arabia led to a spike in oil prices. Brent spiked above $71 per barrel, a level not seen in January mid-2019. Prices have since edged lower but are likely to remain high as supply risks rise at a time of very tight supply.  The attack, purportedly conducted by Iran-backed Houthi rebels in Yemen, was conducted via drones and it didn’t impact production facilities. As one should expect, the already deep backwardation in the Brent curve has deepened further as spikes in short-term prices far outpace that in the back end.

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