Dollar Rally Takes a Breather

March 09, 2021
  • The US fiscal stimulus narrative is by no means over; US 10-year yields are off their recent highs, now around 1.52%; volatility in the bond markets comes alongside US Treasury issuance this week; it was a perfect storm for Brazil; Mexico reports February CPI
  • The ECB released some details of its latest bond-buying operations; European corporate bond markets barely registered the volatility in the US markets; Italy reported firm January IP
  • Japan reported a slew of data; BOJ Deputy Governor Amamiya said the bank’s ability to cut rates further remains an important policy option; Junko Nakagawa was nominated to the BOJ board; reports of state-backed funds used to stabilize China’s cratering equity markets weren’t enough to turn major indices around

The dollar is taking a breather. DXY traded today at the highest level since November 24 near 92.50 but fallen back and may end lower today for the first time since last Tuesday. Some consolidation is to be expected but we believe DXY is on track to test the November 23 high near 92.80 and then the November 11 high near 93.208. The euro is trading around $1.19 but the recent break below the February 5 low near $1.1950 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 a break below that would set up a test of the February 4 low near $1.3565. USD/JPY traded above 109 today for the first time since last June. While it has since fallen back, the pair remains on track to test the June 5 high near 109.85.



The US fiscal stimulus narrative is by no means over. Reports suggest the House may pass the $1.9 trln stimulus bill as soon as today. Yet markets are already looking ahead to President Biden’s next initiative, which is the long-awaited infrastructure plan. It is shaping up to be more than just infrastructure, however. Reports suggest it will address climate change, health care, income equality, and other areas under the umbrella of long-term structural investments. Given the razor-thin margins for this week’s bill, we suspect that Biden’s wish list will be whittled down by the moderates in his party. The bottom line, however, is that more fiscal spending is coming later this year and that should keep the economy humming well into H2.

US 10-year yields are off their recent highs, now around 1.52%. Yesterday’s intra-day high was around 1.62%. The curve also flattened a bit, with the 3-month to 10-year near 149 bp and the 2- to 10-year near 137 bp. Real yields and breakeven inflation rates seemed to have stabilized, albeit at elevated levels. And importantly, the Fed can still take comfort from seeing longer dated inflation expectations below shorter-dated measures, and still not far off from the target.

Volatility in the bond markets comes alongside US Treasury issuance this week. Things kick off with a $58 bln 3-year note auction today. Keep an eye on indirect bidders, which largely represent foreign buyers. At last month’s 3-year auction, this share was 52.7% while the bid-to-cover ratio was 2.39. If the demand metrics deteriorate this week for any of the auctions, then things are likely to get messy.

It was a perfect storm for Brazil. On the heels of the unfavorable Petrobras management change and amid a global risk off moment, markets were rattled by news that a Supreme Court Judge annulled former President Lula’s criminal conviction. This clears the way for him to run in the next presidential elections. From what we can tell, this decision isn’t yet final, but it unlocks another major vector of political risk at a time when Brazilian assets are already out of favor. The real was down 2.5% against the dollar yesterday, closing above the 5.80 level for the first time since May last year. The Bovespa index fell -4% and yields rose by as much as 35 bp across the local swap curve.

Mexico reports February CPI. Headline inflation is expected at 3.75% y/y vs. 3.54% in January. If so, it would be the highest since October and nearing the top of the 2-4% target range. In its quarterly inflation report last week, the bank sees inflation ending the year at 3.6% after peaking at 4.5% in Q2. If inflation is indeed transitory as the bank expects, then another 1-2 cuts are possible. Next Banxico meeting is March 25 and another cut so soon after the February one seems unlikely, especially if the peso remains under pressure. USD/MXN is testing a key level near 21.50 and a clean break above sets up a test of the September higher near 22.70.



The ECB released some details of its latest bond-buying operations. For the week ending March 5, net purchases fell to EUR11.9 bln from $12.04 bln the previous week, a new low since early January. ECB will release more details today, including the amount of offsetting redemptions. These appear to have been significant as the bank noted “Recently there have been large redemptions which lower the net purchases and temporarily delay the increase in our stock of bonds.” There were EUR4.9 bln in redemptions the previous week, but gross purchases of EUR16.9 bln were still the lowest since late January. 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 later this year. These developments will add some drama to the ECB meeting Thursday, and we will be putting out a preview later today.

European corporate bond markets barely registered the volatility in the US markets. The Itraxx indices remain near record tight levels with the cross-over (HY) at 257 bp, the sub-financials at 107 bp, and the IG at 50 bp. Granted, the US IG and HY indices haven’t widened that much either, but it’s still surprising how resilient the entire corporate bond markets have been to what seemed like perfect catalyst for stress. In any case, we suspect that the European corporate sector will continue to outperform. Even though the recovery in the US will move ahead of that in the EU given the vaccine rollout, which is good for corporate balance sheets, the risk of an outsized move higher in sovereign yields is much lower in Europe. Moreover, the ECB will lag far behind the Fed in removing accommodation.

Italy reported firm January IP. It rose 1.0% m/m vs. 0.8% expected, while December was revised to +0.2% m/m from -0.2% previously. This will be followed by France tomorrow, where a gain of 0.6% m/m is expected. Yesterday, Germany reported January IP at -2.5% m/m after a flat reading in December. Eurozone IP will be reported Friday and is expected to rise 0.3% m/m vs. -1.6% in December. German trade data was mixed, with exports up 1.4% m/m vs. -1.8% expected and imports down -4.7% m/m vs. -1.9% expected.



Japan reported a slew of data. January real cash earnings fell -0.1% y/y vs. -0.7% expected and -1.7% in December, which helped drag household spending down -6.1% y/y vs. -2.1% expected and -0.6% in December. Final Q4 GDP growth came in at 11.7% SAAR vs. 12.6% preliminary. Business spending picked up but was offset by inventories. Lastly, February machine tool orders surged 36.7% y/y vs. 9.7% in January. Despite the firm Q4, we know Q1 is a lost cause and so we are left looking ahead to Q2. Restrictions have largely ended, though the Tokyo area state of emergency was just extended for two weeks until March 21. Q2 should be able to start off strong but we fully expect another slug of fiscal stimulus over the summer to help boost Suga’s popularity ahead of the fall elections.

Bank of Japan Deputy Governor Amamiya said the bank’s ability to cut rates further remains an important policy option. However, he acknowledged that the BOJ is mindful of the impact of negative rates on banks. He also added that it’s important to keep the yield curve low and stable and that while some fluctuations could be positive, big moves would have undesirable effects. This summarizes the major policy options for the BOJ in a nutshell, none of which seem particularly palatable right now. We continue to expect the policy review next week to be a non-event.

Elsewhere, Prime Minister Suga nominated Junko Nakagawa to the BOJ board. She replaces outgoing Takako Masai as the only woman on the board. She has had a long career at Nomura and is currently CEO of Nomura Asset Management. Nakagawa is viewed as a centrist and is seen as a counterweight to the other new member Asahi Noguchi, who is viewed as a dove. Governor Kuroda’s current term lasts until 2023 and his replacement will be true key.

Reports of state-backed funds used to stabilize China’s cratering equity markets wasn’t enough to turn major indices around. The actions are supposedly related to the annual NPC meetings ongoing in Beijing. The CSI300 ended the day -2%, the fourth consecutive session of declines and losing around -7% on the month.  

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