Dollar Softens as Falling Real Yields Take a Toll

March 11, 2021

US inflation concerns have eased, at least for now; the 10-year Treasury auction yesterday saw enough demand not to rattle markets but was by no means strong; President Biden got his first major political victory with the stimulus bill passing the House; February budget statement is worth discussing; Brazil reports February IPCA inflation; Peru is expected to keep rates steady at 0.25%.  
The ECB is expected to deliver a dovish hold; the UK is preparing a broad review of its financial markets to defend the City of London’s global standing post-Brexit
Reports suggest the BOJ is still looking at ways to allow bond yields to fluctuate more as it wraps up its policy review; the RBA made it harder to bet against its YCC; Chinese equities rallied as the NPC session ended on a positive note

The dollar continues to soften as falling real yields take a toll.  After trading at a new cycle high this week near 92.50, DXY is down for the third straight day. Some profit-taking and consolidation was to be expected after its recent run and we could see a correction back to the 91 area. However, we believe US fundamentals remain strong and that DXY will eventually test the November 23 high near 92.80 and then the November 11 high near 93.208.  The euro is trading just below $1.20 while sterling is trading just below  $1.40. The rise in USD/JPY was turned back at 109 but we believe the pair will eventually test the June 5 high near 109.85.


US inflation concerns have eased, at least for now.  February CPI was reported yesterday, with headline coming in as expected at 1.7% y/y vs. 1.4% in January. However, markets focused on core inflation, which came in a tick lower than expected at 1.3% y/y.  PPI will be reported Friday, with headline expected at 2.7% y/y vs. 1.7% in January and core expected at 2.6% y/y vs. 2.0% in January. Acceleration would be noteworthy, especially coming before the low base effects that will boost y/y readings in March, April, and May.   However, we remain in the old school Philips Curve camp that believes significant underlying price pressures are unlikely without any wage pressures.  That said, this story is by no means over.

The 10-year Treasury auction yesterday saw enough demand not to rattle markets but was by no means strong. The yield came at 1.523% for the $38 bln sale, with a bid-to-cover ratio of 2.38 vs. 2.37 previously. Indirect bidders took 56.8% vs. 60.6% previously. Treasury will issue $25 bln in 30-year notes today. Treasury yields have been trending lower for the last couple of sessions with the 10-year trading back below the 1.50% level today.  Breakeven rates have remained stable, so real yields followed the move lower in nominals, helping to soften the dollar. Today sees a $24 bln 30-year bond auction.  At last month’s 30-year auctions indirect bidders took 60.5% while the bid-to-cover ratio was 2.18.  Besides weekly jobless claims, the only US data today is January JOLTS job openings, which are expected at 6700 vs. 6646 in December.  

President Biden got his first major political victory with the stimulus bill passing the House.  Reports suggest Biden and his surrogates will take a series of victory laps in the coming days, with an eye towards the 202 midterm elections. We suspect they will also start laying the groundwork for the next package  focusing in infrastructure spending.

The February budget statement is worth discussing.  A deficit of -$311 bln was reported vs. -$305 bln expected and -$162.8 in January.  The 12-month total rose to another record high -$3.55 trln.  Higher outlays continue to put upside pressure on the deficit and that is only going to get worse as the next round of spending kicks in this month. 

Brazil reports February IPCA inflation.  Headline inflation is expected at 5.04% y/y vs. 4.56% in January.  If so, it would be the highest since January 2017 and nearing the top of the 2.25-5.25% target range.  Next COPOM meeting is March 17 and markets are expecting a 50 bp hike to start the tightening cycle.  There are clear risks of a hawkish surprise, however.

Peru central bank is expected to keep rates steady at 0.25%.  CPI rose 2.4% y/y in February, down from the 2.7% peak in January and closer to the center of the 1-3% target range.  Despite high copper prices, the sol continues to weaken to all-time lows due in large part to ongoing political uncertainty. The National Electoral Jury ruled that presidential front-runner George Forsyth can run in the April 11 election.  He was initially barred because he did not disclose all of his income when he registered as a candidate.


The ECB is expected to deliver a dovish hold.  Macro forecasts will be updated and the bank will likely acknowledge the deteriorating outlook.  We expect the ECB to eventually increase the pace of its PEPP purchases in the coming weeks and increase the size of the envelope around mid- year.  There’s risk of more jawboning against rising yields but the strong euro is no longer a concern.   Please see our preview here.

The UK is preparing a broad review of its financial markets to defend the City of London’s global standing post-Brexit.  Economic Secretary to the Treasury Glen said the government will consult with businesses on “detailed proposals for wider reform to the capital markets” this summer. The review will  reportedly look at possible changes to market structure and transparency rules, with the aim of reducing costs for firms whilst maintaining high standards of regulation. Glen stressed that the review will be “as broad and as inclusive as possible so that we really look at everything.”  Stay tuned.


Reports suggest the Bank of Japan is still looking at ways to allow bond yields to fluctuate more as it wraps up its policy review.  This comes after Governor  Kuroda last week shot down any notions of adjusting its YCC. Some officials apparently still want to generate more fluctuation while sticking with the current YCC range of +/- 20 bp  around the 0% target for 10-year yields.  We are still skeptical that they'd do this in a rising rate environment.  We've said it before, we really don't think this policy review was well thought out. Yet the headlines helped push USD/JPY lower yesterday. In a sense, this was the BOJ snatching defeat from the jaws of victory. Policymakers had already seen the market push USD/JPY to the highest since last June.  Why would they rock the boat? We remain confident  that markets are waiting for what is likely to be a largely toothless policy review that maintains the status quo.  Elsewhere, Japan reported February  PPI as expected at -0.7%y/y vs. a revised -1.5% (was 1.6%) in January.  

The Reserve Bank of Australia made it harder to bet against its YCC.  The bank announced it will now charge 100 bp to borrow bonds maturing April 2023 and April 2024 through its own facility.  The usual cost of borrowing bonds from the RBA varies based on the term and amount but there was a minimum fee of 20 bp. As such, the new fee makes it much more expensive to bet against the RBA. AGB yields responded as one would expect, with the 3-year yield back under the 0.10% target for the first time this year.

Chinese equities rallied as the NPC session ended on a positive note. The CSI300 closed up nearly 3% and is now only 1.5% down on the year. We would be cautious on this rebound since regulators have clearly signaled concerns about froth in the equity and real-estate markets. Even though tightening will be gradual, it’s usually not wise to bet against explicit official warnings. That said, China and the entire Asia equity space have gone through a significant correction in the last few weeks and it remains the region with the best fundaments by a wide margin.

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