Dollar Firms as US Yields Rise Ahead of PPI Data

March 12, 2021

•    US Treasury yields are back on the upswing; US PPI data will be the highlight; Canada reports February jobs data
•    ECB delivered a dovish hold; Madame Lagarde tried a delicate balancing act; the usual behind the scenes drama worked against the intended message; UK had its monthly data dump; Poland’s central bank was the latest to enter the fray of rising yields
•    Reports suggest the BOJ is studying the potential impact of deeper negative rates; it appears the BOJ didn’t learn anything from the BOE; more fiscal stimulus is likely in Japan; India reports February CPI and January IP

The dollar has resumed its climb.  This is due largely to the rise in US yields (see below).  DXY found some support near 91.40 and has already clawed back nearly half of this week’s losses.  This supports our view that the recent dollar softness was largely profit-taking and consolidative in nature.  We believe DXY is still on track to test the November 23 high near 92.80 and then the November 11 high near 93.208.  The euro is trading back near $1.19 and 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 is softer after being unable to break back above $1.40 and is now testing support near $1.39.  The rise in USD/JPY has resumed and is trading back above 109.  We believe the pair remains on track to test the June 5 high near 109.85.


US Treasury yields are back on the upswing with the 10-year threatening the 1.60% level once again. Passing the $1.9 trln stimulus package without any significant setbacks certainly helps the trend as the first $1,400 checks should start being sent out soon.  Overall demand metrics for this week’s bond auctions were mixed but that’s not bad in  a rising rate environment. However, the mixed auction results also contributed to the volatile price action. We are especially focused on the foreign demand (i.e. indirect bidders).  Their share fell to 47.8% from 52.7% in the 3-year auction, fell to 56.8% from 60.6% in the 10-year auction, and  rose to 60.6% from 60.5% in the 30-yraer auction.  One partial explanation for this could be that Japanese investors are waiting on the side lines until the end of their fiscal year in March, after which they will be lured back by high US yields both on an outright and hedged basis.
US PPI data will be the highlight.  Headline is expected at 2.7% y/y vs. 1.7% in January and core is expected at 2.6% y/y vs. 2.0% in January.  Such acceleration would be noteworthy, especially coming before the low base effects that will boost y/y readings in March, April, and May.  Recall that headline CPI earlier this week came in as expected at 1.7% y/y vs. 1.4% in January while core slowed a tick to 1.3% y/y when it was expected to remain steady at 1.4%.  Low base effects should boost all of these y/y readings in March, April, and May and this will surely test the markets.  Preliminary March University of Michigan consumer sentiment will also be reported and is expected at 78.0 vs. 76.8 in February.

Canada reports February jobs data.  A 75k gain is expected vs. -212.8k in January, while the unemployment rate is expected to fall a couple of ticks to 9.2%. Like the US, Canada saw a loss of momentum in the economy going into year-end.  Jobs fell in both December and January, and so a gain in February would be welcome.  Yet the vaccine rollout in Canada has lagged even the laggards in Europe and so regaining that momentum will be all the more difficult.  We expect fiscal policy to carry the burden of stimulus in 2021 if needed. 


European Central Bank delivered a dovish hold.  All rates were kept steady and the PEPP envelope was left unchanged at EUR1.85 trln.  However, the bank said it expects its asset purchases in Q2 “to be conducted at a significantly higher pace than during the first months of this year.”  Reports suggest officials agreed on a monthly target for asset purchases but differed on the exact amount.  Unnamed officials said it won’t be above the EUR100 bln per month that it bought last spring but it will be above the EUR60 bln it bought last month. 

Madame Lagarde tried a delicate balancing act.  She noted that “Increases in these market interest rates, when left unchecked, could translate into a premature tightening of financing conditions for all sectors of the economy.  This is undesirable.”  Yet she was also upbeat, noting “Ongoing vaccination campaigns, together with the gradual relaxation of containment measures -- barring any further adverse developments related to the pandemic -– underpin the expectation of a firm rebound in economic activity in the course of 2021.” There were some small tweaks to the growth and inflation forecasts.  We’re surprised they didn't mark down 2021 more due to the slow vaccine roll out so far, while  Inflation forecasts show a similar view as the Fed in that the inflation pick-up is seen as transitory.

Yet the usual behind the scenes drama worked against the intended message.  The decision was reached by consensus, which means that there were those who opposed even the token acceleration of purchases.  Despite the statement that the PEPP could be “recalibrated,” many bank officials reportedly have no intention of increasing it again and that the accelerated purchases aren’t intended to lead to more stimulus. 

Bottom line:  the ECB did the bare minimum. Now the market is left waiting for every Monday's release of the previous week's activity to see just how serious the ECB is about accelerating its purchases. More broadly, the battle over yields between the market and the central banks is in the early stages and more tests will come ahead. It’s far too early for major central banks to declare victory, but we suspect that the ECB will have an easier time containing the moves given the relatively weaker vaccine-reflation growth outlook in the region. Indeed, this can already be seen in the rapidly rising interest rate differentials between the 10-year U.S. and German bonds.  Eurozone IP came in at 0.8% m/m vs. 0.5% expected and a revised -0.1% (was -1.6%) in December. 
UK had its monthly data dump.  January IP, construction output, services index, trade, and GDP were all reported.  IP fell -1.5% m/m vs. -1.0% expected and +0.2% in December, construction rose 0.9% m/m vs. -1.0% expected and -2.9% in December, services fell -3.5% m/m vs. -5.5% expected and +1.7% in December, and GDP fell -2.9% m/m vs. -4.9% expected and +1.2% in December.  With the lockdowns easing and vaccinations rising, January may have been the worst of it for the UK economy. 
Poland’s central bank was the latest to enter the fray of rising yields. Comments by officials yesterday say they are looking into changing their approach towards open market operations. The idea is to increase flexibility and be able to push back against rising yields should it challenge the central bank’s transmission of easy monetary conditions to the real economy. This follows the decision by the Hungarian central bank earlier this week to remove the limit on longer-dated debt purchases. In both cases, officials are worried about the contagion of higher yield in DM impacting EM rates.


Reports suggest the Bank of Japan is studying the potential impact of deeper negative rates.  Officials may release the report, which would assess the impact on commercial banks and possible measures to help offset the side effects of further cuts.  The press report suggests that officials want to shift market expectations for a possible cut but don’t actually plan to go more negative for the time being.  Sound familiar?  Other reports suggest the BOJ may scrap its annual ETF purchase target of JPY6 trln whilst keeping its JPY12 trln ceiling in place.  The more we read, the more we believe that the BOJ’s policy review will result in little of substance.

It appears the BOJ didn’t learn anything from the BOE.  Recall that the BOE helped keep the UK yield curve depressed for much of last year with ongoing talk and study of negative rates.  Then at the December 17 meeting, it said it was appropriate for markets to prepare for negative rates but said it did not intend to signal that negative rates are coming.  The market immediately priced out negative rates and gilt yields bottomed in early January, after which the 10-year gilt yield surged from 15 bp to around 80 bp currently. 

More fiscal stimulus is likely in Japan.  Senior LDP lawmaker Yamamoto sees the need for another big slug of fiscal stimulus similar to what was  just passed in the US.  Japan passed three extra budgets worth about JPY73 trln ($671 bln) last year and Yamamoto said another extra budget matching that total is needed immediately for the FY starting in April.  He played a key role in crafting the fiscal and monetary framework known as Abenomics and is reportedly readying new proposals for Prime Minister Suga.  Yamamoto acknowledged that the BOJ really can’t do much more by itself even as markets await the policy review.

India reports February CPI and January IP.  Inflation is expected at 5.00% y/y vs. 4.06% in January, while IP is expected to remain steady at 1.0% y/y.  If so, inflation would accelerate for the first time since the October peak of 7.61% but would remain within the 2-6% target range.  At its last meeting February 5, the Reserve Bank of India kept rates on hold at 4.0%. This made sense after the upside budget surprise.  If inflation remains relatively low, we see ongoing risks of a rate cut sometime this year.  Next RBI meeting is April 7.  

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