Dollar Bid Amidst Global Bond Rout

October 18, 2021
  • Global bond markets are finally waking up to the risks that inflation isn’t as transitory as most central banks insist; if inflation risks continue to rise, which central banks are best positioned to respond; is the market overreacting; U.S. September IP will be the data highlight
  • Market pricing of BOE tightening has gone parabolic; surprisingly, sterling has yet to react
  • New Zealand reported higher than expected Q3 CPI; China data came in on the weaker side of expectations

The dollar is getting some traction during this global bond rout. DXY is up today just above 94 and follows three straight down days after posting a new cycle high near 94.56 last week. USD/JPY remains bid, trading just below October 2018 high near 114.55. After that is the November 2017 high near 114.75. Elsewhere, the euro remains heavy as it failed again to gain traction above $1.16. Sterling saw no follow-through after breaking above $1.3720 last week, which is where it sits now. With the Fed ready to taper, markets fully pricing in Q3 22 Fed liftoff, and price pressures still rising, we believe this move higher in U.S. rates and the dollar has legs.

AMERICAS

Global bond markets are finally waking up to the risks that inflation isn’t as transitory as most central banks insist. The ostensible sparks were higher than expected New Zealand CPI and hawkish BOE comments (see below), but the tinder has been long building. At the long end, 10-year yields are up across the board, led today by New Zealand (+16 bp), Australia (+9 bp), Italy (+7 bp), U.K. (+6 bp), Canada (+5 bp), and the U.S. (+5 bp). At the short end, rates are also up across the board, reflecting heightened risks that policy makers will have to respond. Here, the move is led today by New Zealand (+24 bp), U.K. (+14 bp), Germany (+6 bp), Italy (+5 bp), the U.S. (+5 bp), and Canada (+4 bp).

If inflation risks continue to rise, which central banks are best positioned to respond? The RBNZ and Norges Bank have already started tightening. BOE seems next in line to hike (see below), while the Fed is likely to begin tapering next month. The Fed Funds futures strip has gotten much more aggressive about lift-off. Q3 22 lift-off is nearly fully priced in, up from about 50% at the start of last week. Another hike in Q4 lift-off is nearly fully priced in too. BOC sees lift-off in H2 22, while RBA sees lift-off in 2024 at the earliest. Of note, the ECB, BOJ, SNB, and Riksbank show no intent to hike rates before 2024 or 2025 at the earliest.

Is the market overreacting? Probably. However, we have long felt that the markets were underreacting to what we saw as serious inflation risks. The truth is probably somewhere in between. Central banks may have to respond to the threat, but probably not to the extent that markets are pricing in. This debate will likely take weeks, if not months, before some sort of true conclusion can be reached. However, we are confident that U.S. rates and the dollar will continue rising throughout this debate.

U.S. September IP will be the data highlight for the day. It is expected to rise 0.2% m/m vs. 0.4% in August. We get lots of U.S. manufacturing data this week. Fed regional surveys will continue to roll out with Philly Fed reporting Thursday, which is expected at 25.0 vs. 30.7 in September. Markit preliminary October PMI readings will be reported Friday. Manufacturing PMI is expected at 60.5 vs. 60.7 in September, while services PMI is expected at 55.2 vs. 54.9 in September. The composite PMI stood at 55.0 in September. August TIC data will also be reported. Quarles and Kashkari speak.

EUROPE/MIDDLE EAST/AFRICA

Market pricing of Bank of England tightening has gone parabolic. This latest move is due to Governor Bailey’s comments over the weekend saying the BOE will have to act on inflation, which led the 2-year gilt yield to spike to 0.75%, nearly double the 0.38% yield at the start of October. The short sterling strip is fully pricing in Q4 lift-off, followed by another four hikes in 2022. Indeed, WIRP suggests a hike at the November 4 meeting is almost fully priced in, followed by nearly 50% odds of another hike at the December 16 meeting.

Surprisingly, sterling has yet to react. The 2-year gilt spread to the U.S. has risen to a new cycle high near 28 bp , which should give cable some support. Sterling is outperforming but it is still down -0.2% on a day when the dollar is bid across the board. Kiwi is also lower despite heightened RBNZ tightening expectations (see below) and this supports our view that it’s all about the Fed right now. Tightening by other central banks may lend their currencies some support, but it’s still King Dollar for now.

ASIA

New Zealand reported higher than expected Q3 CPI. Headline inflation accelerated to 4.9% y/y vs. 4.2% expected and 3.3% in Q2. This was the highest since Q2 2011 and moves further above the 1-3% target range. No wonder the market is pricing in further hikes by the RBNZ after it started the tightening cycle last week. WIRP shows a 25 bp hike to 0.75% is fully priced in for the November 24 meeting, with 50% odds of a 50 bp move then. Looking ahead, 25 bp hikes are priced in for the February 23, April 13, and May 25 meetings that would take the OCR up to 1.75%. Kiwi and Aussie bond yields rose to 10-year highs, dragging NZD and AUD to session highs near .7105 and .7440, respectively.

China data came in on the weaker side of expectations. Q3 GDP rose 0.2% q/q vs. 0.4% expected and rose 4.9% y/y vs. 5.0% expected. Retail sales were stronger than expected at 4.4% y/y but industrial production was weaker than expected at 3.1% y/y. Base effects played an important role here, but the slowdown is more fundamental. China will be up against a series of headwinds including shortages of components (microchips), electricity outages, the impact from tighter regulatory scrutiny (especially on the real estate sector), and the fallout from the delta variant. All of these factors will weigh on China’s data for the rest of the year, though attenuated by policy support.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2021. All rights reserved.

This browser is not fully supported by our public website and may not display or function as expected for this reason. Please note, the Infuse Portal and BBH client applications fully support the IE 11 browser.

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

 
1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see bbhluxembourgfunds.com


captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction