Dollar Firm as U.S. Yields March Higher

October 23, 2023

Win Thin

U.S. yields continue to march higher; September Chicago Fed NAI will be the highlight; Republican Representatives will hold a candidate forum
Bundesbank said the German economy likely contracted in Q3; ECB meets Thursday and is expected to keep rates steady; U.K. got some good news from the ratings agencies; Israel is expected to keep rates steady at 4.75%.
Reports suggests the BOJ will consider tweaking YCC again; Singapore reported September CPI; Korea reported firm trade data for the first twenty days of October

The dollar is getting some traction as U.S. yields march higher. DXY is trading slightly higher near 106.225 after two straight down days. After this period of consolidation is over, we expect a test of the October high near 107.348. The euro is trading flat near $1.0590, while sterling is trading lower near $1.2145 despite some positive ratings news (see below). USD/JPY is trading higher near 150 after trading earlier at a new high for this move near150.10. Markets remain nervous about BOJ intervention but until the BOJ pivots, yen weakness is unlikely to reverse. We believe this current dollar weakness is corrective in nature. Looking beyond the current noise related to dovish Fed comments, nothing fundamentally has changed and we see no reason to believe the dollar’s uptrend has ended. Simply put, the U.S. economy continues to grow above trend and all the recent data confirm that the U.S. economy is still running hot and needs further tightening.

AMERICAS

U.S. yields continue to march higher. The 10-year yield traded at a new cycle high today near 5.02%, while the 30-year yield traded at a new cycle high today near 5.18%. The short end is not fully participating in the move as the 2-year yield traded at a new cycle high last week near 5.26% before ending the week near 5.07% and trading near 5.13% today. With yields hitting new highs, the lack of dollar strength is puzzling. We chalk it up to stretched positioning as well as continued doubts about Fed tightening. However, when all is said and done, we think the case for a stronger dollar remains in place.

There are no Fed speakers this week due to the media blackout. However, Powell’s dovish guidance last week helped cool Fed tightening expectations. WIRP suggests no odds of a hike November 1, rising to 25% December 13 and topping out near 40% January 31. Given how strong the U.S. economy remains, these odds are way too low. A rate cut is not priced in until mid-2024.

Yet financial conditions continue to loosen. The latest Chicago Fed Financial Conditions reading through Friday October 13 was the loosest since early March 2022, before the Fed started hiking rates. So far, higher bond yields do not appear to be having much impact on financial conditions and so the Fed really cannot count on the market doing the heavy lifting.

September Chicago Fed National Activity Index will be the highlight. The headline reading is expected at -0.14 vs. -0.16 in August. If so, the 3-month moving average would rise to -0.08 vs. -0.14 in August. This would be the highest since last October and move further away from the -0.7 that signals recession. This series has taken on greater significance given that the 3-month to 10-year curve remains inverted. The continued resilience in the economy is noteworthy and supports our view the Fed still has more work to do in getting to the desired sub-trend growth.

We get our first official reading for Q3 GDP Thursday. Consensus sees growth at 4.3% SAAR vs. 2.1% in Q2. Personal consumption is expected at 4.0% SAAR vs. 0.8% in Q2. Of note, the Atlanta Fed’s GDPNow model is tracking Q3 growth at 5.4% SAAR vs. 5.1% previously. The final update comes Wednesday. The model will then begin tracking Q4 growth Friday.

Republican Representatives will hold a candidate forum. After Republicans held a secret ballot last week to oust Jim Jordan as the nominee by a 112-86 vote, nine Republicans have thrown their hat into the ring. Majority Whip Tom Emmer is thought to be the frontrunner. After the forum today with all the nominees, another floor vote could be held as early as tomorrow. The longer the House remains without a speaker, the higher the odds that it won’t be able to pass the necessary budget bills to avoid a shutdown when the Continuing Resolution expires November 17.

EUROPE/MIDDLE EAST/AFRICA

The Bundesbank said the German economy likely contracted in Q3. It noted that the economy is being weighed down by weak foreign demand and higher borrowing costs, and added inflation is expected to slow further in the coming months. Q3 GDP data will be reported next Monday. Q2 GDP was flat q/q and hasn’t grown since Q3 2022. Spain will provide the first glimpse of eurozone GDP this Friday.

European Central Bank meets Thursday and is expected to keep rates steady. While there are still a handful of hawkish holdouts, most ECB policymakers have acknowledged that the tightening cycle is over. The bank is expected to discuss modifications to reserve requirements as well has how to shrink its PEPP holdings but no decisions are expected until next year. Updated macro forecasts won’t come until the December 14 meeting. Of note, WIRP suggests no odds of a hike this week, rising to top out around 10% December 14. A rate cut is 75% priced in for June 6 and fully priced in for July 18..

The U.K. got some good news from the ratings agencies. Moody’s removed the negative credit outlook on U.K.’s Aa3 rating, noting “that policy predictability has been restored after heightened volatility last year around the mini-budget. The U.K.’s institutions will continue to operate in effective and predictable ways and, together with a commitment to fiscal consolidation by the government, will deliver effective fiscal policy.” Elsewhere, S&P suggested no change in its view from April, when it raised its outlook on the U.K.’s AA rating to stable from negative. It noted that “The stable outlook reflects the U.K.’s resilient economic performance despite multiple headwinds, as well as our expectation that general government deficits will steadily moderate over the next two to three years.”

Bank of Israel is expected to keep rates steady at 4.75%. At the last meeting September 4, the bank kept rates steady but warned that it “sees a real possibility of having to raise the interest rate in future decisions, if the inflation environment does not continue to moderate as expected.” Rate cut bets have been pared back as the shekel continues to weaken above 4 per dollar but the market still sees 25 bp of easing over the next three months followed by another 25 bp over the subsequent three months. We think there are still risks of a rate hike in the coming months as the bank is likely to focus on stabilizing the shekel in order to avoid a spike in imported inflation.

ASIA

Reports suggests the Bank of Japan will consider tweaking Yield Curve Control again. With JGB yields rising along with other global yields, sources say a tweak will probably be discussed at the October 30-31 meeting. Indeed, with the 10-yaer yield trading near 0.87% and approaching the 1.0% ceiling, something needs to be done. Indeed, we believe YCC will be eliminated late this year or early next year, with liftoff seen shortly thereafter. WIRP suggests nearly 85% odds of liftoff March 19 and fully priced in for April 26, which sounds about right.

Singapore reported September CPI. Headline came in at 4.1% y/y vs. 4.0% expected and actual in August, while core came in at 3.0% y/y s. 3.1% expected and 3.4% in August. This was the first acceleration in headline, while core fell to the lowest since March 2022. The MAS does not have an explicit inflation target and just left policy steady this month. If price pressures continue falling and the economy remains sluggish, we believe it will ease policy at the next meeting in January.

Korea reported firm trade data for the first twenty days of October. Exports came in at 4.6% y/y while imports came in at 0.6% y/y. Adjusting for the number of working days, average daily exports improved to 8.6% y/y. If sustained for the entire month, this would be the first y/y gain since September 2022. Of note, exports to China fell -6.1% y/y while exports to the U.S. rose 12.7% y/y.

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