Dollar Firm as U.S. Yields Resume Climb

November 12, 2021

U.S. yields are moving higher as the bond market reopens after holiday; President Biden is reportedly debating release of oil from the Strategic Petroleum Reserve; data today are limited; Mexico delivered a 25 bp hike to 5.0%, as most expected; Peru hiked rates by 50 bp to 2.0%, as expected
Geopolitical tensions are back on the radar; elsewhere, Brexit tensions remain high; eurozone reported better than expected September IP
Press reports suggest the upcoming stimulus package from Prime Minister Kishida will total more than JPY40 bln; China’s 6th plenum ended yesterday with Xi Jinping getting the expected special resolution to receive a 3rd term and ultimately rule China for life

The dollar continues to gain ahead of the weekend. DXY traded today at a new cycle high near 95.265, the highest since July 2020. There really aren't any major chart points until the June 2020 high near 97.802. Similarly, the euro traded today near $1.1435, the lowest since July 2020. Here, the next major chart point is the June 2020 low near $1.1170. Sterling traded today near $1.3355, the lowest since December 2020 and on track to test that month’s low near $1.3135. USD/JPY is struggling to get a foothold above 114 but should eventually play catch-up with euro and sterling weakness. if this pair can break above last month's high near 114.70, there really aren't any significant chart points until the December 2016 high near 118.65.

AMERICAS

U.S. yields are moving higher as the bond market reopens after holiday. The 2-year yield is currently around 0.54%, up 3 bp on the day and well above the 0.39% posted last Friday. This clearly reflects heightened Fed lift-off expectations. The 2-year differentials with Germany (126 bp) and Japan (65 bp) are at new cycle highs, supporting further dollar gains ahead. Likewise, the 10-year yield is currently around 1.57%, up 2 bp on the day and well above the 1.41% posted earlier this week. We see continued upward pressure on U.S. yields and the dollar.

President Biden is reportedly debating release of oil from the Strategic Petroleum Reserve. With gasoline prices rising, with some aides in the White House pushing for the move meeting resistance from some Department of Energy officials. A task force studying the issue reported consists of White House Chief of Staff Klain, National Economic Council head Deese, National Security Advisor head Sullivan, Energy Secretary Granholm and her deputy Turk, and State Department energy expert Hochstein. Moves in the SPR are largely symbolic, but it’s clear that high inflation is becoming a larger and larger political risk for the Biden administration with less than a year before mid-term elections.

Data today are limited. September JOLTS job openings (10.3 mln expected) and preliminary November University of Michigan consumer sentiment (72.5 expected) will be reported today. JOLTS data should show that supply remains the key issue for the labor market. For the Michigan reading, keep an eye on 1-yaer inflation expectations, which are seen rising a tick to 4.9%. Williams is the only Fed speaker today.

Mexico delivered a 25 bp hike to 5.0%, as most expected. However, a significant number of analysts were calling for a larger move and so there was some palpable disappointment. The result was lower yields across the curve and a weaker peso. Once again one MPC member (Esquivel) voted for no hike, and the statement didn’t suggest a risk of frontloading the cycle despite still high inflation figures. Indeed, Banxico raised its inflation forecast to a peak of 6.8% in Q4, up from 6.2% previously. We expect a few more hikes from the bank, albeit gradually, to make sure they don’t fall behind the curve. Swaps market is pricing in 275 bp of further tightening over the next 12 months, which seems too aggressive.

Peru’s central bank hiked rates by 50 bp to 2.0%, as expected. This is the fourth consecutive hike, but officials insist that accommodation is still needed. Still, more tightening is likely given the strong dollar cycle and upside inflation risks. However, the cycle may be choppy with some data-dependent pauses along the way. The bank forecasts CPI to return to the 1-3^ target range in the second half of next year. The sol was little changed yesterday.

EUROPE/MIDDLE EAST/AFRICA

Geopolitical tensions are back on the radar. Belarus’s President Lukashenko threatened to shut down the Russian gas pipeline to the EU because of the renewed migrant crisis. Migrants are amassing on the border between Belarus and Poland which, in the EU’s view, has been fostered by Lukashenko as retaliation in the political pressure game. Bloomberg estimates that about 20% of gas from Russia flowed through Belarus this year. On a separate note, there has been growing speculation and accusations of possible escalation of Russian involvement in Ukraine, with reports that the U.S. has warned the EU that Russia may be planning another invasion with a recent troop buildup at the border.

Elsewhere, Brexit tensions remain high. The two sides mee today in London as negotiations continue. Latest reports suggest the EU is ready to improve its offer to cut customs checks in Northern Ireland but that is reaching the end of its rope. EC Vice President Sefcovic will reportedly warn the U.K. today that a deal will not be possible unless the UK drops its “unattainable” demands to end the oversight role of the European Court of Justice. Chief U.K Brexit negotiator Frost has called for a complete overhaul of the deal and has threatened unilateral changes if the EU does not make enough concessions. Something has got to give but as we’ve pointed out before, one can always count on the U.K. to overplay a weak hand.

Eurozone reported better than expected September IP. It was expected at -0.5% m/m but instead fell only -0.2% vs. a revised -1.7% (was -1.6%) in August. Last week, German and French IP readings came in much weaker than expected and suggested some downside risks to the headline eurozone number. That said, the reading is nothing to cheer about. Virus numbers are rising in Europe as we head into winter, with Germany being particularly hard hit and posting record daily infections of more than 50k. Looking ahead, it’s clear to us that the U.S. economy will outperform the eurozone in Q4 and most likely Q1 as well.

ASIA

Press reports suggest the upcoming stimulus package from Prime Minister Kishida will total more than JPY40 bln. Official announcement is expected next week, and earlier leaks suggest the plan will include JPY100,000 payments for those 18 and younger. Of note, the real spending will be lower as the headline number includes some loans. Other reports suggest the cost of the package will be covered by both an extra budget for FY21 but also as part of the regular budget for FY22. The economy likely shrunk in Q3 and while it reopened in Q4 as virus numbers dropped, policymakers are taking no chances.

China’s 6th plenum ended yesterday with Xi Jinping getting the expected special resolution to receive a 3rd term and ultimately rule China for life. This should, in theory, imply a longer-term incentive structure for the ruling class to resolve the country’s fundamental financial and economic risks – but again, there is no new incremental news here. Economic and social stability remain the key directives, so balancing short- and long-term risks will always be challenging, as seen by the reaction to the Evergrande story.

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