Dollar Firms as Yields Rise Ahead of FOMC Decision

April 28, 2021

-The two-day FOMC  meeting ends with a decision this afternoon; we will be putting out a lengthy piece this week about the Fed’s likely roadmap for tapering; U.S. yields are rising ahead of the decision
-Brexit was finally approved but hard feelings persist; details of the weekly ECB asset purchases were reported; German GfK consumer confidence for May came in very weak
-Japan reported firm March retail sales; Australia reported soft Q1 CPI; concerns about China’s Huarong Asset Management have eased, at least for now

The dollar is getting some traction as yields rise ahead of the FOMC decision.  DXY is up for the second straight day and is trading at the highest level this week around 91.13.  The euro was unable to sustain the move above $1.21 and is currently trading just below the figure.  Sterling continues to struggle after being unable to sustain the move above $1.40 and is currently back below $1.39.  Lastly, USD/JPY is surging this week after trading below 108 and is trading at the highest level since April 14 just above 109.  We continue to look for resumed dollar strength but this will require a more significant turnaround in U.S. yields.  Let’s see what the Fed delivers.


The two-day FOMC  meeting ends with a decision this afternoon.  No changes are expected in any policy settings or forward guidance.  There will be no new macro forecasts or Dot Plots.  That said, market are starting to look for signs of tapering and Powell will surely be asked about the timing.  A majority of analysts are now looking for Fed tapering in H2 2021 and the Fed will eventually be forced to confront this.  How will the Fed approach tapering?  Very, very, carefully. 

We will be putting out a lengthy piece this week about the Fed’s likely roadmap for tapering.  This will be based on the prior experience of 2013 and so some ancient history will be involved.  Our feeling is that in order to (hopefully) avoid another taper tantrum, the Fed will have to start preparing markets for the likelihood of tapering late in the year.  This meeting seems too early but the June 15-16 meeting is a much better candidate as new macro forecasts and Dot Plots will be released then.  Much will depend on how the US economy evolves, of course, but right now, it is red hot and is feeding into market expectations for tapering to happen sooner rather than later.

US yields are rising ahead of the decision.  This may signal a near-term floor for yields as the bond market sees asymmetric risks.  By this, we mean that the Fed will be hard-pressed to deliver any dovish surprises ahead and risks are getting skewed towards an eventual hawkish surprise from the Fed.  The 10-year UST yield is currently around 1.65% and the 30-year around 2.31%, both firming off their recent lows and trading at mid-April highs but still well below their March highs near 1.77% and 2.51%, respectively.  The move in US yields is in part driven by the weak 7-year auction yesterday.  However, some sort of taper signal from the Fed will likely be the catalyst for higher US yields.  Recall the Fed is buying $120 bln per month of USTs and mortgage-backed securities. 
Besides the FOMC decision, it’s a quiet day in North America.  March advance goods trade (-$88.0 bln expected) and wholesale/retail inventories will be reported in the U.S.  Elsewhere, Canada reports February retail sales.  Headline sales are expected to rise 4.0% m/m vs. -1.1% in January, while sales ex-autos are expected to rise 3.5% m/m vs. -1.2% in January. 


Brexit was finally approved but hard feelings persist.  After the trade deal was approved by the European Parliament by a 660-5 vote today, EC President von der Leyen warned that Brussels would not hesitate to hit the U’K. with tariffs if it failed to implement its commitments in Northern Ireland.  She added that the enforcement mechanisms agreed to were “essential” to ensure that the U.K. complied with all elements of the deal.  This comes just as France is in the middle of a tussle with the U.K regarding fishing licenses.  French officials warned that the EU would hit sectors such as financial services with tariffs if the U.K. did not properly implement the fishing agreement contained in the Brexit deal. Recall also that the EU recently suspended legal action against the U.K. over the Northern Ireland Protocol in an effort to help address the growing violence there.  The bottom line is that both sides continue to regard the other with suspicion and so we believe equivalence (the next big battle) is unlikely to be granted easily to U.K. firms.

Details of the weekly ECB asset purchases were reported.   Redemptions last week were EUR2.8 bln, leaving gross purchases at EUR25.0 bln vs. EUR28.4 bln the previous week.  These are the highest gross purchases since June 2020 and suggests the ECB is serious about keeping yields down.  Eurozone yields have been creeping higher.  The 10-year Bund yield is currently around -22 bp and nearing the February high near -21 bp, while the 10-year BTP yield is currently around 89 bp and has surpassed the February high near 84 bp.  We think the ECB may have to accelerate its purchases even further if eurozone yields continue to climb.  The accelerated pace should be maintained until at least the June 10 meeting, when the ECB will likely reassess its program.  At last week’s meeting, the bank acknowledged that it expects the decision then to be difficult.  If yields continue to rise, then the accelerated pace is likely to be extended into Q3, which would be a dovish sign.

German GfK consumer confidence for May came in very weak.  The reading of -8.8 was more than twice as bad as the -4.2  expected and was also worse than the revised April reading of -6.1 (was -6.2).   The reading also broke a streak of two straight months of improvement, and has been in negative territory since April 2020.  Of note, the IFO Business Climate reading for April came in weaker than expected earlier this week. 


Japan reported firm March retail sales.  Sales rose 1.2% m/m vs. 0.6% expected and 3.1% in February.  The gain is noteworthy as much of the country was under a state of emergency that month.  Restrictions were lifted at the end of March, but the bad news is that several major prefectures accounting for about a quarter of the population have had to reinstate restrictions that are far stricter than the previous round.  This current round is set to expire after the Golden Week holiday next month but the risk is that rising virus numbers will lead to an extension.  Stay tuned.

Australia reported soft Q1 CPI.  Headline inflation rose 1.1% y/y vs. 1.4% expected and 0.9% in Q4, while trimmed mean rose 1.1% y/y vs. 1.2% expected and actual in Q4.  Inflation is still the highest since Q1 2020 but still well below the 2-3%  target range.  The headline figures were boosted by higher fuel prices (+8.7%), with little signs of underlying price pressures.  Indeed, the trimmed mean reading is the lowest on record for the series dating back to 1983.  No wonder the RBA delivered a dovish hold this month, repeating its existing forward guidance that rate hikes won’t be seen until 2024 “at the earliest.”  Next policy meeting is May 4 and another dovish hold is expected, especially after the CPI data.  Australian 10-year government bond yields have been trending lower along with other major fixed income markets in recent weeks, but so far have not participated in this latest bounce.  Q1 PPI will be reported Friday. 
Concerns about China’s Huarong Asset Management have eased, at least for now.  The trouble company repaid an offshore bond maturing this week with funds provided by the largest state-owned bank.  Industrial & Commercial Bank of China’s Singapore branch gave Huarong a loan to help the company repay its SGD600 mln ($452 mln) bond.  The support comes after China’s financial regulator asked banks to extend loans to Huarong by at least six months to help the company refinance debt.  Offshore bonds in particular have been hit hard after the company missed several deadlines to report earnings.  Huarong has more than $20 bln of offshore bonds outstanding, including $3.7 bln due this year.  Huarong is also majority-owned by the Finance Ministry, making it a very special case in terms of government willingness to extend support for its liabilities.  Of course, the risk is that the same support will not be extended to private companies. This saga is by no means over and foreign investors are watching closely.

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