Dollar Firms as Risk Off Impulses Ebb

May 10, 2022

The rise in U.S. yields has stalled out; with the FOMC meeting out of the way, Fed speakers will spread the word this week; there is a heavy slate of UST issuance due to the quarterly refunding

German ZEW survey for May was mixed; BOE’s Saunders continues to push for front-loading its tightening cycle; BOE tightening expectations have stalled; Norway and Czech Republic reported higher than expected April CPI

BOJ is showing no signs of abandoning YCC; the Fed highlighted crypto risks in its most recent financial stability report; the report is especially timely given the recent crypto swoon; we believe the selloff in crypto is mostly about assets that benefited from easy Fed money giving back those gains

The dollar is edging higher even as risk off impulses ease.  DXY is trading near 103.756, just below yesterday’s new cycle high near 104.187, the highest since December 2002.  We continue to target the November 2002 high near 107.  The euro remains stuck near $1.0550 but we continue to target the January 2017 near $1.0340.  USD/JPY is back near 130 after trading yesterday at a new cycle high near 131.35.  We continue to target the January 2002 high near 135.15.  Sterling is trading near $1.2350 after it traded yesterday at a new cycle low $1.2260.  We look for a break below the June 2020 low near $1.2250, which would set up a test of the May 2020 low near $1.2075. With U.S. yields set to rise again, the dollar should resume its climb.

AMERICAS

The rise in U.S. yields has stalled out.  However, risk off impulses seem to be easing and so the upward move should resume.  The U.S. 10-year yield traded yesterday at a new cycle high near 3.20% but has since eased to 3.01% currently.  We still target the October 2018 high near 3.26% and after that is the February 2011 high near 3.77%.  We note that the 10-year breakeven inflation rate has fallen to 2.74%, the lowest since March 7.  As a result, the real 10-year yield climbed to 0.29% yesterday, the highest since July 2019, before easing to 0.27% currently.  The 3-month to 10-year yield curve steepened to 231 bp yesterday, the steepest since July 2015, before easing back to 214 bp currently.   

With the FOMC meeting out of the way, Fed speakers will spread the word this week.  Williams, Barkin, Waller, Kashkari, Mester, and Bostic all speak today.  Last week, Barkin did his job and put 75 bp back on the table, adding that he want to hike rates “as fast as feasible.”  Expect other Fed officials to fall in line with this more hawkish stance this week.  We believe Powell erred in giving up the bazooka in his pocket so easily and now the Fed is working to get it back.  Reports suggest the Senate will vote today to confirm Lisa Cook to the Fed’s Board of Governors. 

There is a heavy slate of UST issuance due to the quarterly refunding.  $45 bln of 3-year notes will be sold today.  At the last auction, indirect bidders took up 53.4%, the bid/cover ratio was 2.48, and the high yield was 2.738%. Will investors be lured by higher yields or will they wait for even higher yields before buying?  Or will investors look to other nations?  With most of the world in tightening cycles, there are other high yielding bonds out there competing with the U.S.  Stay tuned. 

EUROPE/MIDDLE EAST/AFRICA

German ZEW survey for May was mixed.  Expectations came in at -34.3 vs. -43.0 expected and -41.0 in April, while current assessment came in at -36.5 vs. -35.0 expected and -30.8 in April.  Germany is coming off of an awful week of data, where March retail sales came in at -0.1% m/m and was followed by -4.7% m/m for factory orders -3.9% m/m for IP.  Germany is the locomotive for the eurozone economy and this weakness is likely carrying over into Q2.  Italy reported March IP as flat m/m vs. -1.5% expected.  This will be followed by March eurozone IP (-2.0% m/m expected) Friday.   

Bank of England’s Saunders continues to push for front-loading its tightening cycle.   Saunders was one of three MPC members that dissented in favor of a 50 bp hike at last week’s meeting.  He said raising rates quickly may spare households an even worse squeeze on living standards later.  Saunders said he feared inflation expectations may take off unless the bank acts firmly now, noting that “The MPC’s ability to use monetary policy to provide effective support to the economy in 2020 rested on the credibility of the inflation targeting framework. That credibility is not infinite and cannot be taken for granted.”  It also appears that he will continue voting for 50 bp hikes by noting “All else equal, the case for policy to move in a larger step is probably greater when Bank Rate is clearly below neutral.” 

Bank of England tightening expectations have stalled.  WIRP suggests another 25 bp hike is fully priced in for the next meeting June 16, while the odds of a 50 bp move then are minimal.  Looking ahead, the swaps market is pricing in 125-150 bp of total tightening over the next 12 months that would see the policy rate peak between 2.25-2.50%.  There are no other BOE speakers scheduled this week and given last week’s communications disaster, that might not be a bad thing.

Norway reported higher than expected April CPI.  Headline came in at 5.4% y/y vs. 4.7% expected and 4.5% in March, while underlying came in at 2.6% y/y vs. 2.4% expected and 2.1% in March.  Headline accelerated for the second straight month to a new cycle high and further above the 2% target.  Norges Bank kept rates on hold last week but reaffirmed its March rate path and signaled a hike at the next meeting June 23.  Looking ahead, the swaps market is pricing in nearly 150 bp of total tightening over the next 12 months followed by another 40 bp over the subsequent 12 months that sees the policy rate peak between 2.50-2.75%, up slightly from 2.5% at the start of last week.   

Czech Republic reported higher than expected April CPI.  Headline inflation came in at 14.2% y/y vs. 13.3% expected and 12.7% in March.  This was the highest since December 1993 and further above the 1-3% target range.  No wonder the central bank delivered a hawkish surprise last week with a 75 bp hike to 5.75% vs. 50 bp expected.  Next meeting is June 22 and another 75 bp hike is likely then, with risks of an even larger one.  The swaps market is pricing in 75 bp of further tightening over the next 6 months that would see the policy rate peak near 6.5% but we still see upside risks.  Of note, reports suggest Czech President Zeman will name current broad member Alex Michl to be the next Governor of the Czech National Bank.  Michl is considered one of the most dovish at the bank, while other reports suggest Zeman will also appoint more doves to upcoming vacancies on the board.  Governor Rusnok’s term ends in July.   

ASIA

The Bank of Japan is showing no signs of abandoning Yield Curve Control.  BOJ Executive Director Shinichi Uchida said that widening the bank’s YCC target range would be the equivalent of a rate hike and this wouldn’t be good for the economy. The current range around the 0% target is +/- 25 bp.  Uchida stressed that the economy is still in the process of recovering from the pandemic and needs continued support from an easy monetary policy stance.  We stick with our call that Governor Kuroda maintains current policy settings through the end of his term next spring, leaving it to his successor to exit stimulus. 

COMMODITIES AND ALTERNATIVE INVESTMENTS

The Fed highlighted crypto risks in its most recent financial stability report.  Specifically, the report reiterated its concerns over financial risks posed by stablecoins, which are designed to maintain a strict peg against hard currencies like the dollar. The Fed noted that stablecoins are “vulnerable to runs” and stressed the ack of transparency around the assets that are used to back the tokens.  It noted “Additionally, the increasing use of stablecoins to meet margin requirements for levered trading in other cryptocurrencies may amplify volatility in demand for stablecoins and heighten redemption risks.” 

The report is especially timely given the recent crypto swoon. Of note, the Terra stablecoin broke the buck over the weekend and traded as low as 60 cents yesterday.  This required its backers to issue $1.5 bln in loans denominated in both USD and XBT to help support the peg.  Let that one sink in for a moment; the Terra stablecoin peg was defended by taking out loans denominated in another crypto asset that just lost 10% of its value yesterday.  

We believe the selloff in crypto is mostly about assets that benefited from easy Fed money giving back those gains.  One of the most well-known “innovation” funds is nearing its March 2020 low.  XBT is trading at the lowest level since July 2021 and is on its way to testing that month's low near $29308 as well as the June 2021 low near $28824.  That is near $28774, the 62% retracement objective from the March 2020-November 2021 rally.  This area was tested several times mid-2021 but held.  Break below would set up a test of the pandemic low near $3915.  

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