Dollar Gets Traction as U.S. Yields Recover

June 22, 2021
  • U.S. yields have rebounded sharply; Fed speakers will be plentiful; Fed manufacturing surveys for June will continue to roll out; Brazil central bank minutes will be released; the remarkable divergence within Latin America continues as the Brazilian real bucks the regional trend
  • U.K. reported May public sector net borrowing data; details of ECB asset purchases for the week ending June 18 will be reported; ECB speakers are plentiful; Lagarde said that the ECB continues to make good progress on its strategy review; Hungary is expected to be the first in Europe to hike rates
  • Japan reported May department store sales; the liquidity crunch in China tightened even as concerns about financial stability rose; Brent crude jumped above $75 a barrel for the first time since April 2019 on both supply and demand factors

The dollar is getting traction again. DXY trading higher near 92.1 after a down day yesterday following four straight up days. The break above 91.946 last week sets up an eventual test of the March 31 high near 93.437. The euro has been unable to sustain a move above $1.19 for three straight days and the break below $1.1920 last week sets up a test of the March 31 low near $1.1705. Sterling likewise has been unable to sustain a move above $1.39 for three straight days and the break below $1.3890 last week sets up a test of the April 12 low near $1.3670. Lastly, USD/JPY continues to edge higher after the move below 110 yesterday was met with buying interest. The pair is currently trading near 110.50 and is on track to test the March 31 high near 111.

AMERICAS

U.S. yields have rebounded sharply. After trading as low as 1.35% early Monday, the 10-year yield reversed to end the day near 1.49%. It is currently trading around 1.47% after poking above 1.50% earlier today. Likewise, after trading as low as 1.93% early Monday, the 10-year yield reversed to end the day near 2.11%. It is currently trading around 2.08%.

Fed speakers will be plentiful. Today, Mester and Daly speak, while Powell testifies before Congress. Transcripts of his opening remarks suggest no change to the Fed’s messaging but the Q&A will be key. Bowman, Yesterday, Bullard, Kaplan, and Williams spoke. Last Friday, Bullard confirmed that Chair Powell officially opened up the tapering discussions at that FOMC meeting. Kaplan and Bullard are already known to favor tapering sooner rather than later and so their comments to that effect were not surprising. We expect most Fed officials to embrace Powell’s tapering talk, though we know there are several officials that remain more cautious. Indeed, NY Fed President Williams said yesterday that tapering is still “quite a ways off” because the economy has not yet made "substantial further progress" that the Fed wants to first see.

Fed manufacturing surveys for June will continue to roll out. Richmond is expected to remain steady at 18. Kansas City reports Thursday and is expected at 25 vs. 26 in May. So far, Philly Fed came in at 30.7 vs. 31.5 in May and Empire survey came in at 17.4 vs. 24.3 in May. While there are modest downside risks to this week’s Fed surveys, the U.S. manufacturing sector remains in solid shape, growing but at a slightly slower pace. Markit reports preliminary June PMI readings Wednesday, with manufacturing expected at 61.5 vs. 62.1 in May and services expected at 70.0 vs. 70.4 in May. Existing home sales (-2.4% m/m expected) will also be reported today.

Brazil central bank minutes will be released. COPOM just delivered a 75 bp hike to 4.25% last week and flagged another hike of the same magnitude at the next meeting August 4. Brazil reports mid-June IPCA inflation Friday. Headline inflation is expected at 8.16% y/y vs. 7.27% in mid-May. If so, this would be the highest since 2016 and further above the 2.25-5.25% target range. Markets are starting to price in the risk of a 100 bp hike , but we still think they stick to the current pace of 75 bp. The strong BRL appreciation and the frontloaded nature of the cycle should be enough to remove the sense of urgency necessary to scale up the size of hikes. However, it now looks like the terminal COPOM rate for the cycle will be 7.0% or something close to it, and the risk is now for a curve flattening, despite the significant fiscal uncertainty.

The remarkable divergence within Latin America continues as the Brazilian real bucks the regional trend. The real is now up 3.6% year to date, one of the highest gains in the entire EM space, after being the worst performing currency for most of Q1. Much of the outperformance is due to negative idiosyncratic (largely political) developments in other South American countries, such as Colombia and Peru. However, a lot of the credit goes to the central bank’s bold decision to frontload the tightening cycle earlier this year. In addition, the legislative process has been running much smoother with Arthur Lira at the helm of the lower house. The fiscal concerns are still there and will always command some risk premium in the back end of the curve, but a comparatively favorable backdrop here added to improved growth prospects could continue to support the real for a sustained break below R$5.0.

EUROPE/MIDDLE EAST/AFRICA

U.K. reported May public sector net borrowing data. Ex-banking groups, the borrowing need came in at GBP24.3 bln vs. GBP25.5 bln expected and a revised GBP29.1 bln (was GBP31.7 bln) in April. After climbing for three straight months, the May drop is welcome news for gilts. If the economy continues to rebound as the market expected, borrowing needs should continue to drop. The improvement will be seen on both the revenue side (higher tax receipts) and the expenditure side (lower benefits paid). Chancellor Sunak said “As we emerge from the pandemic, we are continuing to support people and businesses to get back on their feet. We are taking to keep debt under control in the years to come.” The government forecasts the budget deficit narrowing to around -10% of GDP this fiscal year from -14.3% last fiscal year, but many expect the gap to come in below target due to the improved economic outlook. In that regard, CBI released the results of it industrial trends survey for June, where total orders rose to 19 vs. 16 expected and selling prices rose to 46 vs. 40 expecgted.

Details of ECB asset purchases for the week ending June 18 will be reported. Redemptions and gross purchases will be reported. For the week ending June 11, redemptions were rather high at EUR7.3 bln and so gross purchases came in at EUR18.1 bln vs. EUR21.3 bln for the week ending June 4. Yesterday, net purchases were reported at EUR19.4 bln vs. EUR10.8 bln the week ending June 11. The ECB has been aiming for net weekly purchases of around EUR20 bln since the accelerated pace began in March, but there have been a couple of outliers like we saw the previous week. The ECB is likely to be happy with the recent slump in eurozone yields, but they will maintain their asset purchases to ensure loose monetary conditions persist in H2.

ECB speakers are plentiful. Kazimir, Rehn, Lane, and Schnabel speak today. Yesterday, Madame Lagarde testified before the European Parliament and was suitably dovish. She noted that rising market rates would pose a risk to the recovery and that the U.S. and the eurozone are clearly in different economic situations. She said the ECB is being very attentive to wage negotiations. Lastly, Lagarde noted that the ECB still has room to cut interest rates if needed. The market no longer believes this, however, as evidenced by the steady rise in EONIA swap rates. Virtually all of the ECB speakers this week are in the dovish camp and so expect a lot of headlines downplaying the need to slow asset purchase. Despite the cyclical pickup in the eurozone economy, policymakers remain concerned about removing accommodation too early.

Lagarde said that the ECB continues to make good progress on its strategy review. The Governing Council met in person this past weekend to continue talks, with results expected to be released before the bank’s annual forum September 28-29. Sources say policymakers are still some way apart on the new strategy due to differences on the definition of price stability and how to achieve it. One source said there was general agreement that the ECB could tolerate inflation exceeding a new goal of 2% for some period of time, as it has been stuck below that level for most of the past decade. This would move the ECB into the average inflation targeting camp started by the Fed. That said, ECB policymakers have yet to agree on how to present this message and whether the bank should be explicit about the extent to which inflation would be allowed to overshoot and for how long.

National Bank of Hungary is expected to be the first European central bank to hike rates. The median expectation is for a 30 bp increase in the base rate to 0.90%, which sounds about right to us. However, the market is split. Of the 18 analysts polled by Bloomberg, 1 sees no hike, 3 see a 15 bp hike, 1 sees a 25 bp hike, 10 see a 30 bp hike, 2 see a 40 bp hike, and 1 sees a 50 bp hike. Monetary policy in Hungary is very opaque and so the wide range of expectations is not surprising. Of note, the bank snugged the 1-week deposit rate up by 15 bp to 0.75% back in September to lend some support to the forint and so it’s not totally clear which channel of tightening the bank will rely on going forward. However, officials have clearly flagged some form of tightening is coming, but it’s a bit too soon to see how long the cycle will be. We expect the Czech Republic to follow soon with a 25 bp hike tomorrow.

ASIA

Japan reported May department store sales. Nationwide sales rose 65.2% vs. 167.0% in April, while Tokyo sales rose 77.7% y/y vs. 186.2% in April. Obviously, much of this is due to low base effects as the state of emergency that month will weigh on activity. GDP may contract in Q2, though Bloomberg consensus currently sees meager 0.7% q/q growth. We still expect a fiscal stimulus package over the summer to help boost the economy and shore up support for Prime Minister Suga ahead of fall elections.

The liquidity crunch in China tightened even as concerns about financial stability rose. The overnight repo rate rose to 2.31%, the highest since early February as PBOC liquidity management has not kept pace with strong quarter-end demand and heavy bond issuance by local governments. The PBOC has signaled no change in its policy stance and so we expect it will address the situation soon. Elsewhere, reports suggest local banks are restricting credit to property developer Evergrande. Three banks with a combined CNY46 bln ($7.1 bln) of exposure to Evergrande as of mid- 2020 have reportedly declined to renew loans to the company when they mature this year. Three other banks are reportedly allowing Evergrande to roll over portions of credit lines it has already used but are limiting access to any unused funds from those lines. Stay tuned.

COMMODITIES AND ALTERNATIVE INVESTMENTS

Brent crude jumped above $75 a barrel for the first time since April 2019 on both supply and demand factors in the oil market. Stockpiles in the U.S. continue to trend lower and we are just entering peak driving season. Inventories at WTI delivery point Cushing, Oklahoma, are back to pre-pandemic lows given high refinery demand. On the supply side, the prospects of greater exports from Iran have been pushed back. In addition, investment by major oil industry players (especially the shale producers) seem to be relatively low, in part due to environmental concerns and tightening financing conditions. Reports suggest Russia will propose an output increase at the July 1 meeting of OPEC+. The nation believes that the global supply shortfall will persist over the medium-term, though officials say its final position is still being formulated.

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