Dollar Powers Ahead to New Highs for 2021

September 29, 2021

U.S. rates story has become the biggest driver for all asset classes; the rise in rates is taking a bit of a pause today; Fed Chair Powell came under fire from Senator Warren yesterday; Yellen warned her department that it will run out of cash October 18
ECB asset purchases for the week ending September 24 were reported; Spain reported higher than expected September CPI; the fishing spat between the U.K. and France is back in the news at the worst time
Japan’s LDP elected former Foreign Minister Kishida as its new leader; China policymakers continue efforts to limit the fallout from the Evergrande crisis; Thailand kept rates steady at 0.50%, as expected

The dollar remains firm even as U.S. rates are off their highs. DXY is up for the fourth straight day and is making new highs for the year near 93.889. Next target is the November high near 94.302. The euro remains heavy and is making new lows for this year near $1.1655. Next target is the November low near $1.1605. Sterling continues to underperform as the negatives pile up (see below) and is on track to test the January low near $1.3450. USD/JPY is trading at new highs for the year near 111.70. The next target is the February 2020 high near 112.25. We continue to believe the hawkish Fed, rising U.S. rates, and ongoing China risks will help keep the dollar rally going.

AMERICAS

The U.S. rates story has become the biggest driver for all asset classes. It actually always has been but we never got the higher yields that many had been calling for. Until now, that is. Higher U.S. rates means lower equities for a variety of reasons (valuations, etc.), a higher dollar, and weaker EM and other risk assets. Is this a head fake or the start of a truly larger trend? It’s too early to say but with the world reopening and energy prices spiking, we tend to believe this is just the beginning in terms of a market reset on rates.

The rise in rates is taking a bit of a pause today. The U.S. 10-year yield is trading back around 1.50% after trading as high as 1.57% yesterday. The 7-year auction yesterday was weak but not as bad as the 2- and 5-year auctions. Indirect bidders took 60.1% vs. 61.1% at the previous auction, while the bid/cover ratio fell to 2.24 from 2.34 at the previous auction. Fed speakers remain plentiful. Harker, Powell, Daly, and Bostic speak today. Pending home sales (1.3% m/m expected) will be the only U.S. data to be reported today.

Fed Chair Powell came under fire from Senator Warren yesterday. She said she opposed his re-nomination, calling him “a dangerous man.” We regret that Warren is resorting to such attacks. Powell has done all that was expected of him and more throughout the pandemic. One could argue that the Fed’s easy monetary policy is leading to excessive risk-taking, but we suspect that Warren also would criticize Powell for hiking rates too soon. Powell said he was open to reviewing regulatory issues, as well he should. Policymaking (including regulatory actions) is never written in stone and are meant to be adjusted as circumstances change. We are hopeful that President Biden will listen to his Treasury Secretary, who has endorsed Powell for a second term.

Yellen warned her department that it will run out of cash October 18 unless Congress passes the necessary legislation. This has become the new effective deadline for passing a bill that addresses the debt ceiling and provides funds to keep the government running and to meet all its obligations. FY21 ends September 30 and it’s not unusual to have to pass a so-called Continuing Resolution that will keep the government running until the full FY budget has been passed. However, when this runs up against the debt ceiling, things can get quite tense. Please read “Some Thoughts on U.S. Fiscal Policy” for our latest outlook. Bottom line: any market movements linked to the debt ceiling battle are likely to be transitory. We retain our bullish call on the dollar and our bearish call on bonds. With yields rising, equity markets will face some headwinds but strong U.S. growth should help offset this.

EUROPE/MIDDLE EAST/AFRICA

ECB asset purchases for the week ending September 24 were reported. This weekly number has taken on more importance after the ECB announced that it would aim for a more “moderate” pace going forward. Net purchases were EUR20.4 bln vs. EUR19.1 bln for the week ending September 17 and EUR14.7 bln for the week ending September 10. The ECB had been aiming for net weekly purchases of around EUR20 bln since the accelerated pace began in March but they have fallen a bit short in recent weeks due to thin market conditions over the summer. Now, it will likely take a few more weeks to figure out what the new pace will be.

Spain reported higher than expected September CPI. Headline EU Harmonized inflation came in at 4.0% y/y vs. 3.6% expected and 3.3% in August. Germany, Italy, and France report tomorrow. Headline inflation is expected to pick up in all three to 4.0% y/y, 3.0% y/y, and 2.8% y/y, respectively. Eurozone reading will be reported Friday, with headline inflation expected to pick up to 3.3% y/y from3.0% in August. However, today’s reading from Spain suggests upside risks for all these other readings. This will surely be keeping the ECB hawks up at night and will further their resolve to prevent extended monetary stimulus.

The fishing spat between the U.K. and France is back in the news. France claims the U.K. is breaching the Brexit deal by limiting the access of small EU boats to its waters. This is flaring up again after the U.K. ruled that only 12 out of 47 applications to fish in British waters were granted permission. The other licenses reportedly weren’t granted because the boats weren’t able to show sufficient evidence of having fished in the waters historically. With the U.K. in the middle of an energy crisis and counting on France to provide power once the cable has been restored, perhaps officials should take a more cooperative approach with its neighbor across the channel. France has also threatened to block U.K. access to EU financial services.

All of these recent developments in the U.K. put to bed the lie that the transition to a post-Brexit world would be nothing but roses for the U.K. We remain very negative on sterling as a result. That said, this week’s move lower was much quicker than we anticipated but here we are. The January low near $1.3450 is within sight. After that, there really isn't much in the way of chart points until the December 2020 low near $1.3135, when Brexit pessimism was rising ahead of the last minute deal.

ASIA

Japan’s Liberal Democratic Party elected former Foreign Minister Kishida as its new leader. Given the LDP’s dominance in the Diet, he is widely expected to become the next Prime Minister after general elections that must be held by the end of November. Kishida inherits a weakened economy that should be on the mend after the state of emergency is lifted this week due rapidly falling infections. As widely expected, Kishida pledged another fiscal package soon. He also said he will consider raising public sector wages. Yet when all is said and done, we do not expect a sea change from the Abenomics framework that Kishida also inherits.

China policymakers continue efforts to limit the fallout from the Evergrande crisis. Reports suggest Evergrande agreed to sell a 20% stake worth CNY10 bln to the local Shenyang government. In return, the bank said that all proceeds should go to pay off its debts to the lender. If so, the sale wouldn’t help Evergrande meets its obligations to bondholders and wealth management clients. However, it does suggest to us that policymakers are dipping their toes into the possibility of partial or full state ownership of some of Evergrande’s assets. While this should not be considered a bailout, we think it is perhaps a trial balloon. Elsewhere, the PBOC injected liquidity into the system for the ninth straight day. Part of this is due to quarter-end pressures, but we think a large part of it is an effort to maintain calm in the financial markets.

Bank of Thailand kept rates steady at 0.50%, as expected. The decision was unanimous. This is noteworthy since at the last meeting August 4, it was a 4-2 vote with the two dissents in favor of a 25 bp cut. The bank maintained its forecast for growth of 0.7% this year but boosted it a couple of ticks to 3.9% next year. We expect rates are likely to remain on hold through 2022, with risks of further backdoor easing via macroprudential measures. After the reversal of the August dissents, it seems that the bar to an outright rate cut remains high. Earlier, Finance Minister Arkhom Termpittayapaisith stressed that monetary policy should remain accommodative in order to allow fiscal policy to function well, adding that both policies must be in sync to maximize support the economy.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2021. All rights reserved.