Dollar Recovery Continues as U.S. Yields Rise Further

October 06, 2022

Win Thin

U.S. yields continue to recover; Fed officials remain hawkish; September ADP private sector jobs report is worth discussing; September ISM services PMI came in strong; the Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 2.7% SAAR; Peru is expected to hike rates 25 bp to 7.0%
The ECB reduced its support for peripheral bond markets over the summer; the eurozone reported soft August retail sales; Germany reported weak August factory orders; the BOE delivered its official post-mortem of the recent gilt market crash; Poland delivered a dovish surprise
Deputy Prime Minister Robertson is optimistic that New Zealand can avoid a recession; the RBNZ is not currently forecasting recession

The dollar continues to gain as U.S. yields rise. DXY is up for the second straight day after five straight down days and is trading near 111.378 after testing the 110 area Wednesday. Sterling remains heavy after being unable to breach strong resistance near $1.15 and is currently trading near $1.1265. Similarly, the euro remains heavy after being unable to breach strong resistance near $1.00 and is currently trading near $0.9885. USD/JPY continues to flirt with the 145 area but has yet to take another stab at Monday’s high near 145.30. This move higher in USD/JPY should continue as markets eventually test the BOJ’s resolve. The combination of ongoing risk off impulses and eventual repricing of Fed tightening risks is likely to see the dollar continue to recover after this recent correction. Much will depend on how the U.S. data come in but so far, the signs are good.

AMERICAS

U.S. yields continue to recover. The 2-year yield is currently back near 4.17% after trading as low as 3.99% Tuesday. A break above 4.21% would set up a test of the September 26 cycle high near 4.35%. Similarly, the 10-year yield is currently back near 3.77% after trading as low as 3.56% Tuesday. A break above 3.84% would set up a test of the September 28 cycle high near 4.02%. Of note, the real 10-year yield has recovered to 1.56% and is nearing the September 30 cycle high near 1.67%.

Fed officials remain hawkish. Yesterday, Daly said the Fed’s aim is to hike rates to a level that is restrictive and then hold them there. She stressed that market pricing for 2023 rate cuts is wrong. Daly added that she would like to see core inflation stay flat or fall and that what happens here is important for the Fed’s pace of tightening. Elsewhere, Bostic said “I would like to reach a point where policy is moderately restrictive --between 4 and 4 1/2 percent by the end of this year -- and then hold at that level and see how the economy and prices react.” He stressed that This is all pretty standard fare these days but it's clear that the Fed is nowhere near pivoting. Evans, Cook, Waller, and Mester speak today. WIRP suggests nearly 70% odds of a 75 bp hike November 2, which we think is a done deal after last week’s data. Looking ahead, the swaps market is pricing in a peak policy rate between 4.50-4.75%.

September ADP private sector jobs report is worth discussing. It came in at 208k vs. 200k expected but this is only the second month using its new methodology. August was revised to 185k vs. 132k previously but that is still a big miss from 315k NFP. We don't think this ADP number holds a ton of weight but it does support the idea that we will get a solid jobs report tomorrow like most of the other clues suggest. Consensus is currently at 260k vs. 315k in August. August Challenger job cuts and weekly jobless claims will be reported today. Initial claims are expected at 204k vs. 193k previously, while continuing claims are expected at 1.350 mln vs. 1.347 mln previously. The recent drop in the claims data point to continued resilience in the labor market.

September ISM services PMI came in strong. Headline came in at 56.7 vs. 56.0 expected and 56.9 in August and so remains near the recent highs. Of note, the employment component came in at 53.0 vs. 50.2 in August and was the highest since March, while the prices paid component came in at 68.7 vs. 71.5 in August and was the lowest since January 2021. Lastly, overall activity came in at 59.1 vs. 60.9 in August but remains near the recent highs. This was just another reminder that the U.S. economy remains resilient. How resilient?

The Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 2.7% SAAR. This is the highest it’s been and was tracking as low as 0.2% SAAR on September 21. Clearly, the recent streak of strong data has improved the overall outlook for Q3. The next model update comes tomorrow. Of note, the advance read for Q3 GDP comes October 27 and current Bloomberg consensus stands near 1.5% SAAR.

Peru central bank is expected to hike rates 25 bp to 7.0%. At the last meeting September 8, the bank delivered a dovish surprise and hiked rates 25 bp to 6.75% vs. 50 bp expected. It noted then that “The board of directors reaffirms its commitment to adopt the necessary actions to ensure the return of inflation to the target range in the horizon of projections.” The bank saw inflation returning to the target range in H2 2023 and said it is continuing its policy normalization. Since then, September CPI came in at 8.53% y/y vs. 8.50% expected and 8.40% in August. This was the first acceleration since June and moves further above the 1-3% target range.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank reduced its support for peripheral bond markets over the summer. Data showed holdings of Italian debt held by the ECB fall by EUR1.243 bln ($1.2 bln) in August and September. Its holding of Greek and Spanish debt also fell, while France saw the biggest net purchases at EUR1.97 bln. This is the opposite of what data showed for June and July, when there was a EUR17.3 bln increase in the ECB’s holding of peripheral debt as the bank first started using reinvestment proceeds to help influence spreads. It’s clear that the market has not yet tested the ECB’s resolve as reinvestment flows are only the first line of defense. After that, the vaguely defined TPI would come into play but we have not seen it yet. Perhaps markets are waiting to see how the Italian political drama plays out but make no mistake, peripheral spreads are likely to come under greater pressure in Q4.

The eurozone reported August retail sales. Sales came in as expected at -0.3% m/m but July was revised down sharply to -0.4% vs. 0.3% previously. As a result, the y/y rate came in at -2.0% vs. -1.7% expected and a revised -1.2% (was -0.9%) in July. This marks the third straight month of y/y contraction and it’s only going to get worse as we move into the winter months and energy prices spike. For all intents and purposes, the eurozone is already in recession even as the ECB continues to hike rates. WIRP suggests a 75 bp hike is nearly priced in October 27, while the swaps market is pricing in 225 bp of tightening over the next 12 months that would see the deposit rate peak near 3.0%.

Germany reported weak August factory orders. Orders came in at -2.4% m/m vs. -0.7% expected. However, July was revised sharply upward to 1.9% vs. -1.1% previously. While the y/y rate improved to -4.1% vs. -5.5% expected and a revised -11.0% (was -13.6%) in July, orders have contracted y/y for six straight months and point to ongoing weakness in the economy. Retail sales and IP will be reported tomorrow. Sales are expected at -1.2% m/m vs. 1.9% in July, while IP is expected at -0.5% m/m vs. -0.3% in July. We see downside risks to both readings. Germany is proving to be the weak link in the eurozone and likely to drag the rest of the region into recession with it.

The Bank of England delivered its official post-mortem of the recent gilt market crash. Deputy Governor Cunliffe said the bank first spotted signs of gilt market stress on the day that Chancellor Kwarteng announced the government’s fiscal package. In particular, liquidity concerns among liability-driven investment (LDI) pension fund managers spiked after the Friday of the budget statement. Cunliffe noted that market stresses escalated as LDI funds attempted to sell gilts in order to meet collateral calls, which the BOE estimated to be as much as GBP50 bln of additional long-term gilt sales “in a short space of time” on top of the normal GBP12 bln daily turnover. Cunliffe said the BOE is carefully monitoring the impact of their emergency purchase program on the gilt market and noted that the BOE’s Financial Policy Committee will assess the impact of the policy next week and publish minutes of their meeting on October 12. The BOE also reaffirmed its commitment to unwind the purchases in a smooth and orderly way once the program is finished.

The Bank of England’s account is important because it undercuts the government’s claim that the gilt market turmoil was due to global forces. As incredible as it may sound, we think it was the other way around. That is, turmoil in the U.K. had negative spillover into global markets. We know this really doesn’t make much sense given the relatively small size of the gilt market and the U.K. economy. However, these are not normal times and market moves are being magnified by extremely thin liquidity conditions across what are normally considered deep, liquid markets. That is how the gilt crisis became a true “wag the dog” moment that punched the global bond market right in the face. Of note, market expectations for BOE tightening have eased this week. WIRP suggests a 125 bp hike is nearly priced in vs. 150 bp last week, while the swaps market is pricing in a peak policy rate near 5.75% vs. the cycle high near 6.25% last week.

National Bank of Poland delivered a dovish surprise and kept rates steady at 6.75% vs. an expected 25 bp hike to 7.0%. The bank noted that “A further slowdown of GDP growth is forecast for the coming quarters, while the economic outlook is subject to significant uncertainty.” Governor Glapinski will hold a press conference today to explain the decision. At the previous meeting September 7, the bank hiked rates 25 bp to 6.75%. Before that meeting, Governor Glapinski had said that he saw only one or two more 25 bp hikes in this cycle. Since then, September CPI came in much higher than expected at 17.2%, the highest since September 1996 and further above the 1.5-3.5% target range. The swaps market is pricing in one more 25 bp hike over the next 12 months that would see the policy rate peak near 7.0% but we see upside risks. Minutes from the September 7 meeting will be released Friday.

ASIA

Deputy Prime Minister Robertson is optimistic that New Zealand can avoid a recession. He noted that exports are holding up “particularly well” and tourism is starting to recover, acknowledging that the RBNZ “still had a job to do” to get inflation back to its 1-3% target range. Robertson admitted that “It’s going to be a challenging year, no doubt, with the global slowdown. Most economists recognize that we will see less demand and some slowdown. But that doesn’t mean, to me, a recession. There is balance to struck here.” With regards to getting the budget back into surplus, Robertson said “Given the global conditions that there are at the moment, doing that any quicker feels unlikely. But we are still targeting that 2024-25 year.”

The RBNZ is not currently forecasting recession. However, the next update comes at the next meeting November 23 and we would expect the bank to cut its growth outlook whilst raising its inflation outlook and expected rate path. It just delivered a 50 bp hike this week along with a very hawkish message. A s such, another 50 bp hike to 4.0% is fully priced in for next month. Furthermore, the swaps market is pricing in 125 of tightening over the next 12 months that would see the policy rate peak near 4.75%. We suspect the new RBNZ rate path will move toward this market pricing.

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