Dollar Remains Firm as U.S. Yields Rise

October 11, 2022
  • U.S. yields continue to rise; the rates markets are pricing in continued hawkishness from the Fed; Fed officials continue the drumbeat of hawkish comments
  • The BOE announced more measures to support the gilt market; Prime Minister Truss named U.K. Treasury veteran James Bowler to become its highest ranking civil servant; Chancellor Kwarteng announced that he will set out his fiscal plan in detail October 31, nearly a month earlier than planned; U.K. reported firm labor market data
  • Japan Prime Minister Kishida said he supports the BOJ’s ultra-loose monetary policy; Japan reported August current account data

The dollar continues to rise. DXY is up for the fifth straight day and trading near 113.164. It is on track to test the September 28 high near 114.778. Sterling remains heavy and traded below $1.10 briefly today before bouncing modestly to $1.1065 currently. A break below $1.0905 would set up a test of the September 28 low near $1.0540. The euro also remains heavy and traded as low as $0.9670 today before bouncing modestly to trade just above $0.97 currently. It remains on track to test the September 28 cycle low near $0.9535. USD/JPY is finally testing the September 22 pre-intervention high near 145.90 despite ongoing fears of BOJ intervention. This move higher in USD/JPY should continue as markets 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 rise. The 2-year yield traded as high as 4.34% Friday after trading as low as 3.99% earlier in the week and is now testing the September 26 cycle high near 4.35%. Similarly, the 10-year yield traded as high as 3.91% Friday after trading as low as 3.56% earlier in the week and is now testing the September 28 cycle high near 4.02%. Of note, the real 10-year yield has recovered to test the September 30 cycle high near 1.67%. We believe this generalized rise in U.S. yields will continue and lend further support to the dollar.

The rates markets are pricing in continued hawkishness from the Fed. The Fed is clearly hiking by 75 bp November 2. What happens December 14 will be very much data-dependent. Between the November 2 and December 14 decisions, the Fed will get two full sets of jobs, CPI, PPI, and retail sales data. A lot can happen to the data in that span and we think that is why markets are still pricing in only 50 bp in December. If (and this is a very big if) the data remain firm, the odds of a 75 bp then rise significantly from around 15% currently. We say this because the recent data suggest solid momentum in the economy as we move into Q4. We believe many Fed officials look to continue hiking in 2023, with the February 1 and March 22 decisions very much live.

Fed officials continue the drumbeat of hawkish comments. Yesterday, Evans said “Front-loading was a good thing, given how far below neutral rates were. But overshooting is costly, too, and there is great uncertainty about how restrictive policy must actually become.” He added that “I see the nominal funds rate rising to a bit above 4.5% early next year and then remaining at this level for some time while we assess how our policy adjustments are affecting the economy.” Brainard said “Moving forward deliberately and in a data-dependent manner will enable us to learn how economic activity, employment, and inflation are adjusting to cumulative tightening in order to inform our assessments of the path of the policy rate.” She added that “Monetary policy will be restrictive for some time to ensure that inflation moves back to target over time.” Mester speaks today.

EUROPE/MIDDLE EAST/AFRICA

The Bank of England announced more new measures to support the gilt market. The BOE will now buy inflation-linked debt in order to maintain orderly markets. Yesterday, it said it would buy up to GBP10 bln of gilts daily until its emergency program ends, double the GBP5 bln in place. It also announced the creation of the Temporary Extended Collateral Repo Facility (TECRF) that will run until November 10. The facility will accept a wider range of assets as collateral and is meant to help U.K. pension funds have better access to liquidity that would limit forced selling of assets. However, gilt markets continue to trade nervously as the BOE confirmed its emergency bond-buying will end Friday as planned. Can the new measures prevent another gilt crash? Only time will tell but we note that whatever measures the BOE takes, it can only address the symptoms (disorderly markets) and not the underlying malady (irresponsible fiscal policy). Only the government can turn this thing around.

Chancellor Kwarteng announced that he will set out his fiscal plan in detail October 31, nearly a month earlier than planned. The outline will include economic forecasts endorsed by the Office of Budget Responsibility. Deputy Governor Ramsden said recently that the proposed fiscal plan is “likely to be material for the economic outlook over the next three years.” He noted that the September 22 decision by the BOE to hike rates 50 bp took into account government plans to cap energy prices but not the tax cuts. This implies that the November 3 BOE decision and the updated macro forecasts will take into fuller account the impact of the fiscal package on inflation and growth. Of note, market expectations for BOE tightening have eased in recent days. WIRP suggests a 125 bp hike is about 60% priced in vs. 150 bp fully priced in back in late September, while the swaps market is pricing in a peak policy rate between 5.75-6.0% vs. the cycle high near 6.25% in late September.

Prime Minister Truss named U.K. Treasury veteran James Bowler to become its highest ranking civil servant. He replaces Tom Scholar, who Kwarteng sacked as one of his first moves as Chancellor. Reports suggest Kwarteng originally favored outsider Antonia Rome for the post but its seems Truss overruled him in favor of a more experienced hand at Treasury. All of these moves this week have done little to allay market concerns, however, as the 30-year gilt yield rose sharply to trade as high as 4.75% yesterday before stabilizing a bit today. Likewise, the 10-year yield spiked to trade as high as 4.55% yesterday and nearly matched the September 28 high near 4.59% before stabilizing today.

The U.K. reported firm labor market data. Average earnings for the three months through August rose a tick more than expected at 6.0% y/y vs. 5.5% previously, while the unemployment rate fell a tick to 3.5%, the lowest since February 1974. The data suggest wage pressures will remain strong as we move into Q4. Lastly, payrolled employees rose 69k in September vs. 35k expected and a revised 31k (was 71k). While the labor market is a lagging indicator, the data should keep the Bank of England on an aggressive tightening path for the time being. In a sign of potential cracks in the labor market, unemployment claims rose for the second straight month to the tune of 25.5k and was the largest rise since February 2021.

Italy reported firm August IP. IP rose 2.3% m/m vs. -0.1% expected and a revised 0.5% (was 0.4%) in July. As a result, the y/y rate improved to 2.9% vs. -1.3% in July. Eurozone IP will be reported tomorrow and is expected at 0.7% m/m vs. -2.3% in July. Here too, the y/y rate should move back into positive territory but the improvement is likely to be fleeting as headwinds grow. Despite rising downside risks to the economic outlook, ECB tightening expectations remain elevated. A 75 bp hike by the ECB October 27 is nearly priced in while the swaps market is pricing in 250 bp of tightening over the next 12 months that would see the deposit rate peak near 3.25%.

ASIA

Japan Prime Minister Kishida said he supports the Bank of Japan’s ultra-loose monetary policy. Kishida acknowledged that the BOJ needs to maintain its policy until wages rise, adding that firms that raise prices should raise wages too. Kishida said that he wants to work closely with BOJ Governor Kuroda and won’t end his term early or apply pressure on him to end ultra-loose policy. Kuroda’s term ends in April and the choice of his replacement will be key in determining when the bank finally pivots. For now, it’s steady as she goes. Next policy meeting is October 28-29 and no change is expected then. Of note, the 10-year JGB has not traded for three straight days, the longest streak since 1999, while USD/JPY tested the September 22 pre-intervention high near 145.90 today. These are the side effects of current BOJ policy and there is little that can be done to address them without a pivot.

Japan reported August current account data. The adjusted balance came in at -JPY531 bln vs. -JPY550 bln expected and -JPY629 bln in July. If so, it would be the second straight monthly deficit as the external accounts continue to worsen due to higher energy prices and weaker exports. However, the investment flows will be of most interest. August data showed that Japan investors were net buyers of U.S. bonds for the first time (JPY565 bln) after nine straight months of net selling. Japan investors remained net sellers (-JPY136 bln) of Australian bonds for the second straight month and Canadian bonds (-JPY119 bln) for the seventh straight month. Lastly, they turned net sellers of Italian bonds (-JPY124 bln).

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