Dollar Softens as U.S. Yields Plunge

June 21, 2021
  • The U.S. yield curve continues to flatten; cross market measures of implied volatility have reawakened from the recent doldrums; with the media embargo over, Fed speakers will be plentiful this week; the U.S. growth outlook for Q2 remains strong
  • ECB asset purchases for the week ending June 18 will be reported; Madame Lagarde speaks; reports suggest the U.S. is preparing additional sanctions on Russia; Iran is back in focus after the election of cleric Ebrahim Raisi amidst little progress in nuclear talks
  • Australia reported weak preliminary May retail sales; China kept its loan prime rates on hold; regional trade data suggest ongoing strength; cryptocurrency markets remain under pressure from a combination of factors

The dollar is giving back some of its recent gains. DXY is down modestly today after four straight up days. It traded Friday at the highest level since April 9 near 92.405 but is currently trading near 92.10. The break above 91.946 last week sets up an eventual test of the March 31 high near 93.437. The euro has recovered to trade back near $1.19 but the break below $1.1920 last week sets up a test of the March 31 low near $1.1705. Sterling has seen support near $1.38 but the break below $1.3890 last week sets up a test of the April 12 low near $1.3670. Lastly, USD/JPY traded below 110 earlier today but has since recovered to trade slightly above that level and the pair is on track to test the March 31 high near 111.

AMERICAS

The U.S. yield curve continues to flatten. The 2-30 part of the curve has flattened over 20 bp since the middle of last week, forcing investors to rethink many of their reflation trades. The 10-year fell below the 1.40% level earlier today for the first time since early March before rebounding a bit. However, the current 1.43% yield is well below the cycle high of 1.77% from March 31. Similarly, the 30-year yield fell below 2% earlier today for the first time since February 12. It traded as low as 1.93% but bounced off the 200-day moving average to trade at 2.02% currently. Can the long end continue to rally in the face of higher inflation readings and eventually Fed tapering? We think it’s too early to say but we continue to see asymmetric risks for U.S. yields. It’s hard to justify lower yields but easy to find ten reasons for higher yields. Stay tuned.

In another reflection of changing moods in the market, cross market measures of implied volatility have reawakened from the recent doldrums. The most notable move has been in the U.S. Treasury index (MOVE), rising to over 60, well above its 1-year average, though still well within its recent ranges. The VIX traded near 22 today, the highest since May 20 before edging back to 20 currently. We had long felt that the recent period of low volatility across many markets would be hard to sustain given all the global cross-currents and believe that a period of heightened volatility is likely to persist near-term.

With the media embargo over, Fed speakers will be plentiful this week. Last Friday, Bullard confirmed that Chair Powell officially opened up the tapering discussions at that FOMC meeting. While we already knew that from Powell’s press conference, Bullard’s acknowledgment means the clock is now ticking. Minutes for last week’s meeting will be released July 7 and will dissected for clues on the timing of tapering. Many are focused on the Fed’s Jackson Hole Symposium in late August for a possible reveal, but we may get more hints before that at the July 27-28 FOMC meeting. Bullard, Kaplan, and Williams speak today. May Chicago Fed National Activity Index (0.70 expected) is the only data report today from the U.S.

 The U.S. growth outlook for Q2 remains strong. The Atlanta Fed’s GDPNow model forecasts Q2 growth at 10.3% SAAR vs. 10.5% previously, while the New York Fed’s Nowcast model currently shows Q2 growth at a more modest 3.7% SAAR vs. 4.2% previously. The New York Fed model estimates Q3 growth at 4.5% SAAR vs. 5.3% previously. Of note, Bloomberg consensus sees 10.0% growth in Q2, easing to 7.0% in Q3 and 4.9% in Q4, all in SAAR terms. Another revision to Q1 will be reported this Thursday and is expected to remain steady at 6.4% SAAR but this is in the rear-view mirror already.

EUROPE/MIDDLE EAST/AFRICA

ECB asset purchases for the week ending June 18 will be reported. Net purchases were only EUR10.8 bln for the week ending June 11 vs. EUR20.6 bln for the week ending June 4. This was about half the weekly average seen during this period of accelerated purchases and so the drop off is a little puzzling. Of note, redemptions were rather high at EUR7.3 bln and so gross purchases came in at EUR18.1 bln for the week ending June 11 vs. EUR21.3 bln for the week ending June 4. Madame Lagarde hinted at seasonal flexibility that would require fewer purchases in thin summer markets, but this seems too early. Let’s see how this week’s purchases come in before making any hasty judgments.

Madame Lagarde speaks today. Virtually all 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. Indeed, eurozone M3 data for May will be reported Friday, with growth expected to slow to 8.5% y/y vs. 9.2% in April. If so this would be the fourth straight month of deceleration from the January peak of 12.5% y/y and is a worrisome sign for policymakers.

Reports suggest the U.S. is preparing additional sanctions on Russia for the poisoning of opposition leader Alexey Navalny. National Security Adviser Jake Sullivan said “We rallied European allies in a joint effort to impose costs on Russia for the use of a chemical agent against one of their citizens on Russian soil. And we are preparing another package of sanctions to apply in this case as well.” President Biden reportedly raised Navalny’s case with President Putin during their summit last week and stressed that Russia would face “devastating” consequences if Navalny were to die in prison.

Iran is back in focus after the election of cleric Ebrahim Raisi amidst little progress in nuclear talks. Raisi is known for being well on the conservative side of the spectrum, so his landslide victory in the presidential race probably means a tougher diplomatic road ahead for the reformist wing. Still, much of the power remains in the hand of Supreme Leader Ayatollah Ali Khamenei. The sixth round of discussions between Iran’s leadership and foreign negotiators ended without a deal, in part due to Iran’s demand for guarantees under future U.S. governments. The impact of both these stories are positive for oil prices, as they likely reduce the nation’s projected crude supply coming back to global markets.

ASIA

Australia reported weak preliminary May retail sales. Sales rose only 0.1% m/m vs. 0.4% expected and 1.1% in April. After last week’s blockbuster jobs data for May, a strong sales print was expected. Still, it’s clear that the economy is still in recovery mode. RBA officials have sounded fairly upbeat recently but have not given any indications on what its plans are for QE at the July 6 meeting. We believe the RBA will extend the program at its current pace but move to a more flexible QE program subject to more frequent reviews. This would set the table for likely tapering in H2 if the labor market continues to heal. Of note, a noted RBA-watcher from Down Under is now calling for rate lift-off in early Q1 23.

China kept its loan prime rates on hold as expected, and we doubt there will be any changes soon. The 1-year remains at 3.85% and the 5-year at 4.65%. As we have discussed, we think officials see the current level of accommodation is appropriate and will focus their energies on localized policy initiatives. These include reducing speculation and price pressures from the commodity sector and managing the influence of the country’s tech industry in the financial sector.

Regional trade data suggest ongoing strength. Korea reported trade data for the first 20 days of June. Exports rose 29.5% y/y vs. 45.6% for all of May. There was a modest calendar effect, and so when adjusted for working days, average daily exports rose 33.7%, which is still quite impressive. During the first 20 days, auto exports jumped 62.2% and semiconductor exports rose 28.5%. Geographically, exports to China rose 7.9%, to the U.S. rose 41.3%, and to the EU rose 48.8%. We expect regional trade and activity to remain strong as we move into H2. Elsewhere, Taiwan May export orders rose 34.5% y/y vs. 42.1% expected and 42.6% in April.

COMMODITIES AND ALTERNATIVE INVESTMENTS

Cryptocurrency markets remain under pressure from a combination of factors, including regulatory risk, hash rates, and the broader decline in risk appetite. The crackdown on bitcoin mining in China has led to a considerable decline in the hash rate (which some use as a proxy for network security). Dips in the hash rate often lead to near-term negative sentiment. That said, the mining crackdown could be a positive long-term development for bitcoin as it will lead to a more globalized and greener mining distribution. There has also news that Agricultural Bank of China (the country’s 3rd largest bank) will prohibit the use of its services for virtual currency transactions. Reports suggest Alipay was asked to do the same. Separately, there has been a re-kindling of regulatory risk in the U.S. in the wake of the collapse of the Titan cryptocurrency protocol, which included a stable coin, and the participation of the high-profile investor Mark Cuban. Bitcoin is trading below $33K and Ethereum at just below $2k, down 51% and 55% from their all-time highs.

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