Dollar Under Modest Pressure as Key Week Begins

October 04, 2021

The U.S. 10-year yield is trading around 1.50% as the new week begins; Fed speakers are limited this week
Press reports the U.K. will trigger the so-called ‘nuclear’ option and unilaterally suspend parts of the Northern Ireland Protocol; Turkey September CPI came in near expectations but still a big jump from the previous month
A cabinet shuffle in Japan saw a new economy team take the reins; in New Zealand, the latest virus outbreak spread from one district to another and prompted the Auckland lockdown to be extended; the news comes days before the RBNZ meets Wednesday; mainland Chinese markets are closed until Friday but the situation around Evergrande remains tense

The dollar is still consolidating its recent gains. DXY is down modestly for the third straight day and trading just below 94 after making new highs for this year just above 94.50. The euro is trading back above $1.16 after trading as low as $1.1565 last week, while sterling is seeing a bit of an extended bounce and trading just below $1.36 after trading as low as $1.3410 last week. We believe the negatives continue to pile up for sterling (see below). Lastly, USD/JPY is trading back above 111 after a brief foray below. We believe the drivers that favored the dollar in Q3 will remain in play for Q4.

Measures of implied volatility for fixed income and equity markets remain elevated but drifting lower over the last few sessions. The VIX is still above 20 but now below its 1-year average of 23. The MOVE index for U.S. Treasuries is at 57, down from the recent highs but still a few points above the 1-year average of 53. Implied vol in G7 FX markets have been the most well behaved at 6, even if off recent lows.

AMERICAS

The U.S. 10-year yield is trading around 1.50% as the new week begins. After trading as high as 1.57% last week, it sank back below 1.50% but is edging higher today. Similarly, the real 10-year yield traded as high as -0.85% last week before trading back below -0.90% but now stands around -0.88%. A strong U.S. economy and rising rates are clearly dollar-supportive, with this Friday’s jobs report taking on even greater importance than usual for the Fed’s tapering timeline. Of note, the dollar weakened every day of that week ahead of the August jobs data September 3. DXY bottomed that day just below 92 and hasn’t looked back. Similarly, the nominal 10-year put in a near-term bottom around 1.26% on September 3 before rising steadily to that 1.57% peak.

Fed speakers are limited this week. Bullard speaks today, followed by Quarles Tuesday and Mester Thursday. We believe Fed officials will continue setting the table for an official tapering announcement at the November 2-3 FOMC meeting. Much will of course depend on this week’s jobs report but we now believe that any gain larger than the 235k gain in August will be enough for the Fed to pull the trigger next month. Consensus sees 470k. August factory orders (1.0% m/m expected) will be reported today, while Canada reports August building permits (3.4% m/m expected).

EUROPE/MIDDLE EAST/AFRICA

Press reports the U.K. will trigger the so-called ‘nuclear’ option and unilaterally suspend parts of the Northern Ireland Protocol. The government has reportedly drawn up plans to permanently replace the deal with the EU in order to maintain an open border between Ireland and Northern Ireland. Brexit Minister Frost is set to announce this at the Tory conference today and will reportedly confirm that full legal texts have been drafted to eliminate the protocol.

During a pandemic and in the middle of a self-induced energy crisis is perhaps not the best time to inflame trade tensions with its largest trading partner. And yet that is what the Johnson government is doing. The EU has already threatened trade sanctions if the U.K. were to take such unilateral actions. Furthermore, the U.K. is still trying to gain so-called equivalence in the E.U. for its financial firms. Why antagonize the E.U. further? It’s becoming clearer and clearer that the grand benefits to the U.K. that the Brexiteers promised are never going to materialize. The way sterling has been trading of late, we think the markets are coming to accept this view as well.

Turkey September CPI came in near expectations but still a big jump from the previous month. The headline printed at 19.6% y/y while core was a tad under 17% y/y. The headline figure has accelerated every month this year except one. Yet despite the worrying trend, and the stark contradiction with the recent rate cut, today’s numbers won’t make a difference to the CBRT’s politicized policy outlook. We still can’t see any light at the end of the tunnel for Turkish assets as the real rate (measured from the CBRT 1-week repo) turns negative. Next policy meeting is October 21 and another cut then seems likely.

ASIA

A cabinet shuffle in Japan saw a new economy team take the reins. Former Olympics Minister Shunichi Suzuki takes over as Finance Minister from outgoing Taro Aso. Suzuki’s first priority is putting together a fiscal package for incoming Prime Minister Kishida ahead of planned general elections this fall. Suzuki and Kishida are unlikely to deviate from the current policy path for the time being. Koichi Hagiuda becomes Trade Minister, Daishiro Yamagiwa becomes Economy Minister, and Takayuki Kobayashi become Economic Security Minister, a newly created cabinet position. In related news, press reports suggest the election will be called for October 31.

In New Zealand, the latest virus outbreak spread from one district to another and prompted the Auckland lockdown to be extended. Movement restrictions were extended for at least another week, but Prime Minister Ardern set forth a roadmap for the lockdowns to be gradually eliminated. However, she stressed that policymakers were not committing to any timeframe.

The news comes days before the RBNZ meets Wednesday. While a 25 bp hike was fully priced in as recently as late September, the odds have steadily fallen and WIRP now suggests about 80% chance for a hike. We think yet another U-turn by the RBNZ would be extremely harmful for market sentiment. Instead, the bank should deliver the 25 bp hike and at the same push back against market expectations for two more subsequent hikes at the November and February meetings.

Mainland Chinese markets are closed until Friday but the situation around Evergrande remains tense. Share sales in Hong Kong were suspended ahead of the next debt repayment today, this one with only a 5-day grace period. Wires reported that Hopson Development Holdings (shares also suspended) is looking to acquire a 51% share in Evergrande Property Services. Hopson’s 2023 bond yields spiked from around 9% to 11.5% on the news.

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