The FX Trader: Yields are in driver's seat, taking risk down and USD up.

The latest 

Long bond yield spike sends USD higher, raises danger of risk-off. The USD rallied sharply Friday in a technically decisive move, as EURUSD was pushed back below 1.1650, USDJPY ramped above 158.00 and GBPUSD plunged through 1.3450. The key one-two punch driving this rally was the fresh aggravated rise in crude oil prices sending key global yield benchmarks over the edge on inflation concerns and on the general notion that central banks - led by the Fed and the BoJ - will do little to tighten policy to counter inflationary risks. The long-quiet US treasury market is finally making waves after having long shown reluctant contagion from oil prices. The benchmark US 10-year treasury yield broke above the 4.50% level for the first time in almost a year, while the 30-year benchmark rose above the psychologically important 5.00% level. The latter benchmark traded at nearly 5.15% early Monday, just a few basis points shy of the highest levels of 2023, when the highest yield since 2007 was established.

Japan's government bonds were already under significant pressure recently, but the action late last week has sent the longest yields there into a virtual melt-up, with the 10-year JGB benchmark up 23 basis points last week and adding several more basis points Monday to trade at 2.71%, its' highest since the late 1990's. The benchmark 30-year JGB yield was up 30 basis points last week, a new record high just over 4%, and saw almost disorderly further pressure Monday. 

Takeaway: while global equity markets have recently done a stunning job of posting a comeback from weak sentiment triggered by the war in Iran, spiking global yields nonetheless dramatically raise the risk of risk-off across markets, which would likely be supportive of a stronger USD and perhaps CHF, while pro-cyclical currencies like the G10 smalls (perhaps ex NOK) and EM currencies would be under pressure. Sterling is also at risk as noted below. Still, at some point, we should be on the lookout for policy initiatives to ease the pressure on bond markets.

Sterling – the timing of political uncertainty couldn’t be worse.  Sterling is suffering here on the political uncertainty surrounding the identity of whoever might replace PM Starmer and whether whoever does will prioritize fiscal stability to the same degree. UK 10-year and 30-year gilt yields vaulted to new post-GFC highs Friday as sterling sold off, taking EURGBP back above 0.8700 last week and GBPUSD down well below the prior 1.3450 range low and almost to 1.3300. 

Takeaway: Any widespread further aggravation of weak global risk sentiment here would put sterling at further risk. The latest employment and claims data for the UK are up tomorrow and CPI up on Wednesday.

Fractious Fed as we await Fed Chair Warsh. The market knows that incoming Fed Chair Warsh, whose nomination was formally approved last week, will be under enormous political pressure from President Trump to at least not hike rates. Perhaps Trump’s advisors will make it clear to the president that the Fed simply can’t cut rates with the current backdrop and that his focus now needs to be on the bond market. Warsh is not yet the sitting Fed Chair, as his nomination approval happened too late for him to take over on Friday, but this will presumably happen in the coming days (Powell will be temporary Fed Chair until Warsh can formally assume the position, as Powell’s term officially ended last Friday). 

Takeaway: The market will be hungry for rhetorical signals from the new Chair, while the range of views among Fed voters and board members are many, as seen in the recent Fed decision where there was both dovish and hawkish dissent. One thing Warsh has signalled and would do well to accomplish, is to dismantle the excesses of the “forward guidance” regime created by Ben Bernanke, which create all kinds of havoc with communication via the “dot plot” and projections etc. This week is quiet on the US macro data front.

Chart focus: EURUSD
EURUSD sold off through important range support in the 1.1650 area, but the price action is still buried in a wide range, with the 1.1580 area 61.8% retracement perhaps more important in determining whether the pair is set for a full collapse back into the low 1.1400’s and perhaps beyond. Bulls would want a quick snap-back rally and close above 1.1700 to suggest that this sell-off is over. Before, we had emphasized that the 1.1825-50 area as the last key resistance zone for the massive bearish rejection wave from the 1.20+ top to the 1.1411 low.