FX Update: US Treasury rally sparks comeback for lowest yielders
Head of FX Strategy
Summary: The sharp rally in US treasuries and fall in yields in recent sessions has brought some profound relief to the lowest yielding currencies, from the euro to the most negative yielding of them all, the Swiss franc. The move could yet deepen further, but far too early to call a change of trend. Elsewhere, India and Russia are worth mention in the EM space.
FX Trading focus: US Treasury rally prompts sharp moves in low-yielders
The comeback in US treasuries, already rather noteworthy in light of recent very strong US macro data, extended sharply yesterday, taking US yields lower all along the yield curve and clearly a driver of the lately very yield-sensitive “lowest yielders” among G10 currencies. Indeed, the lower the 10-year yield, in the case of EUR, JPY and CHF, the better the return in April, as can be seen in the scatter plot below, where the general pattern has been that the highest yielders as of the end of the March have fared more or less the worst while the lowest yielders have clearly done the best. Note that for the calculations below, for the 10-year “EUR yield”, I used the average of the German Bund, French 10yr OAT and Italy 10yr BTP yield.
Graphic: 10-year yield as of March 31 against return vs. USD since then
So what now? First, while the JPY has consolidated back to the strong side, I am somewhat surprised that it has not appreciated more – this may be down to still quite calm EM markets (carry trades, etc, with exceptions noted below) and solid risk sentiment in general. Arguably, the correction in yields can deepen a bit – perhaps taking the US 10-year benchmark back toward the 1.50% level, and thus provide a further nominal further boost for the lowest yielders, but I have a hard time seeing why yields should drop beyond that level unless we are in some unforeseen new bout of risk aversion, so the market will likely soon have to move on to other themes. As well, one of the indicators I like to watch for yield sensitivity is gold, and there, the consolidation was sharp initially but has failed to do much over the last couple of sessions, a bit of a head-scratcher, as the recent past would have seen far peppier gold upside on a chunky drop in US yields.
A key point from here is whether a firmer US treasury market is signaling an agreement with the Fed outlook on inflation and growth, i.e., that we are set for a brief surge of inflationary over-heating, but that the anticipation of a lack of fresh fiscal impulses of notable size beyond this quarter will see the effects wane rapidly – a kind of “stop-start” risk pattern that has been visible in some of this data series. If this is the narrative that begins to win out, a bit of consolidation across the commodity space and even into risk sentiment could mean we continue to see outperformance of the low yielders and the US dollar secondarily, while the traditionally more pro-cyclical currencies come in for some rough sledding.
Note that the FOMC minutes and a bevy of Fed speakers are on tap for later today.
A USDCHF correction has set in, one with somewhat greater amplitude relative to the recent rise than the correction we are seeing in the US treasury market, though the latter is clearly the driver. But the late rally has altered the structure of the chart, neutralizing the former down-move, so whether here, or in USDJPY, we’ll be looking out for support to come in sooner rather than later. With a correction back to 1.50% for the US 10-year benchmark, the USDCHF pair may move back to something like 0.9200 or perhaps even 0.9100, the 200-day moving average.
EM divergences – TRY, INR, RUB, ZAR
In aggregate, things are fairly quiet on the EM front, but there are a few stories worth noting here. The Turkish lira exchange rate continues to triangulate while the forward implied yields have calmed considerably, rewarding those who took the plunge and bet against immediate chaos by selling USDTRY forwards. And the credit spreads on Turkish debt have also tightened a bit less than half way back to where they were before Erdogan’s shock shuffle of the central bank leadership. TRY is still a risky proposition – have to watch the next signals from the new central bank chief – especially on next Thursday’s rate decision.
The Ruble is very weak relative to crude oil and the tightening message from the Russian central bank and has to be an expression of a geopolitical risk discount that is growing. Rumblings of the situation in Ukraine and the overhanging concerns on sanctions could continue to weigh until something sets the situation in a different direction.
The Indian rupee, INR, is in focus after the central bank there moved forward with a modest QE programme, with plans to purchase a trillion rupees (south of $15 billion) in Indian government bonds. The INR was down about 1.5% on the story as of this writing. India is experiencing a vicious new rise in Covid cases, though hopefully the latest jump in the pace of vaccinations can accelerate further in coming days and weeks.
The South African rand is back close to the cycle highs versus the US dollar, held in part aloft by calm seas in EM credit, the stories above notwithstanding, but also by a strong platinum price, which all ZAR traders should track as an important input.
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – US Feb. Trade Balance
- 1230 – Canada Feb. International Merchandise Trade
- 1300 – US Fed’s Evans (Voter) to discuss economic outlook
- 1400 – Canada Mar. Ivey PMI
- 1600 – US Fed’s Barkin (Voter) to speak on monetary policy and the economy
- 1700 – US Fed’s Daly (voter) to Speak on US economic outlook
- 1800 – US FOMC Minutes
- 2301 – UK Mar. RICS House Price Balance
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.