FX Update: FX brushes off rising yields, pounding the USD

FX Trading focus: USD weakens afresh as market shrugs off yield rises

Today’s action suggests I have been getting ahead of myself in fretting the implications of higher global yields, as the market mood has brightened considerably this morning after another wobbly session yesterday for risk sentiment. And the US dollar is dropping across the board as the market can apparently deal with bond yields at these levels.  Arguably, as we move forward, rising yields don’t even necessarily have to trigger any notable meltdown in risk sentiment as long as the market is comfortable that real interest rates will continue to decline (i.e., the inflation “outperforms” or rises faster than any rise in yields). But to get to that place, we will still need to see the Fed vastly expanding its QE purchases, as the market simply can’t absorb the net US treasury issuance later this year without much higher real yields, which would eventually be toxic for asset markets.

So, in terms of the scenarios I outlined on Wednesday for the path from here if yields continue to rise, an extension of today’s action looks very much like “Scenario 1”, which to quote from my FX Update Wednesday is as follows:

Scenario 1 – the slow burn. if the yield rise slows, but persists, while risk sentiment remains stable to positive, the USD would likely roll over again, possibly with the USDJPY trading more or less sideways to slightly higher and EURUSD somewhat boring while EM and commodity currencies rise strongly again. Eventually, however, yields rise to a level that crashes sentiment and spikes the USD higher (and possibly the JPY as well) while the equity market, the Fed’s undeclared third mandate, suffers an ugly consolidation. The Fed comes riding in to the rescue once more, this time with yield curve control, etc…

One addition to the above – it is interesting that USDJPY is struggling to maintain altitude this morning and if that pair can’t maintain 105.00, the USD could be even weaker within the G3 than I anticipated as well when writing the above. 

One factor possibly helping the US dollar lower at the margin was the latest and very terrible initial weekly jobless claims number yesterday from the US, which came in absurdly above expectations at 861k vs. 773k expected. And the revision of the prior week to 848k from 793k suggests that there is very little if any improvement in whole swathes of the US labour market. As the US moves post lockdown, perhaps accelerating in April, this single indicator really needs to drop off a cliff for any sense that a normal job market is returning – not a guaranteed development. For what I mean by that, please refer back to our Outrageous Predictions for 2021 (especially the two discussing UBI driving the decline of big cities and the Citizens Technology Fund) and also have a listen to this morning’s Saxo Market Call podcast, in which our Steen Jakobsen questions whether the Fed is making a policy mistake in assuming that full employment can return in the way it did before the pandemic.

Chart: AUDUSD
A new strong boost to risk sentiment in Europe today together with hefty new buying in industrial commodities has helped to drive AUDUSD back toward the highs of the cycle as the AUD plays its role as one of the highest beta currencies within the G10 to weakness in the US dollar. If the market is able to absorb recent yield rises and further yield rises here, the AUD could continue to lead the pack and AUDUSD may be on the path to testing the next major chart resistance above 0.8100. But first, let’s see if the pair can stick the landing into the close today – I have always found moves on Friday in AUD tough to interpret as they usually come after Australia has headed home for the weekend.