FX Update: Half-hearted USD rally despite yield pressure. FX Update: Half-hearted USD rally despite yield pressure. FX Update: Half-hearted USD rally despite yield pressure.

FX Update: Half-hearted USD rally despite yield pressure.

John Hardy

Head of FX Strategy

Summary:  The US January PCE inflation data came in far hotter than expected at the core, which took US treasury yields and Fed tightening expectations higher still and prompted a USD rally extension, particularly against the yield-sensitive JPY. But risk sentiment held the line in late trading last week on Friday and has sprung back strongly in today’s European session. It will be tough to sustain both higher yields and resilient sentiment for much longer.

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FX Trading focus: The USD is firm, but not impressively so, given yield and sentiment backdrop – perhaps as EU inflation is driving the narrative this week. BoE Governor Bailey reversed recent sterling rally.

The February preliminary EU inflation data added to the full sweep of hotter than expected inflation prints across Europe after Germany’s hot number yesterday. The core EU CPI number was +5.6% YoY, a full 0.3% above the 5.3% expected and the 5.3% high of the cycle in January. European short rates were already ramping so aggressively into today that even this data point failed to make an additional impact as German 2-year yields, for example, have ramped from below 2.9% at the start of this week to a high just above 3.25% today before support finally came in for bonds (we’ve backed down to 3.18% as of this writing.) The fact that EU yields have been driving much of the fresh inflation narrative globally this week is likely behind the mediocre performance of the US dollar relative to the strong supportive backdrop of higher yields and weak risk sentiment. We did get a firmer than expected ISM Manufacturing Prices Paid of 51.3 yesterday, versus 46.5 expected and 44.5 in Jan. The US 10-year yield finally advanced above the symbolic 4.00% level.

USDJPY is reluctant to give much more than a head-nod to higher long US yields as we await the next indications from the Bank of Japan on its uncertain path toward something presumably resembling normalcy. What does that look like? Abandonment of YCC, a policy rate of 1.00% and 10-year JGB yields at about the same? That would still put Japan far south of just about every other country, although on par with the SNB’s policy rate and the Swiss government 10-year yield is exactly 1.50% today. That’s certainly not “in the price” as market forwards suggest only a marginal move to a positive 0.15% for the policy rate through the end of this year from the current -0.10%. The 2-year JGB yields -3 bps! It still feels like the Bank of Japan is hoping that it can get away with a few more policy tweaks, but it will be dragged into a more rapid unwinding if the bank is forced to back up the truck for further massive intervention to maintain the 0.50% cap on 10-year yields and the JPY posts new broad lows. Crude oil prices have bought the BoJ a bit of time as well, a move back to $100+ oil would also change the equation for the BoJ. Surprise skew I toward more action as we await Governor Kuroda’s swan song next Friday before he rides off into the sunset in early April.

The sterling had rallied hard recently after a stronger than expected Service PMI and then on the post-Brexit settlement deal over Northern Ireland. EURGBP teased a move back into the lower zone this week, only to have the rug torn out from under sterling by the cavalcade of hot EU inflation prints, but more importantly in yesterday’s case on Bank of England Governor Bailey’s rhetoric. Mr. Bailey is apparently not yet for returning to a more cautious stance after the last meeting’s confident (insanely complacent) forecast for inflation to return to below 2% by the end of next year. Bailey said “I would caution against suggesting either that we are done with increasing Bank Rate, or that we will inevitably need to do more....nothing is decided.” EURGBP is choppy here and failed to sustain the move above 0.8900 last time and European data is set to get quieter until the March 16 ECB meeting. The next UK CPI print is not up until March 22. The pair has to prove itself beyond the range extremes of 0.8725 to 0.8975 of this year for next steps.

Source: Saxo Group

Where to from here for the greenback? Given how much the market has repriced the Fed recently and what the Fed will now have to deliver at the March 22 FOMC meeting, the path looks difficult for the Fed to deliver a significant hawkish surprise in its shift of the dot plot forecast for March relative to the December dot plot. Still, if the market prices further rate cuts out of next year (Dec 23 to Dec 24 EuroDollar interest rate futures still suggest 136 basis points of Fed rate cutting from early next year to early 2025) and if US longer yields soar anew and take global risk sentiment sharply south, the US dollar could remain firm here, but a major extension higher might require “fear and loathing” level of weak risk sentiment, rather than merely the ratcheting higher of Fed expectations.

Sweden risks a deepening recession, addled by a credit crunch as higher yields eat into the housing market outlook, consumer confidence and the cost of living for those on adjustable rate mortgages, while the PMI don’t suggest as much resilience as the rest of Europe – the Manufacturing PMI was a disappointing 47.0 in Feb. The YoY credit growth dipped to 3.2% in January from 3.5% in December (average for Q4 for this indicator was around 4.5% in a quarter that saw -0.9% QoQ GDP growth) a dramatic low not seen in decades. Swedish yields have failed to keep track with EU counterparts this week, and EURSEK has backed up after its recent test of 11.00.

Table: FX Board of G10 and CNH trend evolution and strength.
The official February China Manufacturing PMI survey was the highest since 2012 and administered a fresh jolt to the China re-opening narrative, with CNH firmer and metals prices rebounding. But this is tough to detect in the Aussie. Overnight, the January Australia Building Approvals plunged to the lowest in over a decade as higher rates eat into plans for building the real estate stock there. Elsewhere, note the Euro strength trying to rival USD strength.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
The EURUSD trend is the USD trend closes to a reversal in the greenback’s favour and that’s not yet particularly close. Elsewhere, the EURGBP downtrend is at risk of a reversal today before it really got started. EURSEK is also in limbo after backing up sharply yesterday.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights

  • 1230 – ECB Meeting Minutes of Feb. ECB meeting
  • 1330 – US Weekly Initial Jobless Claims
  • 1500 – UK Bank of England Chief Economist Huw Pill to speak
  • 1530 – EIA's Weekly Natural Gas Storage Change
  • 1900 – US Fed’s Waller (Voter) to discuss economic outlook
  • 2100 – New Zealand Consumer Confidence Survey
  • 2300 – US Fed’s Kashkari (Voter 2023) to speak
  • 2330 – Japan Tokyo Feb. CPI

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