FX Trading focus: Market slowly towards Fed’s transitory inflation narrative
I have been putting together a few charts for the FX Market Update webinar I am hosting tomorrow (sign up here) and on the surface, it is very difficult to put together a compelling view on anything ahead of a summer that may mostly prove one long exercise in waiting for the autumn and whether the “transitory” nature of inflation begins finding confirmation or rejection over the next three or four months. Two of the first guideposts on how nervous the market is on the subject along the way are tomorrow’s CPI data, where inflation expectations and the Treasury market are showing no signs of fear, and next Wednesday’s FOMC meeting, where I suspect that the Fed may feel emboldened to talk more taper than is expected, though possibly with enough contingency in the language to avoid upsetting the market. If the Fed can pull that off and there is no reaction to a hot CPI print, the US dollar may find itself on the defensive again, although as we note in the chart below, the key real yields narrative as a driver of USD weakness has not been really supported the USD bears’ case for some time now.
Note that after a strong 3-year Treasury auction yesterday that saw a solid pick-up in foreign demand, a 10-year auction is up tonight and a 30-year T-bond auction tomorrow.
Chart: US real yields versus the US dollar
A chart showing that, while nominal US treasury yields are falling for the 10-year benchmark, the 10-year inflation expectations are falling faster in recent weeks, such that US real yields are actually rising slightly, which is making life a bit frustrating for USD bears, with much of the fundamental support for their argument based on US fiscal profligacy driving far more negative real yields than elsewhere. At the moment, there is little support in market pricing, but will be interesting to discover in coming weeks the degree to which US real yields might actually rise more sharply if the Fed transitions to flagging an eventual asset purchase taper and/or if the end of the US Treasury’s drawdown of its general account at the Fed (the drawdown adds to liquidity and is likely contributing to the suppression of bond yields), which as we mentioned on this morning’s Saxo Market Call has some $300 billion further to fall before stabilizing around the Treasury’s deadline for completing the process by August 1.