The US Treasury Department will auction off a staggering $179 billion in T-bills and two-year T-notes as part of a heavy auction schedule this week (through Thursday) of $258 billion in total, including record auctions today of three- and six-month T-bills. This offers an important test of the weak USD narrative: if we see weak auctions, particularly for the two-, five-, and seven-year paper, it would confirm that the market is concerned about the US fiscal outlook this year, including the Fed’s Quantitative tightening, and that the US will struggle to fund its current account deficit without much higher yields.
As Luke Gromen of FFTT has put it, the USD could start behaving like an emerging market currency. Successful auctions this week, on the other hand, would challenge the narrative and provide a challenge to the weak USD consensus.
Another factor intertwined with US yields is risk appetite – the US dollar did relatively well during the worst of the recent market earthquake, but if spiking yields on weak US auctions are the cause of a new downdraft in risk appetite, it’s rather tough to build any stronger US dollar narrative. The most supportive backdrop for the greenback would likely be a successful series of auctions together with fresh weakness in equity markets. Last week’s resistance level in the S&P 500 around 2,750 looks pivotal for whether we can continue to emerge from the shadow the latest selloff.
Elsewhere, new developments are thin to nonexistent, but big themes remain in addition to the dominant theme of risk appetite and the related concerns on the US fiscal outlook. The biggest is perhaps the risk of a trade confrontation or worse between the US and China. Last Friday, the US Commerce Department made recommendations on tariffs on Chinese steel and aluminium imports that have elicited a sharp response from the Chinese side. An excellent FT column (paywall)
today points out the Trump team’s motivation for going after China on this specific area isn’t simply a naïve job-protection scheme that any economist would describe as self-defeating in basic economic growth terms, but also a response to what is arguably an act of economic aggression. In short, Chinese state-sponsored hackers stole intellectual property on steel-making processes from US Steel to improve their own product and then undersell US steelmakers globally. Stories like this one and the recent evidence pointing to Russian state-sponsored cyber-meddling in US politics suggest the risk of deepening hostility between major powers. Perhaps the new face of warfare is here and it isn’t conventionally military but rather occurs in the cyber-informational and trade/economic domains. Chart: USDJPY
The USDJPY bounce needs to fade in the 107.50-108.30 area if we are to maintain the weak USD narrative and the Treasury auctions over the next few days are likely a key driver of the outlook.