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Room for US yields & USD to rise further
FX View:
The USD is on course to close higher for the twelfth consecutive week as measured by the DXY index. The stronger USD trend continues to be driven mainly by the sharp adjustment higher in US yields. The 10-year UST yield hit a fresh cyclical high of 4.89% following the much stronger NFP report for September. The resilience of the US labour market and economy is keeping pressure on the Fed to hike rates one last time this year and to keep rates higher for longer into 2024. On the other hand the sharp move higher in US yields is contributing to a sharp tightening of financial conditions which reduces the need for another Fed hike. The move higher in US yields is becoming more disruptive for financial market conditions. The pick-up in volatility is triggering an unwind of FX carry trades.
G10 COMMODITY CURRENCIES HIT HARDEST
Source: Bloomberg, 15:00 BST, 6th October 2023 (Weekly % Change vs. USD)
Trade Ideas:
We are recommending a new long USD/ZAR trade idea.
JPY Flows:
The Balance of Payments data continue to show an improving external position, helped in part by the depreciation of the yen and the decline in natural gas prices. The end of covid which has revived tourism has also helped reduce the services trade deficit. Foreign bond buying saw buying in the US but sales across key markets in Europe.
US Treasuries: Price Action Analysis:
Our analysis suggests the recent move higher in US yields over (63-days window) is becoming more extreme. The current momentum signal is 1.87 standard deviations above the average of moves over rolling windows going back to 2018. The average momentum signal so far this month is the maximum for the typical distribution of monthly average momentum signals going back to December 2018.
FX Views
Higher for longer rates outlook is proving disruptive for financial markets
It has been a more volatile week in the foreign exchange market which continues to be driven mainly by spill-overs from the US bond market. The sell-off in the US bond market has accelerated over the past month resulting in the 10-year US Treasury yield hitting a fresh cyclical high of 4.89%. It has extended the upward adjustment to 84bps since the low at the start of September and almost 160bps since the low in May. It has been the biggest move higher in US yields since last year when the 10-year US Treasury yield increased by just over 180bps from the low last August to the high from last October. On that occasion the dollar index strengthened sharply by almost 10% to the peak in September of last year followed by a brief period of consolidation in October and, and then finally correcting sharply lower from November into early this year. On this occasion, the dollar index has strengthened sharply again by almost 8% from the lows in July. While we believe that the bulk of the upward adjustment for US yields and the USD has already taken pace now, it is not clear that a peak is yet in place.
The sharp move higher in US yields is becoming more disruptive for financial markets. MSCI’s ACWI global equity index has declined by around -9% since the end of July which compares to a fall of -16.5% between August and October of last year. Volatility has been picking up both in the US fixed income and FX markets. The MOVE index measure of US bond market volatility recently jumped to the highest level since late May which is now spilling into higher volatility in FX market although JP Morgan’s measure of Global FX volatility remains close to year to date. The pick-up in financial market volatility and deterioration in investor risk sentiment has been triggering an unwind of popular carry trades in the FX market. The high yielding emerging market currencies from Latam have been hit the hardest over the past week. The COP (-6.4% vs. USD), MXN (-5.2%), and BRL (-3.4%) have all weakened sharply against the USD. In spite of the recent sell-off all three currencies are still stronger against the USD on a year to date basis suggesting there is still room for the reversal of carry trade gains to extend further in the near-term. The COP is still up by +11.6% vs. USD YTD, the MXN by +6.0% and BRL by +1.3%.
The BRL and MXN have also been hurt over the past week by the sharp decline in commodity prices. One of the most striking sell-offs has been in the oil market where the price of Brent has collapsed by around USD14/barrel after hitting a high of USD97.69/barrel at the end September. It has contributed towards Bloomberg’s commodity price index falling closer to the year to date lows recorded back in Q2. The
10YR UST YIELD PERFORMANCE IN 2022 VS. 2023
Source: Bloomberg, Macrobond & MUFG GMR
USD PERFORMANCE IN 2022 VS. 2023
Source: Bloomberg, Macrobond & MUFG GMR
renewed weakness in commodity prices has weighed more heavily on the G10 commodity currencies over the past week when the NOK (-3.1% vs. USD), and AUD (-1.6%) have been the two worst performing G10 currencies. The weakness in commodity prices and related currencies could be an indication that market participants are becoming more wary again over the irks of harder landing for the global economy is the major central banks are strongly committed to keeping rates at more restrictive levels for longer until there is clearer evidence of slowing growth and inflation falling back to target. The higher for longer mantra adopted by central banks recently signals a higher risk of tightening policy too much rather than too little.
The peak for US yields in October of last year was put in place after more compelling evidence emerged that US inflation was beginning to slow. US yields have been moving sharply higher in recent months even as US inflation has continued to slow and move back closer to the Fed’s 2.0% target. There has been a marked slowdown in core PCE deflator over the last three months when it has increased by an annualized rate of 2.2% in August compared to 3.8% in the previous three months and 5.4% in the same period of last year. If the slower pace of inflation is maintained in the coming months, it should encourage the Fed to end their hiking cycle, and open the door for rate cuts next year. However, the Fed is clearly not convinced that the slowdown in inflation will continue given their optimism over a softer landing for the US economy which results in only a modest pick-up in spare capacity. The unemployment rate is now expected to increase to only 4.1% in the coming years. It supports the Fed’s outlook for rates to remain at higher levels for longer. It will require further evidence of slowing inflation and a more marked economic slowdown to significantly alter current higher US rate market expectations that have encouraged a stronger USD.
However, the first signs are at least starting to emerge from Fed officials that they are not fully comfortable with the recent sharp adjustment higher in US yields. San Francisco Fed President Daly stated that “if financial conditions, which have tightened considerably in the past 90 days, remain tight, the need for us to take further action is diminished”. She likened the recent move higher in market yields to the impact of a 25bp Fed hike. Even the normally more hawkish Cleveland Fed President Harker stated that the move higher in US yields was “certainly going to feed into” decisions about whether another rate hike was necessary this year. It supports our view that the Fed will not follow through on plans for one more hike in November or December.
In these circumstances, the strong employment growth evident in the latest NFP report for September will keep upward pressure on US yields and the USD in the week ahead, and leaves FX carry trades (including long BRL & MXN) vulnerable to a further unwind.
POPULAR FX CARRY TRADES HIT HARD
Source: Bloomberg, Macrobond & MUFG GMR
TIGHTENING US FINANCIAL CONDITIONS
Source: Bloomberg, Macrobond & MUFG GMR
Weekly Calendar
|
Ccy |
Date |
BST |
Indicator/Event |
Period |
Consensus |
Previous |
Mkt Moving |
|
EUR |
10/09/2023 |
07:00 |
Germany Industrial Production SA MoM |
Aug |
-- |
-0.8% |
!! |
|
NOK |
10/09/2023 |
07:00 |
GDP Mainland MoM |
Aug |
-- |
0.2% |
!! |
|
EUR |
10/09/2023 |
09:30 |
Sentix Investor Confidence |
Oct |
-- |
-22 |
!! |
|
USD |
10/09/2023 |
17:50 |
Fed's Jefferson Speaks |
!!! |
|||
|
JPY |
10/10/2023 |
00:50 |
BoP Current Account Adjusted |
Aug |
¥2490.1b |
¥2766.9b |
!! |
|
SEK |
10/10/2023 |
07:00 |
GDP Indicator SA MoM |
Aug |
-- |
0.5% |
!! |
|
NOK |
10/10/2023 |
07:00 |
CPI YoY |
Sep |
-- |
4.8% |
!!! |
|
GBP |
10/10/2023 |
09:30 |
Output Per Hour YoY |
2Q F |
-- |
0.1% |
!! |
|
USD |
10/10/2023 |
11:00 |
NFIB Small Business Optimism |
Sep |
-- |
91.3 |
!! |
|
USD |
10/10/2023 |
18:00 |
Fed's Waller Speaks |
!!! |
|||
|
EUR |
10/11/2023 |
07:00 |
Germany CPI EU Harmonized YoY |
Sep F |
-- |
4.3% |
!! |
|
USD |
10/11/2023 |
13:30 |
PPI Final Demand MoM |
Sep |
0.3% |
0.7% |
!! |
|
USD |
10/11/2023 |
19:00 |
FOMC Meeting Minutes |
-- |
-- |
!!! |
|
|
GBP |
10/12/2023 |
07:00 |
Monthly GDP (MoM) |
Aug |
-- |
-0.5% |
!!! |
|
GBP |
10/12/2023 |
09:30 |
BoE Credit Conditions Survey |
!! |
|||
|
EUR |
10/12/2023 |
09:30 |
ECB's Villeroy Speaks |
!! |
|||
|
EUR |
10/12/2023 |
12:30 |
ECB Publishes Account of Sept Meeting |
!!! |
|||
|
USD |
10/12/2023 |
13:30 |
CPI YoY |
Sep |
3.6% |
3.7% |
!!! |
|
USD |
10/12/2023 |
13:30 |
Initial Jobless Claims |
-- |
-- |
!! |
|
|
CNY |
10/13/2023 |
02:30 |
CPI YoY |
Sep |
0.2% |
0.1% |
!! |
|
CNY |
10/13/2023 |
02:30 |
PPI YoY |
Sep |
-2.4% |
-3.0% |
!! |
|
SEK |
10/13/2023 |
07:00 |
CPI YoY |
Sep |
-- |
7.5% |
!!! |
|
EUR |
10/13/2023 |
10:00 |
Industrial Production SA MoM |
Aug |
-- |
-1.1% |
!! |
|
USD |
10/13/2023 |
13:30 |
Import Price Index YoY |
Sep |
-- |
-3.0% |
!! |
|
EUR |
10/13/2023 |
14:00 |
ECB's Lagarde speaks |
!!! |
|||
|
USD |
10/13/2023 |
15:00 |
U. of Mich. Sentiment |
Oct P |
67.5 |
68.1 |
!! |
Source: Bloomberg, Macrobond & MUFG GMR
Key Events:
- The main focus in the week ahead will be outlook for Fed policy after the release of the latest NFP report for September. There are number of Fed officials who are scheduled to speak in the week ahead including Fed Governors Jefferson (Monday), Waller (Tuesday) and Bowman (Wednesday).
- The minutes from the latest FOMC meeting from 20th September are also scheduled to be released in the week ahead (Wednesday). The minutes are expected to back up the hawkish message delivered at that meeting which has since encouraged market participants to price in higher rates for longer. The minutes though could provide an opportunity for the Fed to dampen upward pressure on yields if they are uncomfortable about the scale of the recent sharp adjustment higher and tightening of financial conditions.
- The main economic data release in the week ahead for the Fed to reassess their outlook for policy will be the latest US CPI report for September (Thursday). It is expected to provide further evidence that the pace of inflation has slowed.
- Outside of the US, the main economic events and data releases will be: i) the latest CPI reports for September from both Norway (Tuesday) and Sweden (Friday), ii) the latest monthly UK GDP report for August, and iii) the latest summary from the ECB policy meeting on 14th
- The Norges Bank and Riksbank have both signaled recently that they plan to hike rates further in response to higher inflation and upside risks to the outlook form weaker domestic currencies. After contracting in July, UK GDP is expected to rebound in August although growth is expected to remain weak for Q3 as a while. The BoE currently expects GDP to expand by 0.1% in Q3. The summary from the ECB’s latest policy meeting is expected to reaffirm expectations that policymakers now favour keeping rates on hold for longer although have not completely ruled out further hikes.
