Not let up for USD rally on back of rising US yields

USD: US yields and the USD continue to hit new highs

The US dollar has continued to strengthen at the start of the week resulting in the dollar index hitting a fresh high of 106.10 yesterday. It has been supported by the ongoing adjustment higher in US yields especially at the long-end of the curve where the 10-year Treasury hit a new cyclical high of 4.56% overnight. The 10-year US Treasury yield has now increased by around 50bps from the intra-day low at the start of this month. Over the same period the 2-year US Treasury yield has increased by around 40bps and the 10-year break-even rate by around 12bps indicating that the move higher in long-term yields is driven mainly by the hawkish repricing of Fed rate hike expectations and a modest increase in market-based measures of long-term inflation expectations. The sharp rebound in the price of oil this month by around USD10/barrel to a high of USD 96/barrel has been contributing to upward pressure on market-based measures of inflation expectations. There were no fresh catalysts for the ongoing sell-off in the US bond market yesterday which was encouraged by the 10-year US Treasury yield breaking above 4.50%. Bloomberg has reported comments from Minneapolis Fed President Kashkari overnight stating that “if the economy is fundamentally stronger than we realized, on the margin that would tell me rates probably have to go a little higher and then be held higher for longer to cool thigs off”. He is a voting member on the FOMC this year and has indicated that he was one of the 12 participants who favour one more final hike later this year. The comments were broadly consistent with the message from last week’s FOMC meeting when the Fed indicated that the majority of members still favour one more hike and have scaled back plans for rate cuts next year by 50bps. The comments have not altered market expectations for one final hike later this year that remains priced at around a 50:50 probability.   

The ongoing adjustment higher in US yields and the US dollar is continuing to gradually lift USD/JPY closer to the 150.00-level. The pair is currently trading just below the 149.00 as moves further above the intra-day low from the start of this month at 144.45 which also coincided with the low point for US yields. Japanese policymakers are  continuing to verbally intervene to slow the pace of yen weakness. Finance Minister Suzuki spoke again overnight and warned that he is watching FX moves with a high sense of urgency. He stated Japan  won’t rule out any options against excessive FX moves and till take action against rapid FX moves. With the current move higher in USD/JPY proving to be gradual, it makes it harder for Japan to justify stepping to the FX market to buy the yen at this point.  

UNUSUALLY WIDE CYCLICAL DIVERGENCE IS MORE LIKELY TO NARROW 

Source: Bloomberg, Macrobond & MUFG Research calculations

EUR: Weak growth outlook for euro-zone should be better priced in now

The broad-based rally for the US dollar and adjustment higher for US yields has contributed to EUR/USD hitting a low yesterday of 1.0576 as the pair moves closer to the bottom of the 1.0500 to 1.1000 trading range that has been in place for most of this year. The euro has failed to derive support from some signs of tentative improvement from the release of the latest business confidence surveys from the euro-zone. After the euro-zone composite PMI survey for September surprised to the upside by 0.4 point at the end of last week, it was followed by an upside surprise for the German IFO survey that came in 0.5 point stronger. The upside surprise for the German composite PMI survey was even bigger at 1.5 point. The latest data releases suggest at least that the weak growth outlook for the euro-zone and Germany in particular should be better priced in now in financial markets. It should make it harder for the euro to keep weakening against the US dollar as it approaches more undervalued levels closer to parity. Admittedly the business surveys remain at levels that are consistent with weak to negative GDP growth in Q3.                    

The ECB acknowledged weaker than expected growth at their latest policy meeting when there were significant downward revisions to the staff GDP forecasts. The weaker growth outlook contributed to the less hawkish signal from the ECB that it is shifting its policy focus to keeping rates higher for longer to get inflation back to target rather than continuing to hike rates. President Lagarde when speaking to the European Parliament yesterday emphasized that message by saying that it’s a “long race that we are in” and pushed back against expectations for rate cuts as soon as next year by stating that rate cuts are not something that the ECB is talking about. The euro-zone rate market is currently pricing in around 60bps of ECB rate cuts by the end of next year. Yesterday’s comments from the ECB will not encourage market participants to price in even more aggressive cuts at the current juncture. Market participants are already making the assumption that weak growth/recession in the euro-zone and/or a sharper pullback in inflation will encourage the ECB to drop their new higher for longer rate pledge sooner.

One European currency that outperformed at the start of this week was the Swedish krona. Yesterday the krona strengthened by around 1.2% against the euro and 0.5% against the US dollar. It has been supported by the Riksbank’s new FX Reserve hedging programme. They announced last week that they would begin selling USD8 billion and EUR2 billion in exchange for krona over the next four to six months with the hedging flows starting yesterday. The announcement could have encouraged speculative buying of the krona as well in anticipation of the FX hedging flows. While the flows helped to support the krona yesterday, we remain sceptical that they are sufficient to trigger a sustained reversal of krona weakness on their own.

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	08:00	ECB's Lane Speaks	--	--	--	!!
US	14:00	S&P/CS HPI Composite - 20 s.a. (MoM)	Jul	--	0.9%	!
US	15:00	New Home Sales	Aug	700K	714K	!!!
US	18:30	FOMC Member Bowman Speaks	--	--	--	!!

Source: Bloomberg