Short Covering in the US Treasury Market Extends the Yield Pullback

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Marc Chandler
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Overview: What appears to be a powerful short-covering rally in the US debt market has helped steady equities and weighed on the dollar.  Singapore and South Korea joined New Zealand and Canada in tightening monetary policy.  Attention turns to the ECB now on the eve of a long-holiday weekend for many members.  The tech-sector led the US equity recovery yesterday, snapping a three-day decline.  Most of the major markets in Asia Pacific advanced but Taiwan and India.  Europe’s Stoxx 600 is posting small gains for the second day, and US futures are little changed.  The 10-year Treasury yield is a little softer at 2.69%.  It peaked on April 12 near 2.83%.  The two-year yield is almost one basis point lower to about 2.34%.  It peaked on April 6 around 2.60%.  The drop in US yields yesterday and softer than expected jobs data conspired to spur a 10 bp drop in Australia’s 10-year yield.  European yields are 3-4 bp higher, with the periphery leading, perhaps on ideas that the ECB will signal the end of its bond-buying.  The dollar is mostly heavier against the major currencies, with the Swedish krona and New Zealand dollar the strongest.  Among emerging market currencies, those from central Europe have been helped by the euro’s bounce.  The high-flying South African rand and Mexican peso have come back a bit lower.  Gold is softer but consolidating inside yesterday’s range.  June WTI is pulling back a little after testing the $104 area.  US natgas prices are higher for the fourth session and have risen by around 58% since mid-March.  Europe’s benchmark is off about 3% and is near its lowest level since March 25.  Iron ore rose 1.6% after yesterday’s 2.5% decline as the sawtooth pattern of alternating gains/declines this week continues.  July copper is edging higher for the third session.  July wheat is struggling after four days of gains.

Asia Pacific

Australia’s March employment report fell shy of expectations. Overall, employment rose by 18k, not the 30k the median forecast (Bloomberg survey) anticipated.  Full-time positions rose by 20.5k after increasing by nearly 122k in February.  The unemployment rate was steady at 4.0% rather than slipping as expected.  The participation rate was steady at 66.4%.  It had been expected to increase slightly.  Separately, the Melbourne Institute’s measure of inflation expectations rose to a new high of 5.2% from 4.9%.  The central bank is waiting for stronger signs of wage pressures to build before lifting rates, but this risks putting it further behind the curve.  A rate hike is expected after next month’s election.

How are Japanese investors responding to the slide in the yen?  For the 10th week of the past 11, Japanese investors have been selling foreign bonds.  US Treasuries are their largest holding, so the divestment hit them hardest.  Given the developments in the foreign exchange market, the repatriation of unhedged proceeds buys more yen.  Sometimes in the past, it appears that the weakness of the yen encouraged Japanese investors to export more savings.

The market will be disappointed if China’s benchmark one-year medium-term lending facility rate is not cut tomorrow.  It was last cut by 10 bp to 2.85% in January.  This was the first cut since the pandemic struck in early 2020.  The MLF rate was cut by 20 bp in April 2020 after a 10 bp cut in February.  Covid and the associated lockdowns are hitting an economy that already appeared to be struggling.  More than a token 10 bp cut is necessary.  There are heightened expectations for a cut in reserve requirements as soon as next week.  Prime loan rates may also be reduced next week.  China reports Q1 GDP early next week.  It has expected to have slowed to 0.7% quarter-over-quarter after growing 1.6% in Q4 21.

The pullback in US yields has helped the yen stabilize after sliding for the past nine consecutive sessions.  Still, the greenback has found support ahead of JPY125.00.  A break of the JPY124.80 area is needed to signal anything important technically.  On the upside, the JPY125.60-JPY125.70 area may offer an immediate cap.  Support at $0.7400 for the Australian dollar frayed yesterday but it recovered to almost $0.7470 today before new offers proved too much.  It is finding support in the European morning near $0.7440.  The Chinese yuan has not drawn much benefit from the heavier US dollar.  The greenback did make a new low for the week near CNY6.3625 but recovered and resurfaced above CNY6.3700. The PBOC set the dollar’s references rate slightly lower than expected at CNY6.3540 (vs. median forecast in Bloomberg’s survey for CNY6.3547).

Europe

The ECB meets amid claims by its first chief economist Issing that its approach to inflation has been misguided.  The preliminary estimate of last month’s CPI was 7.5% (3% core) year-over-year.  At the same time, growth forecasts are being cut. There has also been a serious blow to consumer and business confidence.  Monetary policy, as is well appreciated, has impact with variable lags.  That is partly why simply subtracting inflation from the bond yield may not be the most robust way to think about real interest rates.  Nominal rates should be adjusted for inflation expectations.  In any event, the takeaway from the ECB meeting will be about the forward guidance on its asset purchases. Does it pullback from last month’s decision in which it indicated its monthly bond purchases here in Q2 or does it commit to suspending the Asset Purchases Program at the end of the quarter?  What about the other policy tool discussed in the press that would give the ECB a way to counter a surge in yields that could lead to diverging rates?  It seems like it is not imminent, but more importantly this may be an effort to modify the Outright Monetary Transactions facility that Draghi launched.  Note that there were conditions attached and although the facility has not been used, it seemed to have helped ease the crisis mentality. It reveals something about the power of the communication channel.

Turkey’s central bank sets the one-week repo rate today and it is likely to remain at 14%.  What may prove more interesting are the weekly portfolio flows.  In the week ending April 1, foreign investors were net buyers of Turkish bonds for the first time in six weeks. The $104 mln was slightly more than the cumulative total of the last three weeks that they were net buyers (late Jan-mid-Feb). The Turkish lira has stabilized.  Consider that actual volatility (historic) over the past month is about 7.1%.  A month ago, it was around 13%. At the end of last year, it was almost 100%.

The Johnson government lost its junior Justice Minister Wolfson over the “repeated rule-breaking.”  Meanwhile, reports suggest the prime minister will likely be fined a second time.  However, sterling is unperturbed by these developments.  It is extending yesterday’s dramatic recovery. Sterling posted a key reversal yesterday by falling to new lows before rallying and settling above the previous day’s high.  There has been follow-through buying that has lifted sterling to almost $1.3150 today.  Yesterday, it recorded a low near $1.2975.  The $1.3175-$1.3200 area may offer stronger resistance.  The euro is also extending its recovery.  Buying emerged yesterday ahead of $1.08.  It reached a three-day high slightly below $1.0925.  There is a 600-euro option at $1.0920 that expires today.  Nearby resistance is seen around $1.0950.

America

US retail sales look to have strengthened, but the devil is in the details.  The median forecast (Bloomberg survey) sees retail sales rising 0.6% after a 0.3% gain in February.  However, high price gasoline can again skew the data. Recall that the CPI figures showed an 18% rise in gasoline prices last month (which accounted for more than half of the 1.2% monthly gain). What Bloomberg calls the control measure, which excludes food services, gasoline, autos, and building materials, is used by some economic models of GDP, which pick up those items through a different time series than the retail sales report.  After being crushed in February, falling 1.2%, the median in Bloomberg’s survey calls for a 0.1% gain.  The risk is that rising gasoline prices slams discretionary purchases.

Separately, import and export prices are expected to have continued to accelerate last month.  Although export prices are rising faster than import prices, the US trade deficit has deteriorated. The US reports weekly jobless claims.  Revisions to the seasonal adjustment may be exaggerating the recent decline, but the labor market remains tight in any event.  Business inventories are expected to have risen in February (~1.3%) after a 1.1% gain in January.  While it would be strong, for GDP purposes the key is the change in the change, as it were.  In Q1 business inventories grew by an average of about 1.7% a month.  The slower inventory growth is part of the slowing we anticipate in Q1.  Lastly, the University of Michigan’s consumer confidence measures is likely to have deteriorated, but it may be the inflation gauges that draw the most attention.  Many economists suspect US CPI, especially the core measure, may have peaked.

The Bank of Canada delivered the much anticipated 50 bp hike yesterday.  The market has fully priced in a 25 bp hike at the next meeting in early June.  The risk seems to be for another 50 bp hike. The central bank lifted the neutral rate to 2.50% from 2.25% and suggests that is where it was headed.  It lifted its inflation forecasts.  It now expects CPI to average 5.3% this year, up from the 4.2% forecast in January.  Next year’s forecast was lifted to 2.8% from 2.3%.  Also, as anticipated, the Bank of Canada will stop recycling maturing proceeds and allow its balance sheet to shrink.  Over the next 12-months about a quarter of the bonds bought on net basis during the pandemic (C$350 bln) will roll-off.

The US dollar posted a key downside reversal against the Canadian dollar yesterday and follow-through selling has been seen.  Initially the greenback made new highs for the move to around CAD1.2675 yesterday before turning around and settled below the previous session’s low (~CAD1.2580).  It has been sold to around CAD1.2540 today, which is the (50%) retracement of the greenback’s rally off the April 4 low for the year near CAD1.2400.  The next retracement (61.8%) is closer to CAD1.2500.  The Mexican peso’s run is getting stretched.  It managed to extend the most recent streak to its fifth consecutive advance yesterday, but the upticks are getting harder to secure. The peso is better offered today, with the dollar near MXN19.80.  Initial resistance may be in the MXN19.88-MXN19.92 area.

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