Dramatic Swing in Sentiment Extends the Greenback’s Rally

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Marc Chandler
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Overview:  A series of strong US high-frequency data points after a poor finish to last year has spurred a dramatic shift in market expectations. And talk among a couple of (non-voting) FOMC members of a 50 bp hike has provided added fodder. The greenback is extending its recovery today against all the major currencies, with the Australian and New Zealand dollars hit the hardest. Emerging market currencies have also been knocked back. 

This is part of a larger risk off move and even the yen's decline to new lows for the year failed to help Japanese equities. Indeed, Japan, Hong Kong, and China saw more than a 1% slide in their main equity indices. Europe's Stoxx 600's four-day rally is being snapped, and US futures indices are 0.5%-0.75% lower. Benchmark 10-year yields are rising. The US Treasury yield is up four basis points to 3.90%. European benchmark yields are 5-8 bp higher and peripheral yields are rising faster than core rates. The US 2-year yield is extending is advance for the seventh consecutive session. Its six-basis point increase is pushing the yield to 4.70%, a 60 bp increase since February 2. Rising rates and a stronger dollar are not match for gold, which is off around $15 to around $1820, its lowest level so far this year. April WTI is selling off for the fourth session in a row and around $76.60 is at eight-day lows.  

Asia Pacific

The overnight index swaps market continues to price in a positive policy rate hike in Japan as soon as April, ostensibly the first meeting that the new BOJ governor will chair. However, other indications suggest investors may not believe it. Yesterday's five-year bond sale was well received in terms of price and bid-cover rates. The two-year yield has fallen from around seven basis points in the middle of last month to minus six basis points this week, the lowest in three months before moving a little higher since mid-week. It finished the week around minus three basis points. Bloomberg's latest survey with 39 responses found 70% expect a tightening by July, up from 54% last month. A little more than a quarter see the tightening in April and other quarter see the move in June. The new leadership at the BOJ are likely have a formal policy review but policy analysis is often policy advocacy. We have suggested that a game plan, sequencing the eventual exit would be helpful for investors and businesses, and the BOJ's credibility. 

After the December surprise, the dollar-yen exchange rate became unanchored from US rates. However, the relationship is tightening again, and rising US rates have helped drive the greenback above JPY135.00 today for the first time since that December surprise. Note that options for around $3.6 bln at JPY135 expire today. The next technical area is near JPY136.65, where the 200-day moving average is found, then JPY139.50-JPY140.00. The Australian dollar peaked Tuesday slightly above $0.7000. Today it has been sold about $0.6820. Options for A$790 mln expire today at $0.6800. There is some chart support in the $0.6780-$0.6800 area, and a break of it could signal a move toward $0.6660. Central bank Governor Lowe reiterated concern about the tightness of the labor market earlier today, even after the weakness of this week's report. On another front, he had been criticized for sharing his view privately before going public but does not appear to understand the problem. He is quoted in the press today saying he will speak at a hedge fund event because he cannot be sure his remarks will stay private. His term ends later this year, and a review of the RBA is due at the end of next month. The PBOC injected a record CNY835 bln (~$121 bln) to avert a further squeeze in the money markets. The dollar rose to around CNY6.8850, its highest level since January 5 and slightly above the 200-day moving average. It is the greenback's fourth consecutive weekly advance, the longest rally since September. The PBOC set the dollar's reference rate a little higher than expected (CNY6.8859 vs. CNY6.8653). Lastly, note that the US has announced it was sending its top defense official on China to Taiwan. Beijing has yet to respond.

Europe

While the backing up of US rates in light of the recent string of economic data is understandable, less intuitive may be the continued rise in European two-year rates. We look at the generic rates. German two-year yield, for example is near 2.90%, which it has not seen since the demise of Lehman in October 2008. The adjustment has been relentless since last August. Initially, the higher rate was to ostensibly compensate for exchange rate risk, but through early February the euro has been trending up for four months. The two-year French yield is poking above 3%, which it too has not seen since the Global Financial Crisis. In Italy, the two-year yield is approaching but has not surpassed the highwater mark from last October of almost 3.12%. The UK's generic two-year yield reached 3.85% yesterday, the most since the turmoil last fall. The UK premium over Germany surged to 245 bp during the capital strike spurred by Truss's plans, and by early this month had fallen back to around 65 bp. That is smallest premium since Q1 21. 

There are three UK developments to note. First, UK retail sales (by volume) rose 0.5% last month. The median forecast in Bloomberg's survey anticipated a 0.3% decline. However, dampening but not offsetting this was the downward revision in the December series to show a 1.2% decline rather than a 1.0% fall. Second, the chief economist for the Bank of England acknowledged officials are ready to slow the pace of hikes. The next BOE meeting is March 23, and the swaps market is pricing in about an 85% chance of a 25 bp hike. Third, there appears to have been a breakthrough over the Northern Ireland protocol. There was much external pressure to reach a resolution by the 25th anniversary of the Good Friday Agreement on April 10.

The euro briefly poked above $1.08 on Valentine's Day and has fallen to $1.0630 today, its lowest level since January 6. Nearby support is seen around $1.0615, but the next important area is $1.0460-$1.0500. Note that there are expiring options for 1.4 bln euros today at $1.06. Speculators in the futures market appear caught leaning the wrong way. That said, the key driver is not in Europe but the reassessment of Fed policy. Previous support around $1.0660 now offers resistance. Sterling's losses have compounded, and it has been sold through the $1.1960 that held early this month to $1.1915 today. The January low near $1.1850 is key support. It could be the neckline of a double top pattern and its violation would suggest a move toward $1.12. The $1.1960 area offers first resistance and $1.20 may be more formidable.

America

Without intending to rain on anyone's parade, can we suggest that the best news for the US is behind it? It is not reasonable to expect half million net jobs are being created this month, or that retail sales will jump by another 3%. Moreover, seasonal adjustments, partly skewed by the Covid experience, methodological changes, and the unseasonably (?) warm weather further distorted the signal. The Philadelphia manufacturing survey for February may give insight. Now, the Empire State survey was released last week, but it has been an outlier, much weaker than other surveys. The Philly Fed's survey bottomed last November (-15.5) and improved in December and January, reaching -8.9. It fell to 24.3 this month. New orders fell back after a marked improvement in January. Employment slowed and inventories soared. Prices paid ticked up while prices received slowed sharply. The future conditions index worsened and both measures of prices are expected to continue to slow. And that brings us to today's report of leading economic indicators. As noted yesterday, it fell at an annualized rate of 7.5% in the second half of last year and such marked deterioration is not seen outside a recession. What is making it hard for many to see is that the labor market remains strong. The sub-200k weekly initial jobless claims illustrate this, though the four-week moving average did tick-up ever so slightly for the first time since the end of November. Yet, the US economy contracted in Q1 22 and Q2 22 with a strong labor market and the UK appears to be experiencing the same thing now. Japan has experienced contractions without a deterioration it its labor force too.

Meanwhile, the Fed officials Mester and Bullard helped drive the pendulum of market expectations by not ruling out a 50 bp hike in March. Mester said she favored such a move earlier this month. We had suggested that insight from game theory might have also bolstered the case. Bullard, a leading hawk, also admitted he was open to a reacceleration of the Fed's pace. Barkin and Bowman speak today. Of these four Fed officials only, Governor Bowman has a vote. The swing in sentiment has been so strong that is has moved from lagging behind the Fed to leading it. Still, the Fed funds futures are still looking at a 25 bp hike at the March, with about a 12% chance of a half-point move.

There is not holding the Mexican peso back. After an initial short squeeze Wednesday from a 4 1/2-year low a little below MXN18.50 to MXN18,75, the greenback was sold aggressively and reached almost MXN18.48 yesterday. There is little meaningful support ahead of our medium-term target of MXN18.00, but the peso bulls stall near MXN18.44, the lower Bollinger Band and around MXN18.25 the dollar may also find some support. We have led with the carry trade, encouraged by the wide interest rate differentials, and relatively subdued currency volatility. However, the equity market is attracting flows. After a strong start, it pulled back in the first half part of February but is up nearly 4% from last week's lows. USMCA and near/friend-shoring is also reportedly drawing direct investment. That said, the peso is struggling today in the face of the greenback's surge. The dollar has rebounded to MXN18.6655 today in late Asia Pacific turnover. Yesterday's high was about MXN18.6850. The greenback settled near MXN18.67 last week. Rising US rate expectation, while the Bank of Canada signaled it was pausing, and the knock-on sell-off in US equities, are driving the greenback to its best level in a month against the Canadian dollar today. It has reached CAD1.3520 and apparently forcing some option-related buying with about $650 mln in options struck that that expire today. We saw potential toward CAD1.3550, but the momentum is sufficient to raise the prospect of a move toward CAD1.36, which the halfway point of the greenback's decline since reaching almost CAD1.3980 last October.