US Dollar Tracks Yields Lower

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  • The US dollar has been unable to find any traction as US yields continue to move lower
  • The euro strengthened despite the prospects for continued divergence, while the yen has extended its gains despite a sharper than expected downward revision in Q2 GDP
  • China reported August trade figures; the Hong Kong dollar is finally seeing some catch-up gains

The dollar is mostly weaker against the majors as the week winds down. The yen and the Antipodeans are outperforming, while the Scandies and Loonie are underperforming. EM currencies are mostly firmer. IDR and CZK are outperforming, while TRY and ZAR are underperforming. MSCI Asia Pacific was up 0.5%, with the Nikkei falling 0.6%. MSCI EM is up 0.3%, with the Shanghai Composite flat. Euro Stoxx 600 is down 0.2% near midday, while S&P futures are pointing to a higher open. The 10-year US yield is down 1 bp at 2.03%. Commodity prices are mixed, with oil narrowly mixed, copper down 1.6%, and gold up 0.3%.

The US dollar has been unable to find any traction as US yields continue to move lower. The US 10-year year is slipping below 2.03% in European turnover, the lowest level in ten months. The risk, as we have noted, is that without prospects of stronger growth and inflation impulses, the yield returns to where was before the US election (~1.85%). The two-year note yield, anchored more by Fed policy than the long-end, is also soft. It yields 1.25% today, the same as the upper end of the Fed funds target range, and the rate that the Federal Reserve pays on all bank reserves (not just excess reserves).

Moreover, the developments over the past 24 hours suggest that the divergence theme between the US and Europe remains intact. Although Draghi indicated the level of concern about the euro has increased since July (something that a few members cited then compared to “most” now), he also signaled a gradual process of “calibrating” the adjustment of the program (within current parameters).

At the same time, comments from Fed officials this week ahead of the blackout period in front of the FOMC meeting suggest that the consensus appears to remain intact to begin allowing the Fed’s balance sheet to be shrinking. The process will also begin slowly ($10 bln a month), but in Q3 18, this will have been gradually ratcheted up to $40 bln a month. The ECB’s balance sheet may still be expanding.

The euro neared $1.2100 in late Asian turnover but is trading a bit heavier in Europe. It has mostly remained above levels seen at the end of the North American session yesterday. There is a 585 mln euro option struck at $1.2050 that may be in place. The $1.2165 area corresponds to a 50% retracement of the euro’s slide that began in mid-2014. Above there (and some are already forecasting it), a move toward $1.25-$1.26 becomes more likely.

Note that Draghi indicated that the euro had averaged around $1.18 when the staff made its forecasts. The euro’s continued appreciation will impact the next set of forecasts. At the same time, it appears that the staff forecast changes were less than one would have thought based on the pass-through from the currency strength.

Whereas the euro strengthened despite the prospects for continued divergence, the yen has extended its gains despite a sharper than expected downward revision in Q2 GDP. The revision is from spectacular growth (1% quarter-over-quarter) to solid (0.6%). The culprit was a business investment. It was revised to 0.5% from the initial 2.4%. Consumption was shaved to 0.8% from 0.9%. Part of these drags was blunted by an increase in public investment (6.0% vs. 5.1%). The GDP deflator remained at minus 0.4%.

The decline in US yields seems to explain the bulk of the dollar’s drop against the yen.   It has broken through JPY108 for the first time since last November. We have suggested that a break of JPY108 would set up a test on the JPY106.50 area. This still seems reasonable, especially if the US 10-year falls below 2.0%. The geopolitical uncertainty, with fears that North Korea may have another missile launch over the weekend, may be a short-term factor that is discouraging much of a short-covering dollar bounce in North America today.

Sterling has continued to advance. Yesterday it closed above the 61.8% retracement of the pullback since the August 3 high near $1.3265. That retracement (~$1.3080) is now supported.   We suggested the move above $1.3020 earlier in the week generated a technical signal suggesting a near-term move toward $1.3200. Long-term, the $1.3430 area may need to be tested. It is the 50% retracement of the decline since the referendum.

Today’s UK industrial production figures for July were largely in line with expectations with a 0.2% monthly advance. Within industrial output, manufacturing was a bright spot. It rose 0.5% after a flat June reading. Construction output was considerably weaker than expected (-0.9% vs. median guesstimate of -0.2%). It is the fourth consecutive monthly decline. Separately, the UK reported a somewhat smaller trade deficit, but much of the improvement was due to revisions to the June series.

China reported August trade figures. Exports were less robust and imports more, leading to a narrower trade surplus. Export growth slowed to 5.5% from 7.2% (expectations ~6.0%). Imports accelerated to 13.3% from 11.0% (expectations ~10%). The trade surplus fell to $42 bln from $46.7 bln. Exports to the US are up 8.4% from a year ago to $39.2 bln. Its bilateral trade surplus of $26.2 bln is the largest in two years. China reports August CPI and PPI Saturday, which are expected to rise 1.7% y/y and 5.7% y/y, respectively. PBOC is targeting 3% inflation this year.

The dollar fell 1.5% against the yuan this week. The dollar has not fallen 1% or more in a week against the yuan in over a decade, and now it has done it for two back-to-back. It is the third consecutive weekly decline. In fact, here in Q3, the yuan has fallen in only two weeks. The US dollar bottomed against the yuan in early 2014 near CNY6.04. It peaked at the end of last year near CNY6.9650. It shot through CNY6.50 this week, which is the 50% marker. The 61.8% retracement objective is seen by CNY6.39.

The Hong Kong dollar is finally seeing some catch-up gains. Whilst EM FX was gaining against USD in recent month, USD/HKD had been climbing steadily. That is, until now. Two straight days of HKD gains pushed the pair beneath the 7.8 peg rate today for the first time since late June. Some local analysts are skeptical that the HKD gains can be extended given still-low local interest rates. Indeed, the fact that the lower odds that the HKMA will need to intervene at the 7.85 level suggests HK interest rates will probably stay low.