FX Commentary - April 23, 2018
10-year U.S. Treasury yields rose to 3% for the first time since 2014, marking a pivotal milestone for the world’s primary bond market benchmark and perhaps signaling the beginning of the end for the era of ultra-low interest rates.
The immediate effects have been most prominent in the U.S. dollar which has rallied to its strongest levels in 3 months on a trade-weighted basis. Cooling diplomatic and trade tensions have also provided relief to the dollar, as President Trump prepares for a meeting with North Korean Leader, Kim Jong Un, and Treasury Secretary, Steve Mnuchin, is scheduled for a visit to China to resolve trade disputes.
On the data front, the U.S. economy has shown strong fundamentals with solid readings in retail sales, housing data, and industrial production last week. The string of good data has continued into the current week, with April’s purchasing manager’s index, March’s home sales, and February’s home prices all coming in above expectations. Beyond supporting the dollar rally, the data have also firmed market expectations of a rate hike by the Fed in June—with markets currently pricing in a 95.3% chance. Taken in tandem with slowing economic data in the other major economies, there appears to be narrative developing of a widening interest rate differential between the U.S. and other developed countries. Playing into this narrative, the Eurozone, UK, and Canada have all witnessed varying degrees of cautiousness recently communicated by their central banks in response to recent moderations in data.
Meeting this Thursday, the European Central Bank (ECB) is expected to maintain its current interest rates and leave its policy statement mostly unchanged. Last year’s economic expansion in the EU and hawkish cues by the ECB early this year drove the euro to a surging start against the dollar, but growth numbers, sentiment indicators, and inflation readings since have failed to provide any further support to the euro. As it is, the ECB will have little incentive to make any changes in its forward guidance and will thus offer little opportunity for any immediate upside risk in the single currency.
Weakening data has also heavily depressed the British pound since last week, bringing the pound off its highest levels since Brexit. Data on average earnings, inflation, and retail sales last week all missed expectations and showed declines from the prior month. Meanwhile, dovish comments by Bank of England Governor, Mark Carney, further weighed on sterling and led to a recalibration of rate hike expectations. The primary release this week will be GDP growth for the first quarter, which is forecast to show quarterly growth moderating to 0.3%.
On Friday, the Bank of Japan announces its latest interest rate decision and releases its quarterly outlook report, both of which are expected to be unchanged. A detente in geopolitical and trade tensions in recent weeks has helped support a recovery of risk-on flows, rallying dollar-yen from 15 month lows. However, with 10 year yields now at 3% an interesting scenario could potentially play out for the yen. Although higher yields have resulted in a stronger dollar thus far, should yields stabilize markets could possibly see the negative effects on equity markets start to become a more dominant theme for dollar-yen, perhaps once again resulting in risk-off flows for the pair.
Sources: Bloomberg, Wall Street Journal, Reuters, Barclays, Bank of America, Econoday, 4cast
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