Dollar Rally Intact as US Yields Enter New Phase

  • The rise in US yields has entered a new phase
  • Details of the Italian draft budget are emerging and they’re not good
  • After holding up relatively well, it is EM’s turn to lead the move lower
  • UK Prime Minister May’s speech at the annual Tory conference turned out to be a bit of a non-event
  • During the North American session, the US reports September Challenger job cuts, weekly jobless claims, and August factory orders
  • Markets are really running with the most recent Brazil poll numbers; Banco de Mexico is expected to keep rates steady at 7.75%

The dollar is mixed against the majors even as UST yields march higher.  The euro and sterling are outperforming, while the dollar bloc is underperforming.  EM currencies are broadly weaker.  MXN and RON are outperforming, while TRY and KRW are underperforming.  MSCI Asia Pacific was down 1.1%, with the Nikkei falling 0.6%.  MSCI EM is down nearly 2% so far today, with China on holiday all week.  Euro Stoxx 600 is down 0.8% near midday, while US futures are pointing to a lower open.  The 10-year US yield is up 3 bp at 3.21%.  Commodity prices are mostly lower, with Brent oil down 0.2%, copper down 0.2%, and gold up 0.2%.

The rise in US yields has entered a new phase.  After being unable to break much above 3.10% this past month, the 10-year yield shot up to 3.19% yesterday.  Today has seen a continuation of this, with yields trading as high as 3.23% before stalling.  This is the highest rate since May 2011.   The next round number target should be 3.50%, but charts suggest that a test of the February 2011 high near 3.77% is in order.  This is dollar-positive, to state the obvious.

Stronger than expected US data helped, though much of the move in rates was later in the day.  ADP reported 230k new private sector jobs created in September vs. 184k expected.  In light of weekly claims data, ISM employment component, and now ADP, markets are likely to be leaning towards a nonfarm payroll reading that’s higher than the current 184k consensus.  Note ISM non-manufacturing PMI came in at 61.6 vs. 58.0 expected.

After holding up relatively well, it is EM’s turn to lead the move lower even as the majors trade mixed today.  EM bonds are suffering as UST yields rise, with Turkey and South Africa local currency yields up 64 bp and 13 bp today, respectively.  In terms of EM FX, TRY is the worst performer today and the second worst over the past week, behind only ZAR.  In terms of equities, MSCI EM is down 2% today and has fallen four of the past five days.  It is on track to test the September low just below 1000.  We remain bearish on EM assets broadly.

Details of the Italian draft budget are emerging and they’re not good.  Deputy Finance Minister Garaviglia said the draft assumes 1.6% growth next year as well as the two years following.  Contrast that with IMF forecasts of 1.0% and 0.9% for 2019 and 2020, respectively.  With global growth slowing, it’s hard to paint a picture where Italy is able to outperform like the draft budget assumes.  As such, it’s clear that the deficit assumption of -2.4% of GDP will most likely be overshot next year.

Despite this news, the euro has stabilized a bit after breaking below $1.15 low late yesterday.  Still, that break sets up a test of the August low near $1.13.  With USTs selling off, Italian BTPs are giving back some of yesterday’s gains, with the 10-year yield up 4 bp and the 2-year up 2 bp.  Italian officials are moving into damage control mode, but we think they will revert to form after it submits the 2019 draft budget mid-month. EU criticism is likely, and Italy will most likely push back.

UK Prime Minister May’s speech at the annual Tory conference turned out to be a bit of a non-event.  However, press reports since suggest she is pushing to get a Brexit bill through Parliament by the beginning of December.  This would seem a risky strategy and it will likely be opposed by those within her party as well as the opposition Labour.  Like the euro, sterling has also stabilized a bit after making a new low for this move earlier today near $1.2920.  Break below $1.29 is needed to set up a test of the August low near $1.2660.

USD/JPY has reacted to higher UST rates as one would expect, breaking above the 114 level this week to trade at the highest level since last November near 114.55.  The high of 114.75 from that month is the obvious near-term target.  At the risk of sounding too bold, longer-term charts suggest an eventual test of the January 2017 high near 118.60.  An intermediate target is the March 2017 high near 115.50, but there really aren’t any major chart points after that.

Australia reported August trade data overnight.  The surplus was AUD1.6 bln vs. AUD1.45 expected.  However, Aussie saw little relief and is trading at new lows for this cycle.  Indeed, it is now trading at its lowest level since February 2016 and is on track to test the January 2016 low near 0.6825.  And it’s not just Aussie.  Kiwi is actually leading this move and is much closer to testing its January 2016 low near 0.6350.

During the North American session, the US reports September Challenger job cuts, weekly jobless claims, and August factory orders.  None are particularly market-moving.  The only Fed speaker today is Quarles.  Elsewhere, Canada reports September Ivey PMI.  Firm data out of Canada has led CAD to outperform recently and it is the only major currency to be up against the dollar over the past week (+1.3%).  According to Bloomberg’s WIRP, markets see a 93% chance of a BOC hike at the next meeting October 24.

Markets are really running with the most recent Brazil poll numbers.  USD/BRL traded yesterday at its lowest level since August 10 near 3.8250 before rebounding a bit.  Yes, Bolsonaro is getting more traction but a first round win seems a stretch and he is statistically tied with Haddad in the second round.  After its recent outperformance, it just does not make sense to go long BRL near 3.85 given such uncertainty, both domestically and globally.

Banco de Mexico is expected to keep rates steady at 7.75%.  2 out of the 26 analysts polled by Bloomberg look for a 25 bp hike to 8.0%.  CPI rose 4.9% y/y in August, which is accelerating and well above the 2-4% target range.  The peso had for the most part remained relatively firm and so we think the bank can afford to take a “wait and see” approach.  However, this week’s sell-off bears watching, as a break of the 19.2335 area would set up a test of the September high for USD/MXN near 19.6860.