The greenback is fighting back once again on resurgence in US yields across the curve after Obama tax deal and renewed growth hopes. Does this jibe with action in other markets and will the renewed USD strength persist?
Higher US yields and the USD
The sharply higher yields at the long end of the US yield curve are pushing the USD stronger – a relatively rare phenomenon if we look at the post-global financial crisis environment. Generally since 2008, we’ve been trained to look for USD strength when interest rate spreads improve in favor of the US via non-US yields falling more rapidly than the already very low us yields. This time is very different, as we are seeing US yields sharply higher all along the curve on renewed hopes that US growth will surprise in the coming year. This view is supported by the new round of “stimulus” by the Obama administration in its unemployment benefits/tax cut extension move this week. Although this program only adds new outlays via the unemployment benefits, the combination of these benefits in addition to the Bush era tax cut extensions and the payroll tax cut are north of 5% of GDP relative to what would have been the case had no action been taken. This virtually guarantees that there will be no real double dip in 2011 for the US. Of course, this comes at a huge cost to the already dire fiscal picture, but for the moment, the market continues to express no worry on that front, perhaps hoping that the economy will make a strong enough comeback to keep the Fed sidelined and grow tax revenues. This is an impossibly sanguine view on the fiscal side, but the market seems very content to live in the now these days and as long as US yields outperform, we should see a continuation of the USD strength – particularly against the low-yielding JPY.
The sharply higher yields at the long end of the US yield curve are pushing the USD stronger – a relatively rare phenomenon if we look at the post-global financial crisis environment. Generally since 2008, we’ve been trained to look for USD strength when interest rate spreads improve in favor of the US via non-US yields falling more rapidly than the already very low us yields. This time is very different, as we are seeing US yields sharply higher all along the curve on renewed hopes that US growth will surprise in the coming year. This view is supported by the new round of “stimulus” by the Obama administration in its unemployment benefits/tax cut extension move this week. Although this program only adds new outlays via the unemployment benefits, the combination of these benefits in addition to the Bush era tax cut extensions and the payroll tax cut are north of 5% of GDP relative to what would have been the case had no action been taken. This virtually guarantees that there will be no real double dip in 2011 for the US. Of course, this comes at a huge cost to the already dire fiscal picture, but for the moment, the market continues to express no worry on that front, perhaps hoping that the economy will make a strong enough comeback to keep the Fed sidelined and grow tax revenues. This is an impossibly sanguine view on the fiscal side, but the market seems very content to live in the now these days and as long as US yields outperform, we should see a continuation of the USD strength – particularly against the low-yielding JPY.
EuroZone periphery
The Irish budget passed as expected, with no strong reaction in the FX markets, save for continue weakness. The sovereign debt noise is now shifting to Italy, where Berlusconi’s hold on the reins of power seems to be slipping and he faces a confidence vote on December 14. If one dials back to the past of Italian politics, one can easily find grounds for further worry that fractious politics could hinder any timely solution to Italy’s deficit and debt challenges. See this Bloomberg article for coverage of Italy’s 2011 budget proposal and Berlusconi’s confidence vote.
The Irish budget passed as expected, with no strong reaction in the FX markets, save for continue weakness. The sovereign debt noise is now shifting to Italy, where Berlusconi’s hold on the reins of power seems to be slipping and he faces a confidence vote on December 14. If one dials back to the past of Italian politics, one can easily find grounds for further worry that fractious politics could hinder any timely solution to Italy’s deficit and debt challenges. See this Bloomberg article for coverage of Italy’s 2011 budget proposal and Berlusconi’s confidence vote.
UK manufacturing data
The UK CBI manufacturing orders data surged to its strongest level in years and well above expectations. This together with Euro-area nervousness has EURGBP trading to a new low for the week as last week’s low around 0.8335 is rapidly coming into view. The current yield spread picture at the front of the curve suggests that GBPUSD is fairly priced in the 1.5800-1.6000 area. UK vs. Japanese yield spreads suggest that GBPJPY should be breaking to new highs for the cycle.
The UK CBI manufacturing orders data surged to its strongest level in years and well above expectations. This together with Euro-area nervousness has EURGBP trading to a new low for the week as last week’s low around 0.8335 is rapidly coming into view. The current yield spread picture at the front of the curve suggests that GBPUSD is fairly priced in the 1.5800-1.6000 area. UK vs. Japanese yield spreads suggest that GBPJPY should be breaking to new highs for the cycle.
Chart: GBPJPY
Yield spreads suggest GBPJPY should be trading at a new high for the recent cycle. While the pair has rallied sharply on the last couple of days of bonds selling off, it is still below the previous highs. Also looming soon is the 200-day moving average above 134.00. We’ll likely need to see a continued pummeling of the bond market to get the pair to achieve further altitude. Otherwise, this is just one more false hope rally for the JPY funded carry trades.
Yield spreads suggest GBPJPY should be trading at a new high for the recent cycle. While the pair has rallied sharply on the last couple of days of bonds selling off, it is still below the previous highs. Also looming soon is the 200-day moving average above 134.00. We’ll likely need to see a continued pummeling of the bond market to get the pair to achieve further altitude. Otherwise, this is just one more false hope rally for the JPY funded carry trades.
Looking ahead
Reversal to see follow through?
Yesterday was a key technical event across markets, as the break to new highs in equities failed to close at new highs and as we saw an almost climactic reversal in some of the most volatile markets like precious metals. Silver, for example, posted a strong new high above 30.50, but then closed the day below 29 dollars and therefore below the previous high. As well, US treasuries resumed a sell-off and USDJPY reversed sharply back to the upside. Today and the rest of the week will be about determining whether this move continues or whether it was just a headfake. The next key triggers are the 1.2970 lows in EURUSD and perhaps the 0.9700 area in AUDUSD (which is struggling today to figure out whether it wants to break down through the 55-day moving average just above the 0.9800 level.
Yesterday was a key technical event across markets, as the break to new highs in equities failed to close at new highs and as we saw an almost climactic reversal in some of the most volatile markets like precious metals. Silver, for example, posted a strong new high above 30.50, but then closed the day below 29 dollars and therefore below the previous high. As well, US treasuries resumed a sell-off and USDJPY reversed sharply back to the upside. Today and the rest of the week will be about determining whether this move continues or whether it was just a headfake. The next key triggers are the 1.2970 lows in EURUSD and perhaps the 0.9700 area in AUDUSD (which is struggling today to figure out whether it wants to break down through the 55-day moving average just above the 0.9800 level.
Key US 10-year auction
Today’s US 10-year auction is one of the more important auctions in recent memory now that bond yields have punched through critical levels. At some point, rather than serving as a reflection that risk appetite is improving, higher bond yields might generate worries for growth rates. Certainly, sharply higher rates from current levels mean that we need to see strong fundamental improvement in economies and corporate earnings again, since the higher rates go, the more they pressure the fragile mentality of the liquidity punchbowl and rising asset prices as a response to Fed priming.
Today’s US 10-year auction is one of the more important auctions in recent memory now that bond yields have punched through critical levels. At some point, rather than serving as a reflection that risk appetite is improving, higher bond yields might generate worries for growth rates. Certainly, sharply higher rates from current levels mean that we need to see strong fundamental improvement in economies and corporate earnings again, since the higher rates go, the more they pressure the fragile mentality of the liquidity punchbowl and rising asset prices as a response to Fed priming.
RBNZ on tap
Don’t forget that the RBNZ is on tap with its rate decision (no change expected – we’re sure that the RBNZ is not particularly happy with the strong kiwi – even if it is resigned to it. On the economic data front, there is little to suggest that the RBNZ needs to pull the level here and now with housing sales collapsing and prices easing lower while there are few signs of inflation and the major activity surveys have decelerated a bit recently. Still, guidance will be worth watching.
Don’t forget that the RBNZ is on tap with its rate decision (no change expected – we’re sure that the RBNZ is not particularly happy with the strong kiwi – even if it is resigned to it. On the economic data front, there is little to suggest that the RBNZ needs to pull the level here and now with housing sales collapsing and prices easing lower while there are few signs of inflation and the major activity surveys have decelerated a bit recently. Still, guidance will be worth watching.
Economic Data Highlights
- US Weekly ABC Consumer Confidence out unchanged at -45
- Japan Oct. Adjusted Current Account Total out at ¥1463B vs. ¥1556B expected and ¥1661B in Sep.
- Japan Oct. Machine Orders fell -1.4% YoY and rose +7.0% YoY vs. -0.1%/+8.3% expected, and +4.2% YoY in Sep.
- UK Nov. BRC Shop Price Index rose +2.0% YoY vs. +2.2% in Oct.
- Australia Oct. Home Loans rose 1.9% MoM vs. 0% expected
- Germany Oct. Current Account out at +11.7B vs. +14.3B expected and +14.5B in Sep.
- Germany Oct. Trade Balance out at +14.2B vs. +15.1B expected and +16.8B in Sep.
- Germany Oct. Industrial Production rose +2.9% MoM and +11.7% YoY vs. +1.0%/+10.0% expected, respectively and vs. +7.7% YoY in Sep.
- UK Dec. CBI Total Orders Trend rises to -3 vs. -13 expected and -15 in Nov.
- Canada Nov. Housing Starts out at 187.2k vs. 173k expected and 167.8k in Oct.
Upcoming Economic Calendar Highlights
- US Weekly DoE Crude Oil and Product Inventories (1530)
- New Zealand RBNZ to announce Cash Target (2000)
- New Zealand Nov. Credit Card Spending (2145)
- Australia Q4 Westpac ACCI Industrial Survey (2330)
- Australia Nov. Employment Change and Unemployment Rate (0030)
- Japan BoJ’s Morimoto to Speak (0130)
- Japan Nov. Machine Tool Orders (0600)
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