US yields started moving higher during the Asian day yesterday Tuesday 15th of May 2018 and even higher during US trading.
Good US economic news was behind the jump in yields. On the one hand, US retail sales came out as expected or even a little weaker, but the previous month’s data was revised up notably, including the crucial “control” measure, which feeds into the Gross Domestic Product (GDP) calculation – meaning Q2 GDP may be higher than expected. At the same time, the Empire State manufacturing index unexpectedly rose instead of falling slightly as expected, with the prices paid component – a forward-looking indicator of inflation – rising to the highest level since 2011. Just for good measure, 1 ½ hours later the National Association of home builders (NAHB) index registered an unexpected increase.
Last week, the dollar fell as US yields fell; this week, the dollar rose as US yields rose. The interesting question is, which market is leading which? In fact there may well be some feedback between the two markets in which higher yields push the dollar higher, and the higher dollar pushes yields up too. That’s because a stronger dollar reduces the likelihood of foreign central bank intervention and thereby eliminates one major source of demand for Treasuries. At the same time, a stronger dollar boosts inflation globally so long as commodity prices – denominated in dollars – are stable to rising, as they are now. Rising commodity prices will give central banks more confidence that they’re likely to hit their inflation targets and can therefore proceed with normalizing policy. A more hawkish environment for central banks coupled with the Federal Reserve Systems (Fed’s) continued normalization of policy means a less favorable picture for bond markets around the world.
Which currencies are most closely correlated with US yields alone (ignoring the question of yield gaps)? Looking just at the last two months, it’s clearly JPY and CHF, which makes sense: Japanese yields never move, so any change in UST yields equals a change in the US-JP yield spread, while Swiss yields are not just the lowest in the world, but actually the lowest in recorded human history (the two-year yield is currently -0.82%. Yes, that’s minus.) (Note: 2-year yields and 10-year breakevens were used because those have the highest correlation with currency moves.)
Rising tensions in the Middle East and a possible breakdown in the growing strained relations with North Korea, plus falling stock markets and a big increase in VIX, all make for a good background for the “safe haven” currencies.
Risk aversion and a flight to safe-haven currencies may also explain why JPY only fell slightly. One might have expected a greater decline considering that Japan’s Q1 Gross Domestic Product (GDP) undershot expectations and actually contracted.
The safe-haven explanation seems reasonable, as both JPY and CHF tend to strengthen when the US stock market falls and when the VIX index rises, which both occurred yesterday Tuesday 15th of May 2018 too.
The day starts out with an European Central Bank (ECB) colloquium in honor of ECB Vice President Vitor Constancio, who’s retiring. There will be a welcome address by ECB President Mario Draghi, and then Board Member Benoit Couere chairs the first session and ECB Chief Economist Peter Praet chairs the second session. There’s no indication what these sessions will be about. Since Coeure and Praet just spoke on Monday 14th of May nothing new is expected.
Canadian manufacturing sales are expected to grow, but not by as much as in the previous month. Nonetheless, this is an erratic series and two consecutive months of decent growth is fairly encouraging. In fact the expected rise of +1.0% mom is above the trend rate of +0.7% mom. Much of the increase though is apparently caused simply by higher energy prices. Nonetheless, the turnout could be positive for CAD.
US housing starts and building permits are both expected to be slightly lower. Although permits are obviously the more forward-looking of the two indicators, the market tends to pay more attention to starts, and since that’s expected to be almost unchanged, the figures are not expected to have much of an impact on the dollar. Remember that January’s 1339k figure was the highest since the Global Financial Crisis, so a small decline from that is still quite a high level of starts.
Atlanta Fed President Raphael Bostic, a voting member of the Federal Open Market Committee (FOMC), will give an economic update. He’s spoken a lot this month, most recently on the 9th of May 2018 when he gave a speech on the economic outlook and monetary policy, so nothing new is expected. Note though that the April 2018 Consumer Price Index (CPI) came out on the 10th, so he could have adjusted his view on inflation after seeing that number – that will be the main point of interest in the speech.
US industrial production is expected to accelerate a bit to be more or less in line with the recent trend. Aggregate factory hours were strong in the April 2018 employment report and the rig count increased slightly, indicating gains in manufacturing and mining. The news could be neutral to supportive for the dollar.
The Fundamental Analysis is provided by Marshall Gittler who is an external service provider of Claws and Horns (Cyprus) Limited, an independent analytical company. Any views and opinions expressed are explicitly those of the writer. Any information contained in the article, is believed to be reliable, and has not been verified by STO and is not guaranteed to be accurate. References to specific products, are for illustrative purposes only and are not a form of solicitation, recommendation or investment advice. Past performance is not a guarantee of future performance.