All That Surprising

As Treasury yields keep on rising
It shouldn’t be all that surprising
The dollar is stronger
And will be for longer
Than most traders are yet realizing

We begin a new week in the markets with the dollar flexing its muscles. The proximate cause seems to be the 10-year yield, which has traded up to 2.99%, a new high for the move, and which certainly seems like it is going to breech the psychologically important 3.00% level pretty soon. The Treasury move is based on a combination of two factors, namely continuing strength in commodity prices and an increased supply of new paper. And quite frankly, it is hard to see a reason for either of those to change in the short run. (As an aside, you may recall last week’s anxious discussions regarding an inverted yield curve in the US and its potential to be a harbinger for a recession. Funnily enough, that conversation has gone quiet!)

Oil continues to lead the commodity sector as recent data indicates the glut overhanging the market for the past several years has finally been absorbed. With WTI approaching $70/bbl (and Brent well above that already), I’m sure you have all noticed the rise in prices at the pump. And oil prices tend to be one of the most important factors in inflation expectations, so higher oil today, higher inflation expected in the future. As to the supply of Treasuries, just this week the Treasury is going to auction $181 billion in new debt, of which $96 billion is comprised of 2, 5 and 7-year notes. And remember, too, the Fed has reduced its presence at auctions as it allows its balance sheet to shrink via lessened reinvestment of maturing proceeds. All this leads to the thought that Treasury yields have further to rise.

The one thing that can stop it would be a significant risk-off type of event, but even on this front things seem to be abating. After all, the weekend was replete with articles about Treasury Secretary Mnuchin’s likely trip to China to discuss trade issues, and we continue to hear about the upcoming summit between President Trump and North Korea’s Kim Jong-un, a clear de-escalation of the nuclear war rhetoric. With the US economy still showing decent growth, at this point all signs point to the dollar regaining some of the ground lost earlier this year. At least for now, the question of cyclical dollar factors vs. structural dollar factors seems to be pointing in favor of the cyclical driving things.

But it’s not just the US side of the equation that is helping the dollar. Data released elsewhere continues to point to a slowing growth trajectory in both Europe and Japan (PMI data continues to ebb from Q4’s results) and no sign of inflation making a comeback in either place. In fact, despite the fact that measured inflation in the US seems to be modest, the reality is that it is far more robust here than elsewhere around the world. All told, the dollar is looking pretty good for now.

To be specific, we have seen the euro slip a further 0.4% this morning, which makes 1.4% since last Tuesday’s peak. The pound, too, has been suffering, down another 0.3% this morning (and 2.8% from last Tuesday.) And things wouldn’t be complete without discussing the yen, down 0.5% this morning which actually represents almost half the 1.1% decline since the dollar’s nadir. In all these cases, PMI data has disappointed and US yields seem more attractive.

We have seen some larger moves in the EMG space, which is to be expected, with ZAR falling more than 1.1% and MXN down 0.9%. In neither case is there a specific story driving things, rather both of these have been among the best performers in the bloc over the past several weeks and simply have more room to decline. In the end, today is a dollar story day, not a currency specific one.

Looking ahead, we have our first look at Q1 GDP in the US on Friday, but prior to that the data doesn’t excite.

Today Existing Home Sales 5.513M
Tuesday New Home Sales 630K
Thursday Initial Claims 230K
  Durable Goods 1.7%
  -ex transport 0.5%
  Goods Trade Balance -$74.5B
Friday Q1 GDP 2.0%
  Chicago PMI 57.9
  Michigan Sentiment 98.0

So all eyes will really be on Friday’s GDP data, with the question just how much things have slowed since Q4. As I have written before, it appears that the global growth story peaked in Q4 of last year, and we are just starting to get the harder data that is going to bear that out. While the Fed is in their quiet period ahead of next week’s meeting, the last we heard from them was Cleveland president Mester’s call for continued higher rates in order to prevent an overheating economy and financial imbalances. She is clearly not in the camp of letting things run ‘hot’ for very long. However, as she is one of the avowed hawks on the FOMC, this is no real surprise. In addition, the BOJ meets on Friday, but it is hard to believe that there will be anything new to discuss from that. For the time being, central banks remain on hold, with the only truly uncertain outcome being next week’s BOE meeting.

At this point, I see no reason for the dollar to give up its gains, as the cyclical features appear ascendant. That said, we have already seen a pretty good move, so I imagine that any further strength today will be quite minimal.

Good luck