US interest climbs

Analysts are attributing the increase to a strong US economy, hawkish Fed comments, technical factors or even possible demand for return premia. Yet, significant corporate issuance, higher dollar funding basis and even mortgage convexity hedging issues could all have pushed the curve. Given the expected heavy US issuances between sovereign and corporate we suspect that markets are getting crowded and solid US data just provided a push.

The Fed has softened its language around estimates of neutral rate, which has given the market room to re-forecast key levels. The rise in rates is not just a US phenomenon. European yields have general kept pace. The correlation between US yield and USD and equities will eventually turn negative. Higher interest rates (US 10-year yields around 3.50%) also pressure financial conditions, which should weigh on stock valuations. Historically, equities do not rise in harmony with rates. Perhaps this is why we see the S&P 500 falling.

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Mexico holds

The Bank of Mexico held its overnight rate at 7.75%, as expected. The trade deal between Mexico, Canada and US and higher interest rate yields suggest we should see further improvement in MXN. The next inflation read will be critical in forecasting Banxico’s next move.

US economy healthy

Markets expect the USA unemployment rate to have eased to 3.8% in September. Non-Farm payrolls should have eased to 185,000 from 204,000 in the previous month. Average hourly earnings are expected to have edged down to 2.8% from 2.9% in August. All indicators have been on green in the job market.

Unemployment is at its lowest level since the millennium. Inflation has been moving in the right direction. This goldilocks scenario has allowed the Federal Reserve to hike interest rates eight times over the last three years. According to the latest projections, this cycle would most likely stop in 2020. By then the Fed funds rate would reach around 3.4%. So what will drive exchange rates? The US dollar has had a nice ride since the beginning of the year but has been unable to extend gains despite widening interest rate differential against most of its currency peers. One can argue that the Federal Reserve’s balance sheet unwinding will become the main driver for the buck, but we believe that developments in the job market and inflation will remain key drivers.

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