US yields stabilise ahead of FOMC meeting
After soaring continuously for the last 10 days in anticipation of this week FOMC meeting, US rates are taking a breather. The monetary policy sensitive 2-year yield rose more than 12bps since September 8th and stabilised slightly below 1.40% on Tuesday morning. Similarly, 5-year and 10-year yields consolidated gains after a rally of 0.21bps and 0.22bps, respectively.
The recovery in US yields was of little help for the US dollar as this is part of a broader move as rates across the globe also increased in anticipation of tighter monetary policies from most central banks. Although the Federal Reserve should keep the federal funds rates unchanged tomorrow, market participants are looking for a starting date of the balance sheet runoff. It is hard to say when the Fed will start to unload its massive holding, most likely October or December this year, but it will act gradually and with extreme caution in order to avoid a sell-off in bonds and therefore an uncontrolled surged in yields that could be extremely damaging for the US economy.
The USD has been trading broadly lower today, falling more than 0.20% against the single currency and around 0.30% against the Aussie and the Kiwi. Investors will most likely avoid taking too much risk as the risk for disappointment should not be underestimated. Nevertheless, given the fact that the market is mostly short USD, we think the risk should be skewed to the upside.
Eurozone: capital inflows increase at a faster pace
Today has been released the current account of the balance of payments for July which is a good metric to measure any change in regards to the ECB monetary policy. It helps us to measure any potential capital inflow or outflow. The July data has seen an increase of the current account balance to €8.625billion from €5.257 billion. Inflows towards the Eurozone are increasing at a faster pace.
Those inflows are mostly due because of strong market expectations that the ECB will starts tightening its monetary policy by announcing a reduction of its asset purchase program at its next meeting. The ECB monetary policy has largely driven, over the past few years, money towards the global bonds market which has risen significantly. Any further tapering would likely push investors to unwind their foreign assets position and drive money back to the Eurozone.
As a result, we believe that upside pressures on the Eurodollar pair are very likely to continue despite the rate differential between the US and the EU is rising, in particular the front-end of the US yield curve. Anyway the rate differential is not a great metric for estimating future currency demand. We keep on considering that the state of the US economy is overestimated and that investors are keen to unwind their long dollar position. A Eurodollar at 1.23 represents a decent medium-term target.
Volatile Asia
Risk appetite started strong in Asia, but weaken as Europe walked through the door. Volatility in USDHKD continue to surges as HKMA withdrew excess liquidity from the banking system by offering additional $HK40bn of exchanges bills. The market was caught short HKD, which has been used as a funding currency in carry trades, causing USDHKD to fall sharply. However, the influence on rates and liquidity is questionable suggesting USDHKD will likely move back about 7.82. In Japan, Japan’s PM Shinzo Abe confirmed that snap elections were on the table (rumored that Oct 22nd could be the proposed date). PM Abe rating have recovered over public worries over North Korea and disarray in the opposition Democratic Party For the market the focus will be on the fate of Abenomics which is connect to the ruling party. USDJPY rally to 111.70 has been is support by expectation another Liberal Democratic Party (LDP) win will extend Abenomics. FX trader will be watching the Polls cautiously, should Abe popularity wane, watch for JPY to gain strength.
