The Correction on US Yields Didn’t Hurt the Dollar

Markets

Yesterday’s US CPI caused investors to take a step backward and assess the standing uptrend in US/global yields. Both the headline CPI (1.2% M/M and 8.5% Y/Y) and core (0.3% M/M and 6.5% Y/Y) reached the highest levels since 1981/1982, but contrary to previous months, there was no upside surprise. Core inflation even rose less than expected. The jury is still out whether this marked some kind of peak. Even if so, a more important question is whether this will be start of a real and protracted slowdown (decline in M/M dynamics).

Whatever, after touching cycle peaks for yields at maturities longer than 5 year earlier, US bonds were caught in a ‘profit taking short-squeeze’. The US yield curve steepened with the 2-y/5-y easing 9.2/9.5 bps, the 10-y lost 5.9 bps. The 30-y still gained marginally (+0.1 bp). Markets now will look out for further Fed communication on frontloading of policy normalization. We don’t expect any change of the (hawkish) tone yet.

EMU markets showed a similar steepening move (German 2-y -5.3 bps, 30-y + 1.9 bps), but the correction was more modest as investors were looking forward to the assessment at the ECB meeting tomorrow.

The easing in the bond sell-off initially propelled US equities. However, headlines from Russian president Putin that talks with Ukraine were ‘at a dead end’ dampened optimism. Major US  indices closed about 0.3% lower.

The correction on US yields didn’t hurt the dollar. On the contrary: DXY closed north of 100 for the first time since May 2020. EUR/USD immediately after the US CPI release touched the 1.09 area, but the move lacked momentum and persistent uncertainty on the war in Ukraine/Putin comments didn’t help. EUR/USD closed at 1.0828, within reach of the YTD low of 1.0806. USD/JPY also closed little changed at 125.38.

This morning, the pause in the US yield rally also gives some breathing room for Asia. Equity markets mostly trade in positive territory with Japan outperforming. The dollar remains well bid. USD/JPY (125.60) is again with reach of the 2015 top (125.86).

Later today, the calendar contains the US PPI (headline expected to rise to 10.6%). However, we doubt this report will change markets’ assessment after yesterday’s CPI release.

On interest rate markets, we look out whether yesterday’s correction as further to go. The picture/trend especially for LT yields both in the US and Europe hasn’t changed in any profound way. Especially in Europe, an ongoing rise in inflation expectations supports yields at longer maturities.

On FX markets question is whether EUR/USD can avoid a return/break of the 1.0806 YTD low. Probably a convincing anti-inflation message from Lagarde an Co is needed to ‘save’ the euro.

his morning, both UK core (5.7% Y/Y) and headline CPI (7.0% y/y) surprised on the upside. It questions recent soft BoE speak. Even so, sterling hardly gains in a first reaction (EUR/GBP 0.8330).

News Headlines

The Reserve Bank of New Zealand stepped up its tightening cycle by unexpectedly raising its policy rate by 50 bps (to 1.5%) instead of 25 bps like at the previous three meetings. The MPC also agreed to continue to tighten monetary conditions at pace even as they remain comfortable with the outlook as outlined in February. This implies a 2.2% policy rate end this year and 3.3% by end of 2023. Moving the policy rate to a more neutral level sooner, reduces the risks of rising inflation expectations. A larger move now also provides more policy flexibility ahead in light of the highly uncertain global economic environment. First local signs come from weakening consumer confidence (eco uncertainty + inflation) and a reduction in mortgage demand and house prices (rise in mortgage rates). The NZD swap curve bull steepens this morning (up to 15 bps lower for 2-y tenor) as markets ran ahead of their selves and the February RBNZ guidance. The MPC sticking to that view now triggers some return action despite the 50 bps rate hike. NZD/USD attempted to take out the 0.69 big figure, but failed to do so and tumbled to the low 0.68-area

Bloomberg reports that China is allowing Shanghai, Guangzhou and six other cities to shorten quarantines for overseas travelers and those who’ve had a close contact with infected individuals from 14 days to 10 days as authorities test potential tweaks to the country’s rigorous Covid-measures. Apartment complexes, retail outlets and office building will also be allowed to reopen more quickly. The trial period will run for a month.