The dollar is retreating from yesterday’s extreme levels as currency markets stage a modest and hesitant recovery against a materially-tighter financial backdrop. Benchmark Treasury yields holding near a 15-year peak on fears that the Federal Reserve will keep rates higher for longer, and rates in most major advanced economies are pushing upward in sympathy.
North America
A record of the Fed’s July policy meeting showed officials remaining relatively hawkish. Some policymakers turned more cautious, pointing out that risks had become “more two-sided,” making it “important that the committee’s decisions balance the risk of an inadvertent over-tightening of policy against the cost of an insufficient tightening,” but a majority saw “significant” upside risks to inflation which “could require further tightening of monetary policy”. Markets, already reeling from the devastating realization that the economy might not be tumbling toward recession, reacted badly, with ten-year yields topping levels last hit in 2007 as odds on rate cuts were pulled back.
Ten-year government bond yields, %
The number of American submitting initial claims for unemployment benefits fell by 11,000 in the week ended August 12, emphasizing continued strength in labour markets. Still ahead today, the Conference Board’s leading economic index – once seen as a reliable harbinger of recession – is expected to fall 0.4 percent from the prior month, remaining in negative territory for a 13th month. Markets are unlikely to react.
The Canadian dollar is struggling to break back through 1.35, with rate differentials moving in opposite directions at different parts of the curve. After a raft of positive US data and a relatively-hawkish meeting record from the Fed, two-year US yields exceed their Canadian equivalents by roughly 14 basis points, down from yesterday’s 16, while ten-years are paying almost 49 points, up from yesterday’s 47. There are no major data releases on the docket for the day ahead, suggesting that technicals could play a bigger role, with the 1.3450 200-day moving average looming as a potential target.
Europe
The euro is trading at slightly stronger levels after a data update confirmed the economy expanded 0.3 percent in the second quarter, but there are signs of a near-term top emerging as policymakers turn more cautious. The typically-hawkish European Central Bank Governing Council member Mārtiņš Kazāks seemed to reverse course this morning on imposing additional monetary tightening in coming months, saying “if there’ll be increases in interest rates then they’ll be very small”. He had previously warned of asymmetries in the inflation outlook, mirroring hawks on the other side of the Atlantic in saying that the downsides of doing too much were outweighed by the risks of doing too little.
With British yields also pushing past their 2008 highs, rate differentials are lending support to the pound, pushing it almost inexorably toward the 1.28 threshold against the dollar. Yesterday’s inflation data showed core and services inflation remaining stubbornly elevated in the island nation, firming expectations for at least three more rate hikes from the Bank of England – an outlook that sets the central bank apart from most of its developed-market counterparts, which are mostly seen holding rates for now, with cuts beginning in early 2024.
Market-implied change in policy rates, %
Asia Pacific
The Chinese yuan popped higher this morning on reports of intervention from state-owned banks, snapping upward from 7.32 to 7.28 against the dollar in the space of an hour. Quoting people “people familiar with the matter,” Bloomberg said authorities had instructed major institutions to buy the yuan in an effort to prevent a disorderly move lower, and had investigated whether domestic companies were betting against the currency – steps that would suggest officials are preparing to impose additional restrictions on taking short positions in forward markets.
Pressure on the exchange rate increased yesterday when one of the country’s biggest financial services firms – Zhongrong International Trust Co. – stopped paying holders of dozens of investment products, threatening to trigger a crisis of confidence among households, businesses, and investors. But liquidity conditions within the Chinese financial system remain relatively accommodative, suggesting that regulators are managing to keep major banks flush with cash and interest rate spreads under control – in contrast with prior periods of stress, when turbulence in interest rates threatened to squeeze the entire economy.
1-year Interbank Negotiable Certificate Deposit yield less 1-year Medium-Term Lending rate, %
Implied volatility on the Japanese yen remains relatively subdued even as the exchange rate pushes lower, suggesting that traders and authorities are aligned in viewing the move as supported by the fundamentals. Few doubt that the Ministry of Finance will authorize intervention if short positioning hits extremes or the yen begins to drop at a more aggressive pace, but with the dollar gaining strength against virtually every major currency at the same time, the case for taking a lonely stand against the greenback is not particularly solid.