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Market Briefing: Fear Grips Financial System as Dollar Climbs and Bank of England Intervenes

With American policymakers issuing this generation’s version of former Treasury Secretary John Connally’s 1971 “the dollar is our currency, but it’s your problem” speech, a surging greenback is crushing all of its major rivals and triggering turmoil across the global financial system.

Speaking with reporters yesterday, Treasury Secretary Janet Yellen said “with the United States moving faster than many other countries, we’re seeing upward pressure on the dollar and downward pressure on many other foreign currencies,” and “these kinds of developments — which represent a tightening in financial conditions — are part of what’s involved in addressing inflation”. White House National Economic Council Director Brian Deese followed this up by saying another Plaza Accord — the mid-eighties effort to slow the dollar’s ascent — was unlikely, saying “The most striking feature of the US economy right now is resilience: the resilience of households and consumer balance sheets, resilience of business and business investment, and, globally, the resilience of the US economy in an uncertain global environment.”

Ten-year Treasury yields briefly broke through 4 percent in European trading hours before fading slightly. With headline inflation still running above 8 percent and underlying price pressures continuing to build, fixed income investors are bracing for sharp — and durable — rate hikes from the Federal Reserve in months ahead. By our reckoning, ten-year yields have climbed the most on a year-to-date basis since 1981, when Paul Volcker’s war on inflation was in full flight. Minneapolis Fed president Neel Kashkari, once one of the most dovish officials on the central bank’s rate-setting committee, yesterday said “The one mistake that I’m acutely aware of — that I want to avoid repeating from the 1970s — is when policy makers saw the economy weakening, saw inflation start to tick down, and then they cut rates, thinking they had done the job. And then inflation flared back up again — that, I believe, is a mistake we cannot make and will not make”.

Long-term UK government yields shot higher and then plunged by the most in living memory after the Bank of England took emergency action, postponing its planned gilt sale operations and announcing it would instead buy long-dated bonds “on whatever scale is necessary” to restore orderly market conditions. This came after reaction to chancellor Kwasi Kwarteng’s tax cutting and borrowing plans sent 30-year yields soaring through the 5-percent mark in highly volatile and illiquid trading conditions. In an official statement, policymakers said market repricing “has become more significant in the past day – and it is particularly affecting long-dated UK government debt. Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy”.

Market stress is shifting back into currency markets, where the pound is now falling as inflation concerns escalate and longer-term rate expectations drop. As we went to pixels, the currency was down almost 1.7 percent against the dollar.

Natural gas prices in Europe are surging, triggering renewed weakness in the euro after Russian officials said they were considering cutting off supply lines that currently run through Ukraine. This came after yesterday’s underwater explosions on several inactive parts of the Nord Stream 1 pipeline — broadly believed to be a part of a Russian sabotage effort — made a resumption of gas flows less likely.

The offshore Chinese renminbi is trading near post-2008 lows, after slicing through the 7.2 mark against the dollar last night when authorities failed to stem the currency’s losses. For almost a month, the central bank has set its official fixing rate – which influences the onshore trading band – above market levels, and earlier this week reintroduced a 20-percent deposit requirement on forward contracts. Policymakers issued a statement saying “Do not bet on one-way appreciation or depreciation in the yuan, as losses will definitely be incurred in the long term.”

The yen is flirting with the 145 level against the dollar as traders dare the Bank of Japan to intervene.

Today’s data calendar is relatively bare: US trade balance, pending-home sales, and oil inventory numbers will be published later this morning, but markets are likely to focus more tightly on comments from Fed officials including Powell, Bullard, Bowman and Evans. Tomorrow will bring Canadian growth numbers and more Fedspeak.

Karl Schamotta, Chief Market Strategist

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