US dollar strengthened on rising US yields, inflation lifts Pound

Reuters: The US dollar strengthened on Wednesday, lifted by rising Treasury yields, though the pound gained against the greenback after British inflation stayed above 10% in March and put more pressure on the Bank of England to keep raising rates.

US dollar strengthened

The dollar index , which tracks the currency against a basket of its peers, was up 0.206% as markets turn more skeptical that the Federal Reserve will cut rates later this year. The yield on two-year Treasury notes, which are sensitive to expectations for the U.S. central bank’s monetary policy, rose 7 basis points to 4.269% after hitting a one-month high of 4.286%. But the dollar’s gain was a “temporary reprieve,” said Bipan Rai, North America head of FX strategy at CIBC Capital Markets in Toronto.

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“We still think that over the medium- to long-term that the dollar is going to continue to come under considerable amounts of pressure. And that’s tied to our view that the Fed is probably going to hike one more time and then that’s it.” Futures pricing show an 85.7% chance the Fed will hike rates 25 basis points when policymakers conclude a two-day meeting on May 3, according to CME’s FedWatch Tool. But the likelihood of a rate cut by December has narrowed considerably this week. The dollar has been on the defensive for some time with the debt ceiling in Congress unresolved and the migration of deposits in the U.S. banking system still a concern, Rai said. Sterling was last trading at $1.244, up 0.13% on the day, while the dollar rose 0.46% against the rate-sensitive yen at 134.71, after briefly poking above 135 for the first time in a month.

The immediate outlook for the dollar is less than bullish given that central banks abroad have more hiking to do over the balance of the year than the Fed, said Joe Manimbo, senior market analyst at Convera in Washington. “If core inflation takes longer to come back to the Fed’s 2% goal, then maybe the Fed has to raise rates more than once over the course of the year,” he said, adding that could halt or slow the dollar’s slide. “We’re just in a very choppy state right now for FX until we get some greater clarity on the policy outlook.” Expectations for higher official rates in a market relative to those elsewhere typically drag money market and government bond yields higher, attracting cash into a country while boosting its currency at least in the short term.

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Wednesday data showed British consumer price inflation eased less than expected in March to 10.1% from February’s 10.4%, meaning Britain has western Europe’s highest rate of consumer inflation. “It looks like UK’s 10%+ CPI reading was the culprit. This has revived worries that interest rates will remain high for longer in the UK – and Europe,” said Fawad Razaqzada, market analyst at City Index. Deutsche Bank on Wednesday revised up expectations for British rates to include two more 25 basis point rate hikes from the Bank of England. Morgan Stanley now predict one, with a risk of a second.

British Pound

Reuters: Sterling eased on Wednesday as a higher dollar wiped out earlier gains made after data showed Britain has the highest inflation in western Europe, cementing market expectations for a rate hike at the Bank of England’s meeting in May. Data on Wednesday showed consumer prices rose by an annual 10.1%, the Office for National Statistics said, down from 10.4% in February but higher than the 9.8% forecast by economists polled by Reuters. “Yesterday’s wage data was strong and higher than expected and today’s CPIs were higher than expected, so it’s looking more likely that the BoE will hike by 25bps,” said Francesco Pesole, FX Strategist at ING, who said in the short term this improves the outlook for the pound.

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The inflation data initially sent sterling as much as 0.8% higher against the dollar. It was last down 0.2% at $1.2396 against the dollar, but held firm against the euro, rising 0.3% to 88.05 pence. “In the longer run, markets are pricing in three more hikes by the BoE, and are basically saying the BoE will take rates to 5%, but we’re really not convinced they will,” said Pesole, who said around 50 bps of tightening will need to be priced out of the sterling curve, a factor weighing on his outlook for the pound.

On Tuesday data showed British wages rose faster than anticipated last month, further supporting more hikes by the BoE. More rate rises also raise the prospect of recession and a darkening economic outlook, even though concerns about a deeper downturn have receded in recent weeks. “There is a real risk that the BoE will need to tighten to the extent that the UK economy slips into recession if it is to get the inflation genie back into the bottle. And that, for me, is why sterling has given up its early gains,” said Stuart Cole, chief macro economist at Equiti Capital. The market is currently pricing in a 99% chance of a 25 bp rate hike from the Bank of England at its next meeting.

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South African Rand

Reuters: The South African rand recovered some losses it incurred earlier on Wednesday after local inflation data showed a rise in prices for the second consecutive month. At 15:18 GMT, the rand traded at 18.1300 against the dollar, 0.19% stronger than its previous close. Inflation in Africa’s most industrialised economy rose 7.1% year-on-year in March, driven by a steep increase in food prices, Statistics South Africa said. The reading was a surprise as analysts polled by Reuters had predicted a drop in March to 6.9%.

The South African currency, which has been on a downward path for the better part of the year, slumped more than 0.8% after the announcement, before regaining some ground. The earlier weakness in the rand was also due to a stronger dollar and lower export commodity prices, said Shaun Murison, senior market analyst at IG. Inflation numbers are closely watched for their implications for the South African Reserve Bank’s monetary policy. The central bank has raised interest rates nine times in a row since November 2021 in a bid to tame inflation, with last month’s hike a bigger-than-expected 50 basis points.

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Separately, South African retail sales fell 0.5% year-on-year in February after falling by 0.8% in January, data showed. Shares ended lower on the Johannesburg Stock Exchange, with both the blue-chip Top-40 index and the broader all-share index closing around 0.6% lower. The government’s benchmark 2030 bond was weaker, with the yield up 6.5 basis points at 10.115%.

Global Markets

Reuters: Asian stocks edged lower on Thursday, while the dollar was on the back foot as investors remained cautious ahead of an expected 25 basis point hike in interest rates by the U.S. Federal Reserve next month. MSCI’s broadest index of Asia-Pacific shares outside Japan was 0.16% lower, while Japan’s Nikkei was up 0.07%. Australia’s S&P/ASX 200 index was 0.07% lower. Shares of Tesla Inc slid 6% in after-hours trading after the electric vehicle maker posted its lowest quarterly gross margin in two years, missing market estimates. Elon Musk doubled down on the price war he started at the end of last year, saying Tesla would prioritise sales growth ahead of profit margins in a weak economy. E-mini futures for the S&P 500 fell 0.25%, while Nasdaq futures slid 0.36%. Investor focus in Asia will be on earnings from Taiwan Semiconductor Manufacturing Co Ltd (TSMC) later in the day, with analysts expecting the company to post a 5% fall in first-quarter net profit.

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China’s blue-chip CSI 300 Index was down 0.16%, while the Shanghai Composite Index eased 0.22%. Hong Kong’s Hang Seng index was 0.6% higher. Traders are bracing for meetings from central banks in the next few weeks as easing worries over the banking sector brings inflation and monetary policy back into focus. “Global central banks’ narrow focus on combating inflation has gotten more complicated as they are now faced with the added task of maintaining financial stability,” said Thomas Poullaouec, head of multi-asset solutions APAC at T. Rowe Price. A Reuters poll of economists showed the Fed is likely to deliver a final 25-basis-point rate increase in May and then hold rates steady for the rest of the year. Markets are pricing in an 83% chance of the Fed hiking by 25 basis points, CME FedWatch tool showed.

The hawkish rhetoric from Fed speakers continued with Federal Reserve Bank of New York President John Williams saying that the inflation rate is still at problematic levels and that the U.S. central bank will act to lower it. U.S. economic activity was little changed in recent weeks as employment growth moderated somewhat and price increases appeared to slow, showed a Fed report on Wednesday. The central bank’s latest read on the state of the economy provides a snapshot of business, bank and worker conditions in the aftermath of the mid-March failure of two large regional banks that shook confidence in the U.S. financial sector. But as fears of a broad crisis eased, volatility has become less wild. On Wednesday, the CBOE Volatility index, nicknamed Wall Street’s fear gauge, fell to its lowest point since November 2021.

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Meanwhile, benchmark 10-year yields eased to 3.597% in Asian hours after scaling a four-week peak of 3.639% on Wednesday. The two-year U.S. Treasury yield, which typically moves in step with interest rate expectations, was down 1.3 basis points at 4.252%, having touched 4.286% on Wednesday, the highest since March 15. In currency markets, the U.S. dollar index fell 0.039%, with the euro up 0.04% to $1.0958. The yen weakened 0.08% to 134.83 per dollar, while sterling was last trading at $1.2432, down 0.05% on the day. Elsewhere, U.S. crude fell 0.45% to $78.80 per barrel and Brent was at $82.68, down 0.53% on the day.

Published by the Mercury Team on 20 April 2023

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