Not Let Up for USD Rally on Back of Rising US Yields

USD: US yields and the USD continue to hit new highs.

The US dollar has maintained its upward momentum as the week commenced, resulting in the dollar index reaching a fresh peak of 106.30 yesterday. This surge has been fuelled by the continual rise in US yields, particularly at the long end of the yield curve. The 10-year Treasury yield reached a new cyclical high of 4.56% overnight, marking an approximately 50 basis points increase from the intraday low at the beginning of the month. During this same timeframe, the 2-year US Treasury yield has risen by around 40 basis points, and the 10-year break-even rate has increased by approximately 12 basis points. This indicates that the upward movement in long-term yields is primarily driven by a more hawkish reassessment of Federal Reserve rate hike expectations and a modest uptick in market-based measures of long-term inflation projections.

The notable rebound in oil prices this month, climbing by roughly $10 per barrel to a peak of $96 per barrel, has added to the inflationary pressures reflected in market-based expectations. Despite the absence of fresh catalysts, the ongoing sell-off in the US bond market was propelled by the 10-year US Treasury yield surpassing the 4.50% threshold. Minneapolis Fed President Kashkari's comments, as reported by Bloomberg, played a role in this shift. Kashkari acknowledged that "if the economy is fundamentally stronger than we realized, on the margin that would tell me rates probably have to go a little higher and then be held higher for longer to cool things off." He holds a voting position on the Federal Open Market Committee (FOMC) this year and has indicated that he is one of the 12 participants who support one more rate hike later this year. These remarks align with the message conveyed during last week's FOMC meeting, where most members still favoured one additional hike and scaled back plans for rate cuts in the following year by 50 basis points. Market expectations for one final hike this year remain at roughly a 50:50 probability.

The ongoing adjustment towards higher US yields and the strength of the US dollar are steadily pushing USD/JPY towards the 150.00-level. Currently, the pair is trading just below 149.00, surpassing the intraday low from the beginning of the month at 144.45, which coincided with the lowest point for US yields. Japanese policymakers continue to verbally intervene to slow down the pace of yen depreciation. Finance Minister Suzuki reiterated this stance overnight, emphasizing that he closely monitors foreign exchange movements with a high sense of urgency. He stated that Japan will consider all options to counter excessive forex fluctuations and will act against rapid movements. Given the gradual nature of the recent increase in USD/JPY, it becomes more challenging for Japan to justify immediate intervention in the forex market to purchase yen at this juncture.

UNUSUALLY WIDE CYCLICAL DIVERGENCE IS MORE LIKELY TO NARROW

 Source: Bloomberg, Macrobond & MUFG Research

EUR: Weak growth outlook for euro-zone should be better priced in now.

The broad-based rally of the US dollar and the upward adjustment in US yields have exerted downward pressure on EUR/USD, with the pair reaching a low of 1.0560 yesterday. This move brings it closer to the lower end of the trading range between 1.0500 and 1.1000 that has predominated for much of this year. Despite some tentative signs of improvement in business confidence surveys from the eurozone, the euro has failed to find support.

Last week, the eurozone composite PMI survey for September pleasantly surprised by 0.4 points, followed by a stronger-than-expected German IFO survey, which was 0.5 points higher. The German composite PMI survey saw an even larger upside surprise, rising by 1.5 points. These data releases indicate that the pessimistic growth outlook for the eurozone, especially Germany, may already be adequately reflected in financial markets. This could make it increasingly challenging for the euro to weaken further against the US dollar as it approaches levels that some consider undervalued, nearing parity. Nevertheless, it's important to note that these business surveys still indicate weak or negative GDP growth in Q3.

At its latest policy meeting, the European Central Bank (ECB) acknowledged weaker-than-expected growth, leading to significant downward revisions in staff GDP forecasts. This weaker growth outlook has contributed to a less hawkish stance from the ECB, which is now focusing on maintaining higher interest rates for an extended period to bring inflation back to its target, rather than continuing with rate hikes. President Lagarde emphasized this message while addressing the European Parliament, stating that they are in a "long race" and pushing back against expectations of rate cuts as early as next year, asserting that rate cuts are not under consideration. Despite this, the eurozone rate market is currently pricing in approximately 60 basis points of ECB rate cuts by the end of next year. The ECB's recent comments are unlikely to encourage even more aggressive rate cut expectations at this juncture. Market participants are already assuming that weak economic growth or a sharper decline in inflation could prompt the ECB to abandon its commitment to higher rates soon.

One European currency that performed well at the beginning of the week was the Swedish krona. It strengthened by around 1.2% against the euro and 0.5% against the US dollar yesterday. This boost can be attributed to the Riksbank's new FX Reserve hedging program. Last week, the Riksbank announced its intention to sell USD 8 billion and EUR 2 billion in exchange for krona over the next four to six months, with hedging flows commencing yesterday. This announcement may have encouraged speculative buying of the krona in anticipation of these FX hedging flows. However, it is important to exercise caution and not overstate the potential impact of these flows in bringing about a sustained reversal of krona weakness on their own.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.