Post date: 08/03/2021 11:01
The severe sell-off in the US Treasury market accelerated last week as economic news continues to suggest a fast improving economy and the massive Biden stimulus package secured approval in the US Senate. While the short end of the interest rate curve remains securely anchored by the Fed’s explicit promise to ignore inflationary pressures and keep rates at zero, last week’s sell-off in longer maturities finally spilled over to currency markets. The dollar gained against most G10 currencies, but the effects where most keenly felt in emerging markets. While the Pacific Rim currencies held off well, anchored by the stability of the Chinese yuan, most other major emerging market currencies sold-off between 1% and 3% last week. This week we expect the action in US rate markets to remain the dominant factor in financial markets worldwide. The ECB meeting on Thursday will be very interesting in order to gauge the central bank’s institutional reaction to the (so far modest) increase in sovereign borrowing costs across the Eurozone. In the US, inflation data out on Wednesday could hurt skittish bond markets if it provides another upward surprise.
Sterling continues to hold its own better than most currencies in the face of the backup in US rates. The UK’s world-leading vaccination rates are providing key support to the currency, and the vaccination gap versus the Eurozone shows no sign of closing. The UK has now administered at least one vaccine dose to around 40% of all adults and has started easing lockdown measures today with the return of schools. This vaccine outperformance should continue to support the pound against the euro. The January monthly GDP number out on Friday should be a negative print due to the third national lockdown, but we expect FX markets to look through this backward looking indicator and remain focused on events elsewhere. Most data out of the UK of late has been largely ignored by markets, which remain much more focused on the UK’s upbeat medium-term prospects.
All eyes now shift to the February European Central Bank meeting on Thursday. The focus should remain on the disappointing economic data, the sluggishness of the European vaccination effort, and the sell-off in European sovereign bonds as a result of the market moves in the US. We do not expect any policy changes from the ECB, but communications from the central bank will be key in two areas. First, the extent of the inevitable downward revision to the 2021 economic forecasts. Second, the possibility of deploying the pandemic tools to stop undesirable upward moves in rates. The latter could weigh down on the common currency, and further moves down in the short-term cannot be ruled out.
The payrolls report for February provided the latest evidence that the US economic recovery is picking up the pace after the lockdown-induces slowdown of the fall. The recovery in hospitality and leisure sectorial hiring meant that net jobs created doubled expectations at nearly 400,000. Unemployment ticked down and the labour force participation rate held. The passage of Biden’s massive stimulus plan in the Senate over the weekend means a net transfer of income of more than $10,000 for the median American family, not including the increase in unemployment benefits or the various transfers to state and localities. This wall of money will hit an economy that is picking up steam on the demand side, but experiencing increasing bottlenecks on the supply side. We believe the sell-off in Treasuries has room to run, but the short-term effect on the US dollar of this spending spree with no offsetting tax revenue measures is anyone’s guess.