US interest rates break out higher, dragging Dollar with them

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23 April 2018

thomasdodds

Currency markets finally shook off some of their recent torpor last week.

T
he US Dollar moved higher against most of its peers, buoyed by the break out higher in US bond yields. As the key 10 year Treasury rate approached 3.00%, the traditional relationship between higher US yields and a higher Dollar appeared to re-establish itself and the greenback rose against every G10 currency, except the Swedish Krona. All major emerging markets ended the week lower as well, save for the Russian Ruble, up on news that no further sanctions are in the offing, and the Turkish Lira, buoyed by Erdogan’s announcement of new elections.

The ECB meeting takes center stage on Thursday. We expect no change in policy or forward guidance and a generally cautious tone from President Draghi, which could pressure the Euro downwards. Also important will be the meetings of the Bank of Japan and the Riksbank in Sweden.

Major currencies

GBP

Sterling was hit last week by the double whammy of softer economic data and dovish comments by Mark Carney, which cast doubt on the possibility of a May hike by the Bank of England. Inflation data and retail sales were both disappointing, and markets are now pricing in just a 50% chance of a hike in May, against 85% last week.

First quarter growth is released this Friday. We expect it to come in around market expectations of 0.3%. We still expect a hike by the MPC in May and therefore think the recent market retracement in Sterling is a buying opportunity.

EUR

A disappointing downward revision to the March inflation numbers set the Euro on a downward path early in the week. A report released late on Friday that suggested any communication from the ECB on an end to its asset purchases would be delayed until mid-summer didn’t help the common currency.

The string of disappointing data from the Eurozone over the past few weeks cannot have gone unnoticed by the ECB. Although there will be no formal revision of staff forecasts at this week’s meetings, we do expect this weakness to be acknowledged by President Draghi at the press conference.

USD

US bond yields appear poised to break out of their multiyear range, on the back of higher oil prices and the expected deluge of new borrowing from the US federal government. The market has ratcheted down its expectations for this week’s first quarter GDP numbers. In our view, this sets us up for an upside surprise that may finally push the critical 10 year Treasury yield above the 3.0% psychological level. Such a development would almost certainly push the US Dollar higher, perhaps testing the bottom of the recent range in the EUR/USD cross rate.