USD Special: The rebound
Yet more strong data from the USA - on Friday, in the shape of jobs data (916,000 jobs created in March), and ISM on Monday showing decent underlying growth. Despite these fantastic numbers, we saw a short-term USD pull back, as US equities advanced. We can put this down to quarter-end re-allocations, a holiday weekend and the USD having been on a strong rally for the last 3 weeks. The medium-term picture for the USD looks strong, with the economy opening up and real data supporting Biden’s quote from Friday: “..help is here. Opportunity is coming.”
With (consensus) economists estimating the US economy to grow at 5.7% in 2020, against a 3.5% drop in 2020, Biden’s remarks are correct. Goldman Sachs currently estimates US growth 7.2% in 2021 and 4.9% in 2022. They estimate the Eurozone economy will grow at 5.1% in 2021 … the divergence between USD and EUR growth expectations accounts for EUR/USD at low levels near the critical 1.1700 rate.
This week’s highlight is the publication of the Fed minutes on Wednesday, where we expect the Fed to maintain its stance of allowing inflation and growth to slightly overshoot, and stick to its guns when maintaining low interest rates for a prolonged period. Deviation from this tone will cause excitement amongst us FX lot(!)
A consequence of a strong US economy is that emerging market currencies and economies may suffer, as the US is tempted to raise interest rates. Short-term yields rose on Friday, and the 10y yield now sits at 1.7% .. the bond market clearly expects rates to rise – Stephen Major of HSBC was recently forced to state: “.. all of us have been caught out….” when talking about the US bond market.
Rising US yields means that economies that have large holdings of US debt are faced with higher funding costs of holding that debt – straining emerging economies and stoking fears of a repeat of the ‘taper tantrum’ of 2013 when the Fed began discussing the removal of Quantitative Easing after the Financial Crisis. As Schroders recount:
“US Treasuries immediately sold off and the value of the US dollar shot up. Emerging markets suffered, particularly the “fragile five” of Brazil, India, Indonesia, Turkey and South Africa, as foreign capital was withdrawn and their currencies depreciated sharply.”
It is for this reason that markets are fearful of a repeat.
My friend Mr John Marley (found on Linkedin if you wish) this morning noted the strength of the Canadian $.. “Canadian data has been good, many believing the Bank Of Canada are most likely to be first to hike rates in the next cycle. Oil prices have helped..” he continues by saying that markets use CAD to express a bullish view on the global economy. A move from 1.4250 to 1.2550 in the last year proves the story of continued CAD strength!