FX Update: USD at a crossroads, awaiting treasury auctions, FOMC

FX Trading focus: USD at a cross-roads ahead of auctions, FOMC

The USD rise has paused on balance over the last twenty-four hours as the US treasury market finally found a decent bid yesterday, although the strong bid-to-cover level at the 3-year US treasury auction yesterday that produced some extra pep in the equity market’s step was not the whole story, with indirect bidders (foreigners) not showing up strongly at that auction. To be fair as well, the 3-year yield has hardly lifted off in nominal yield terms relative to the longer end of the curve, so it is tonight’s 10-year auction and the 30-year T-bond auction tomorrow that are the key arbiters for the status of US yields at this point. A punch lower in US yields on strong demand could indicate that treasuries have lurched into a consolidation period of some duration that actually just may put an end to the USD bull run here, while signs of weak or very weak demand keep the drama high and risk another rally leg for the US dollar.

As we have stated extensively recently, the Fed is not about to do yield curve control just yet. We have argued that with the fiscal tsunami incoming, the Fed will tolerate much higher yields at the longer end of the yield curve before sounding the alarm (though it may need to move on the technical side to improve liquidity and issues linked with that such as the rules around banks’ leverage ratios. It was these issues perhaps more than anything else that aggravated treasury market volatility the week before last. Such a Fed move could be forthcoming already at next week’s FOMC meeting in some supplemental note or similar.)

ECB is in an unenviable position – can’t do much.
The reason for the title above is that the ECB is operating in a very unfortunate environment, made only somewhat more fortunate for their inflation mandate by the recent weakening of the euro, as the strong rise in US yields has helped to boost the US dollar. The problem for the ECB is that its policy tools are lacking for addressing a rising yields environment and for doing anything to boost the economy. The EU needs more fiscal to get with the transition to this new era of “fiscal dominance” and the unwieldy EU has not only botched the vaccine roll-out, but has all of the usual difficulty of acting forcefully when the time has long passed to do so.

The recovery fund of EUR 750 billion spread over the seven years of the 2021-2027 budget is a pittance compared to the $1.9 trillion in US stimulus that will be hitting a US economy in full in coming quarters – and that for a US economy that is already more open and more vaccinated and ready to open more quickly than Europe. Italy is actually shutting down some areas again on a recent rise in cases. The chief argument here for an extension lower in the Euro is that the ECB simply can’t afford to allow long yields in the EU to rise if there isn’t a sufficiently large fiscal impulse to make that yield rise less problematic. Pulling forward purchases or other monetary shenanigans are futile for addressing the economy, even if they can push the euro around a bit. A dovish ECB doesn’t have to weaken the euro much if US yields are also beating a retreat, but imagine we get all of: dovish ECB, higher inflation globally and a higher US long yields. The EU needs fiscal, not ECB fiddling.

Interesting chart development: NOKSEK
NOKSEK upside is worth considering on the pair breaking above parity for the first time since the Covid wipeout last year – trade could extend to at least 1.05 assuming crude oil doesn’t suffer a major setback, with some further fundamental support from a weak EU fiscal impulse keeping SEK somewhat subdued relative to NOK, which is directly plugged into the rise in crude oil prices.

Graphic: FX Board of G10 trends and momentum
The momentum is seeping out of the move higher in the US dollar as we watch for whether the surge in US yields is over for this round, as can be seen in the  momentum readings in our FX board. It feels like the next week through the March 17 FOMC meeting will help to establish whether recent trend developments in oil-linked currencies to the upside and old carry currencies JPY and CHF to the downside, as well as the big dollar itself, will extend or reverse.