US dollar cranks up on surging yields

Summary:

• US dollar trades at the highest level since mid-August following astounding ISM as well as a hawkish Powell’s speech

• US Treasury yield curve steepens meaningfully with the 10Y yield reaching its highest level since the first half of 2011

• Antipodean currencies and equities feel the pain of higher rates in the US

The US dollar extended its rally during Asian hours trading following a strong economic data from the US in conjunction with Federal Reserve Jerome Powell’s hawkish remarks. He said the Fed could raise rates beyond neutral underlining the neutral threshold was still a long way off from where we were right now. Fed’s chairman added that “interest rates are still accommodative, but we’re gradually moving to a place where they’ll be neutral neither holding back nore spurring growth”. These remarks are considered as exceptionally hawkish taking into account the Fed removed a phrase ‘accommodative’ from its statement last month revising up its long-term interest rate just modestly. Let us remind the US central bank lifted rates last week for the third time this year to a range of 2-2.25%. During his speech at an event in Washington hosted by The Atlantic magazine and the Aspen Institute Powell suggested that the US is experiencing “a remarkably positive set of economic circumstances, and we’re working hard to try to sustain the expansion and keep unemployment low and keep inflation right no target”. He concluded that “there’s really no reason the think that this cycle can’t continue for quite some time”.

The US Treasury yield curve has steepened significantly over the past two days. Source: Bloomberg

The last sentence signals that the Federal Reserve could keep on hiking interest rates along with the booming economy. As a result investors have adjusted their growth expectations dumping bonds with higher duration and thereby pushing the long-end of the yield curve measurably higher as evidenced by the chart above. On top of that, we cannot forget that the remarks delivered by Jerome Powell were earlier confirmed by the superior services ISM release as well as another excellent ADP report implying strong labour market numbers on Friday. The former increased in September to 61.6 from 58.5 smashing the median estimate suggesting a slight slowdown. In turn, the ADP reported that the US economy added as much as 230 thousand new jobs last month well above the level necessary to keep the unemployment rate falling. As a consequence the US 10Y yield jumped to 3.18% on Wednesday and it extended its rally to beyond 3.22% during the Asian session. The US dollar saw the corresponding increase with the EURUSD plunging to the lowest level since mid-August.

Having broken 1.1540 in the EURUSD one may assume the pair could extend its slide even toward 1.13. However, a lot will be depend on further moves in the US bond market. Source: xStation5

Looking around financial markets one may identify that high-beta currencies are performing the worst in an environment of higher rates in the US as both AUD and NZD are clearly lower this morning. The higher rates also mean the higher borrowing costs for heavily indebted US companies. In turn, the higher discount rate means that current earnings are worth less implying that stocks become less attractive compared to risk-free assets. In response to the above-mentioned developments the Hang Seng moved down 2.3% while the Japanese NIKKEI lost over 0.5%.

The SP500 (US500) is testing the lower limit of the bullish channel. If bears mange to break through this level, they may push toward 2880 points. Source: xStation5

In the other news:

• Australian trade balance showed a surplus of 1604 million AUD compared to the consensus of a 1450 million AUD surplus

• Italian government will target GDP growth at 1.5%, 1.6%, 1.4% for 2019, 2020 and 2021 respectively, according to a report by Sole