- Dollar eases from highs as yields rally pauses for breath ahead of ISM services PMI
- But Wall Street bounces back as Fed officials hint at ‘steady as she goes’ approach
- Euro fights back as ECB hawkish soundbites keep coming, yen mixed on BoJ doubts
Supercharged bond yields take a breather
Government bond yields in Europe and the United States scaled new heights this week as investors were once again caught off guard by fresh evidence of persisting inflationary pressures. Most prominently, the US benchmark 10-year yield crossed above the 4% threshold on Thursday for the first time since November last year and the 30-year Treasury yield did the same.
Both were off their highs on Friday and Eurozone yields fell slightly too, having surged all week.
Bonds globally have been in a rout since early February as investors upped their bets of the Fed’s peak rate as well as for the ECB and other major central banks. This latest round of selloff comes on the back of last week’s hot PCE inflation numbers and Wednesday’s uptick in the ISM manufacturing PMI’s prices paid component. Euro area inflation also surprised to the upside, fuelling overtightening fears.
Subsequently, there are some jitters ahead of the ISM non-manufacturing PMI due out of the US at 15:00 GMT. The Fed is probably trying not to read too much into the second consecutive rise in the manufacturing prices paid index just yet even though it does undermine the claim that the process of disinflation has begun within the goods sector. But as it is more concerned about inflation in the services economy, a similar rise in the non-manufacturing prices paid gauge could stoke further panic about a higher terminal rate.
Fed to stick to the plan, but open to upwards adjustment
For now, policymakers seem to be keeping their options open, ready to lift rates higher than the current projections if needed, but at the same time, wanting to wait until the summer first to see what impact the existing tightening will have on inflation and growth.
This was the main takeaway from Raphael Bostic’s and Christopher Waller’s remarks yesterday, though Waller – an influential governor of the board – was more hawkish leaning. Describing the labour market as “excessively tight”, Waller signalled he would back raising rates above the current market-implied level of 5.4% if the “data reports continue to come in too hot”.
His tightening bias was underscored by another robust set of jobless claims figures on Thursday.
Inflation fears can’t keep stocks down
But as bond markets took note of the upside risks to the Fed’s rate path, equity traders opted to focus on the fact that policymakers will stay the course with another two or three 25-bps rate increases and then pause.
Shares on Wall Street staged a surprise rebound on Thursday, with the S&P 500 adding 0.76% to notch up weekly gains. US stocks were looking somewhat oversold so this is probably just a technical correction, but it does also suggest that many investors are still holding onto the hopes of a soft landing despite the inflation picture becoming less and less supportive of this narrative.
European stocks are also headed for a positive week after a bumpy ride and US futures are slightly up on the day.
Dollar softer as ECB hawks put a floor under euro’s slide
In the currency markets, the US dollar pulled back in line with the moves in Treasury yields. Interestingly, the greenback is on track to finish the week with losses despite the symbolic gains in yields. The Japanese yen also had an unimpressive week amid ongoing uncertainty about how soon the Bank of Japan will abandon its yield curve control policy.
Nevertheless, the Bank’s upper yield cap of 0.50% on 10-year JGB yields is being tested again, having been breached several times in recent days.
The euro is edging higher on Friday after managing to find support in the familiar territory around $1.0580. Whilst euro bulls are finding it hard to make progress right now against the dollar, there is limited downside as investors increasingly see the ECB hiking rates to 4.0%, a level that Belgium’s central bank chief Pierre Wunsch did not rule out in comments today.
With underlying inflation still rising in the Eurozone, the ECB could be hiking well after the Fed has paused and ECB members agreed in February that there is "substantial distance to the prospective terminal rate" according to the minutes of that meeting published yesterday.
Pound and aussie also bounce back
The pound also found support after the Bank of England’s chief economist Huw Pill said on Thursday the UK economy is slightly stronger than expected. Sterling is gaining some positive traction today and is the second best performer after the aussie.
The Australian dollar is recovering along with the improved risk tone and ahead of the start of the annual session of China’s National People’s Congress on Sunday. Investors are waiting to see what economic policies will be announced in the week-long gathering of parliament, particularly what growth target will be set. Should the government aim for growth as high as 6%, the aussie could be bolstered as it would suggest more stimulus is on the way.