Euro-Dollar: Bond Markey Dynamics Underpin USD Support says XM.com
The Euro-Dollar exchange rate was unable to hold onto post-U.S. CPI inflation gains as U.S. bond market dynamics underscored ongoing USD support, writes Marios Hadjikyriacos, Senior Investment Analyst at XM.com.
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It was a wild trading session for global markets on Thursday, in the aftermath of the US inflation data.
The CPI report itself was slightly cooler than expected, with both the headline and core rates coming in slightly below forecasts in yearly terms, at 3.2% and 4.7% respectively.
Spearheading the moderation in price pressures were declines in airfares, used cars, and medical costs.
That said, ‘super core’ measures of inflation such as services excluding medical care still clocked in at 6.6%, underscoring the fact that the Fed has won the battle but not the war just yet.
In the markets, the initial reaction was precisely what one would expect from a cold CPI reading: the dollar and yields fell, while equities and gold rose. But these reactions didn't last. Most of these assets quickly erased their post-CPI moves to trade in the opposite direction, as the bond market gained control.
Once the dust settled, US yields powered higher, sapping stocks and boosting the dollar in the process.
Above: Euro-Dollar is forming a near-term base following a phase of weakness.
This reversal likely reflects the recent shift in demand/supply dynamics in the US bond market.
Amid runaway government deficits and the Treasury increasing its debt issuance both in size and duration, the balance of power seems to be shifting in favour of higher yields.
A soft 30-year Treasury auction certainly reinforced this notion yesterday, helping to propel yields higher alongside some commentary from the Fed’s Daly, who is typically a centrist but stressed that there is still ‘more work to be done’ for policymakers.
With gasoline prices on the rise and worries that inflation might reaccelerate in August, the risk is that Powell strikes a similar tone at his Jackson Hole address in two weeks’ time.
In the FX arena, rising yields translated into a boost for the US dollar through the interest rate differential channel.
The world’s reserve currency erased some early losses to close higher against most of its major counterparts even despite the CPI miss, which is very encouraging.
It is clear by now that the US economy is superior to its competitors. The Atlanta Fed GDPNow model is tracking economic growth near 4% this quarter, whereas business surveys suggest the Eurozone is teetering on the verge of recession and China is losing steam.
Therefore, it is not rocket science to suggest that this economic divergence might eventually be reflected in the FX market through a stronger dollar, especially now that increased bond supply is putting upward pressure on US yields.
With Japanese yields being among the lowest in the world and soaring energy prices dimming the outlook for oil-importing currencies, the yen continues to suffer.
Dollar/yen sliced above the 144.00 level yesterday - the region where Japanese authorities decided to defend last year via FX intervention.
But Tokyo has been silent this time, which in itself speaks volumes. The absence of any worried comments about exchange rates implies that the bar for another round of intervention is much higher now, which effectively gives speculators free rein to keep hammering the yen.