The Virus, Vaccine, And Economic Velocity

10 and one 10 us dollar bill

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The fact that neither the dollar nor US interest rates rose after the stronger-than-expected March CPI may be saying something about market sentiment and positioning. It lends credence to the idea that the markets have entered a new phase.

Consider the US 10-year yield. For the two months after the November election, the US 10-year yield traded between 0.80% and 1.0%. It traded up to 1.20% in early January, but by the end of the month, it was back at 1.0%. From there and then, the yield marched higher for the next six or seven weeks to around 1.75% on March 18. Since then, it has largely moved sideways, chopping out a range of roughly 1.60% to 1.75%. It fell to 1.55% before the weekend. 

The dollar generally appreciated in the first quarter, but has since softened here in April. Four currencies have gained on the greenback. The Norwegian krone leads with little more than a 2.6% gain, followed by the Canadian dollar's 1.75% gain. Sterling has risen by nearly 1.2%, while the Aussie managed to turn higher last week. Its 1.4% gain put it positive for the year by 0.5%.

Arguably, this is the reflation trade being expressed in the foreign exchange market. Norway's central bank indicated that it would hike rates later this year. That could spill into next year if the AstraZeneca (AZN) and Johnson & Johnson (JNJ) vaccines are rejected. Canada's economic recovery is strengthening, and the acceleration of US growth adds to the favorable outlook. While a Bank of Canada rate hike this year seems unlikely, it could be among the first to begin winding down its government bond purchases.

The Bank of England does not appear poised to adjust monetary policy in the near-term. In fact, the leading hawk, the chief economist Haldane, who recently has warned about complacency toward inflation and the risk of undue pessimism toward the economy, unexpectedly announced he would step down after the June MPC meeting.

However, the vaccine rollout's economic implications have encouraged participants to recognize sterling as a currency levered for growth. Sterling has appreciated around 2.75% against the euro.

A year ago, the dollar was undervalued against all the major currencies but the Swiss franc, according to the OECD's model of Purchasing Power Parity. Now, it is only over-valued against the euro (~17.7%), the yen (~5.5%), the Canadian dollar (~4.6%), and sterling (~1.5%). Recall that in mid-April 2020, sterling was almost 16% under-valued. According to the OECD, around 11.75%, the Australian dollar is the second most over-valued currency after the Swiss franc (~19.3%).

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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