Week Ahead Highlights And The Dollar

The global capital markets are adjusting to higher interest rates and the reflation trade appears to have reached an inflection point. Commodity prices continue to rally, partly on supply issues, including low inventories, and partly in anticipation of more robust demand. The CRB's 1.75% decline before the weekend was the largest since the US election and the announcement of a vaccine, but it still finished higher for the fifth consecutive week.

The high-flying technology sector has seen a dramatic bout of profit-taking and there appears to be a bit of a rotation into some consumer staples and financials. Without putting too fine of a point on it, rising rates and steeper curves have seen the MSCI World bank index rally more than 16.6% in February.

We thought the dollar's upside correction after the sharp sell-off in the last two months of 2020 could have been extended on the back of the growing divergence favoring the US, with the help of fiscal stimulus of around 14% of US GDP (December 2020 and the current package). While the US 10-year yield rose about 42 bps in the past month, yields have risen even faster in Australia, New Zealand, and the UK, whose currencies outperformed until the very end of February.

The market seems increasingly skeptical of the pledge to not raise rates for a long time. First, the market pushed back against the Bank of England's forward guidance. The market swung from the risk of negative rates to a rate hike by the end of 2022. The futures contract on three-month sterling deposits ("short-sterling") for December 2022 implied negative rates in early January. It is now implying a rate of 40 bps.

Then, in the face of rising forecasts for US GDP and Fed leadership (Powell and Clarida) seemingly dismissing inflation fears, the market reacted dramatically. The implied yield on the December 2022 Eurodollar futures contract rose to 50 bps last week (before settling around 45 bps) from 32.5 bps the week before and 27 bps at the end of January. The swing in the pendulum of market sentiment toward an earlier rate hike by the Fed seemed to finally give the dollar a reprieve.

That offers a helpful segue into the other consideration that may be offsetting the positive growth differentials. As has been previously discussed here and elsewhere, as the US Treasury draws down its cash balance at the Federal Reserve, liquidity pours into the market, driving money market rates lower. This is evident in the T-bill auctions and the decline in other rates.

The Treasury paid down about $96 billion in T-bills last week. Some bills maturing in March have a negative yield. The overnight repo rate traded below zero last week for the first time since last March. The benchmark three-month LIBOR is pinned below 20 bps since late January and fell to a record low around 17.5 bps on Feb. 19. 

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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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