Demand for US Dollar Tied to Yields and NFP

The mighty dollar took advantage of thin holiday trading conditions yesterday and rallied against the single currency. That trend continues this morning with the selloff in U.S. bonds pushing the 30-year yield (+2.86%) back to highs last seen in December, a move which seems to be solidifying a bid tone for the buck against Group of Seven currencies.

Some investors seem content to book profit on the recent gains for the EUR ahead of the nonfarm payrolls release on Friday. In the past three weeks, the EUR has appreciated +5% outright, supported by a spate of weak U.S. data (business investment, gross domestic product, and jobs) and on some early positive signs that the European Central Bank’s (ECB) quantitative easing program is providing dividends.

With the Greece situation remaining on the front burner, Greek risk is again fueling and supporting fresh EUR short positions. Investors should expect Greece headlines to continue to flourish ahead of tomorrow’s +€200 million payback and next week’s +€750 million payment to the International Monetary Fund.

Single Currency in the Crosshairs

Friday’s U.S. jobs report will test the EUR. A disappointing report (the market expects a +213,000 headline gain and an unemployment rate falling to +5.4%) would boost the dollar bears’ Federal Reserve hike timing theory. A weak number could encourage the Fed to wade to the sidelines, a move that pushes the timing of the first rate hike further out the curve. This will renew support for the EUR and pressure the dollar across the board.

The first barrage of Fed speakers since last week’s Federal Open Market Committee (FOMC) meeting seems to have one message in common: the June Fed meeting remains in play for rate hikes. Last week, Cleveland Fed President Loretta Mester and San Francisco Fed President John Williams each suggested that even with the weak start to 2015, they are keeping an open mind about the rate outlook. Yesterday, Chicago Fed President Charles Evans, one of the Fed’s biggest doves, indicated that with weak U.S. inflation, this year would not be a good year to begin a rate normalization policy. Tomorrow, keep an eye out for Atlanta Fed President Dennis Lockhart who is speaking on the U.S. economy and monetary policy (13:30 ET). The market usually considers him to be a bellwether for FOMC outlook.

Yields Providing Clues

Treasurys are a touch higher ahead of the European session handover this morning, steading after the selloff seen in the last few days (U.S. 10’s +2.136%), and close to their two-month high print on Monday. This morning’s gains come despite further weakness in German bunds, which have been the driving force in fixed-income markets over the past week. Investors have to decide, “Are we experiencing a healthy correction or a new trend?”

The U.S. 10-year Treasury has never offered an extra +2% in yield over the German 10-year bund. The current yield gap is straddling +170 basis points. Fixed-income traders are beginning to price in the +200 basis points rate divergence actually occurring by year-end. Investors will always demand more yield from U.S. bonds when inflationary pressures mount. In Europe, deflation remains one of the ECB’s biggest concerns, and reason enough to expect eurozone sovereign bond yields to underperform relative to its counterpart.

RBA Slashes Rates Again

The Reserve Bank of Australia’s (RBA) decision to cut rates to a new record low (+2%) confirms that Governor Glenn Stevens and company have grown more worried about the Aussie’s recent rise. An above inflation print or a hot property market Down Under was not a barrier to Aussie policymakers. The AUD immediate reaction was to print new fresh lows, but has since rallied (A$0.7870) as investors wondered whether the easing cycle might now be over. Indeed, the statement announcing the move noted some improvement in the economy while omitting a mention that further action could prove necessary. The lack of explicit easing bias in the statement is nothing unusual — the February cut also came with a neutral outlook.

Are Commodity Currencies’ Rallies Sustainable?

The bulk of commodity currencies’ (AUD, NZD, NOK and CAD) rise over the past eight weeks have been fueled mostly by the market’s expectation of further easing policy by the People’s Bank of China (PBoC). Excluding investors’ feelings on the RBA, the AUD (a proxy for China risk), the loonie, and NOK have found support from China’s April manufacturing purchasing managers’ index data miss on the weekend.

The final print was the worst reading in a year (48.9 versus 49.4 expected), and is leading to more speculation of pending rate cuts from the PBoC. The market should be wary of how much future PBoC monetary easing has already been priced in. Depending on that, the upside for China in the short term could be capped, and so with it are the rallies in commodity prices which will have a direct impact on commodity currencies. If commodity prices do not find consistent traction, prices will run out of stamina when investors least expect it.

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