The US dollar is modestly firmer, but nothing to suggest an outright correction rather than consolidation. However, have a dramatic drop over the past month, much more than we think is justified by macroeconomic developments and interest rates, we think the dollar may have overshot.
That said there does seem to be a change in the market’s reaction function. Consider that comments by ECB’s Knot urging asset purchases to end as soon as possible, allowing a rate hike in 2019. This may be the first time that a rate hike and 2019 were explicitly linked by an ECB official. At any other time in the past month, this would have sent the euro higher: not today.
The fact of the matter is that the ECB just met and rejected Knot and other hawks argument to give a date certain to end the purchases. It is strategically folly to pre-commit to stop the purchases when the said purchases have been linked to the central bank’s legal mandate to achieve the inflation target. It would make it more difficult to dip into the same toolkit again if necessary because the purchases would be unanchored to the ECB’s mandate. This is a Trojan Horse.
It is tactically naive to signal a precommitment to end the purchases in September. The anticipatory nature of investors and the discounting mechanism of the market would spur a sharp appreciation of the euro and higher interest rates, jeopardizing the very conditions that facilitated the action in the first place.
There is talk that the Swiss National Bank intervened to weaken the franc. It may have, but the impact has been marginal at best. The franc is off about 0.55% at pixel time (~CHF0.9375), the most among the majors, but sterling, the second weakest is off 0.4% (~$1.4095).
The US 10-year yield traded up to nearly 2.72%. It is the highest level since 2014. The US Treasury will announce its quarterly refunding this week. The market appears to be building a concession ahead of what promises to be a large increase in coupon supply this year. The net supply of Treasuries will double this year to over $1 trillion. About a third or so will be bills, but this is not possible until a resolution of the debt ceiling. At the same time, market-based measures inflation expectations are rising, and the Federal Reserve will be buying $420 bln few bonds this year than 2017.
