For several years now, many have asked themselves where are the bond vigilantes, those bond bears that push back against "QE forever" and never-ending government deficits. They appeared with a vengeance last week. Many investors took comments from Federal Reserve officials, especially the leadership, as evidence of complacency over inflation. The market also concluded that the Bank of England was more likely to hike rates by the end of next year than adopted negative rates, which had seemed like a distinct possibility a few short weeks ago.
We have argued that if a central bank, like the Fed, were to step away from the market and end the long-term asset purchases, it is likely that after the headline shock, yields would fall. As monetary support for the recovery/expansion was removed, the economy would weaken. Even with central bank buying, we had been persuaded that investors' views of growth and inflation ultimately drove bond yields in the G7. In the past month, the US 10-year yield has risen by 44 bp, and the UK yield has increased by 53 bp. Australia has seen an 80 bp increase. German and French yields rose by almost 30 bp.
The impact of the vaccine and the massive fiscal stimulus is rippling through the system. Between December's package and the one that will be approved in March, the US is on the hook for about 14% of GDP. The UK may extend its support next week and announce as much as another 5% of fiscal assistance (spending increases, like the furlough program, and give some tax breaks (VAT?) to small and medium-sized businesses that have been decimated by the pandemic and lockdowns.
With this in mind, we turn to the price action in the currency market:
Dollar Index: After going nowhere for a few days, but fraying support near 90.00, the Dollar Index fell below 89.70 on February 25, its lowest since January 8. A dramatic swing in Fed expectations helped spark a recovery, and additional gains were registered into the weekend when it approached 90.80. The MACD has trended lower throughout the month but appears poised to turn higher. The Slow Stochastic is at its lows for the year and may also turn higher shortly. The pullback from the early February high, around 91.60, was deeper than we had anticipated, but the firm close (at a six-day high) is promising. It must get above 91.00-91.10 to be anything significant.
Euro: The euro exceeded the (61.8%) retracement of the decline from the January high, near $1.2350, to the early February low, around $1.1950. The retracement objective was by $1.22, and the euro peaked on February 25, a little shy of $1.2250. Shifting views on Fed policy seemed to have helped spur the euro's pullback that tested the 20-day moving average (~$1.21) before the weekend. That also corresponds with the trendline drawn off the month's lows. The MACD appears to be poised to turn lower if there is further weakness in early March. The Slow Stochastic is stretched at the highs for the year. The convincing break of $1.2100 set up for a more important technical test on the $1.2000-$1.2025 area, and then the February low. On the upside, initial resistance will likely be encountered in the $1.2150 area.
Japanese Yen: Two opposing forces were resolved, with the dollar reaching its best level against the Japanese yen in five months to almost JPY106.70. The yen's risk-off demand is associated with dramatic sell-offs in equities. The evaporation of risk appetites, in general, was overwhelmed by the yen sales associated with higher global interest rates. The dollar closed firmer, and there seems to be little in the way of a push toward JPY107.00, though we suspect potential extends to JPY108 initially. Before the pandemic, the dollar was hovering around JPY110. The momentum indicators are not clear. The MACD is stretched but rising, and the Slow Stochastic maybe curling up from a little above midrange. The other note of caution comes from the upper Bollinger® Band, which starts the new week/month by JPY106.40.
British Pound: Sterling inexplicably spiked from around $1.4100 to almost $1.4240 in early Asia on February 24. That might have been the last capitulation in its relentless rise since the end of October. Sterling hard subsequently and dipped below $1.3900 before the weekend, which corresponds to the (50%) retracement of the February rally. The 20-day average is found a little lower (~$1.3870). The MACD has turned down from its highest level since last August, and the Slow Stochastic has also turned down from elevated levels. Note that the (38.2%) retracement of the rally since the end of October is near $1.3700. A move back above the $1.4050 area would likely stabilize the technical tone.
Canadian Dollar: The US dollar posted a key reversal against the Canadian dollar on February 25 by making a new multiyear low (~CAD1.2470) and then recovering to close above the previous session's high (~CAD1.26). Follow-through buying ahead of the weekend lifted the greenback to almost CAD1.2690, where the 20-day moving average is found. The MACD is turning up after trending lower for most of February. The Slow Stochastic appears to be trying to turn higher from overextended territory that it has not seen in the first half of last December. A move above CAD1.2700-CAD1.2725 could signal a move to the February high near CAD1.2850.
Australian Dollar: The Australian dollar also posted a key reversal on February 25. Before turning around, the Aussie poked above $0.8000 for the first time in three years. It settled below the previous day's low and continued selling off and pushed below the last week's low (~$0.7725). Last week's 1.7% loss was the largest since last May. The central bank meets next week and is likely to expand its bond-buying program especially given its need to bolster the credibility of the yield curve control regime that targets the 3-year yield at the cash rate of 10 bp. The 3-year yield finished the week near 14 bp. The MACD and Slow Stochastics have rolled over, and the Australian dollar has already fallen below the (61.8%) retracement objective of the February rally. A (38.2%) correction of the rally since the end of October is around $0.7620. That seems like a reasonable near-term target. Below there, the next target is around $0.7500.
Mexican Peso: The market, which adored the peso in the last half of 2020, has fallen out of love. A combination of risk aversion and unpopular government policies (for investors) drove the Mexican peso 2.4% lower last week. It was the second consecutive week of losses of that magnitude. The attractiveness of its high rates lost some of its appeal as global interest rates rose. In the last two sessions, the dollar traded above MXN21 to return to levels not seen since early November. The (50%) retracement of the dollar's losses since last September is around MXN21.1250, and the 200-day moving average (~MXN21.20) has not been overcome for four months. A word of caution comes from the fact the greenback closed above the upper Bollinger Band (~MXN20.8590) for the second consecutive session ahead of the weekend. The MACD is stretched but still trending higher. The Slow Stochastic's ascent has slowed, but it has not turned lower. Initial support is seen near MXN20.80.
Chinese Yuan: Before the weekend, a Dow Jones headline read, "Beijing Lets the Yuan Go Up Steadily." And yet, the yuan has been stuck in a range through the first two months of 2021. Indeed, as we have pointed, with a minor exception or two, the range so far this year was set in the first two trading days of the year (~CNY6.43-CNY6.5150). That is the point. While most of the major currencies and many emerging market currencies were trending higher against the dollar, the yuan did not really move much. But now that the dollar is poised to recover, the yuan may weaken. At the least, the dollar should test the CNY6.50-CNY6.51 area that marks the upper end of the range. One of the attractions of the yuan was the relatively high yields Beijing offered. The Chinese premium was over 250 bp in mid-November. It is now less than 180 bp, the smallest in nearly a year.