Sour sentiment sees yields higher but USD lacklustre

The latest theme in FX markets has been characterised by the recent big bounce back in both nominal and real USD rates and the general re-tightening of global financial conditions.

This was only strengthened further yesterday by poor guidance from large US retail chains late in the session.

More positive data on both sides of the pond added to Treasury yields surging higher. The widely watched 10-year Treasury yield, a global proxy for borrowing costs, is nearing the key psychological level of 4% which it last touched back at the start of November.

Along with the hawkish Fedspeak we have heard recently, markets have been trying to catch up with the recent bumper data. How can we forget that the US economy was looking down n’out at the end of last year around November and December.

Investors were banking on a Fed pivot and rate cuts by the fourth quarter of this year. But a slew of positive and much stronger than expected data has surprised nearly everyone.

The blowout NFP, CPI and retail sales figures stand out, plus we’ve seen better sentiment in housing data and also industrial production.

This has seen markets now finally readjust to a more hawkish Fed.

 

FOMC minutes to act as a gauge

There is much focus on the Fed minutes released later today.

They should give us some clues on the amount of dissent of moving down gears to only a 25bp rate hike at its February meeting. This may point to changes in the March FOMC and projections / dot plot (SEPs).

But the debate will not include those latest upside surprises in the January data. This is because the meeting occurred before the reports.

We have also since had numerous recent hawkish remarks from Fed officials.

 

Markets now fully price in three 25bp Fed rate hikes by the summer.

There is around a 21% chance of the Fed moving back to a 50bp rate rise in March.

Fed fund futures for the first time, trade above the average Fed forecast for year end of 5.13%. The peak rate is close to 5.30%, an all-time high, having been below 4.9% just a few months ago.

And yet the dollar is relatively subdued and has not made fresh cycle highs.

The DXY is a basket of six currencies with the euro holding around a 57% weighting.

This means EUR direction governs the DXY price action to a large extent.

 

And at the moment, EUR/USD is holding above 1.06.

PMI data in the eurozone was strong while German investor sentiment also improved which all suggests the economy is in decent shape and is helping the ECB hawks call for rate hikes beyond March.

Key for EUR/USD is support just above 1.06 which includes a retracement level (38.2%) of last year’s drop at 1.0610.

The 50-day simple moving average sits above at 1.0727 to potentially offer immediate resistance.