US Dollar Gets the Green Light from Fixed Income

  • Thin trading conditions dominate
  • Greece: No “moola” for the IMF
  • Rising prices makes Fed hike timing difficult
  • Fixed income looks to September for first hike

Over the past few weeks dollar bulls have been trading with their backs against the wall, pressured by the spike in global sovereign bond yields, and the unknown timing of the Federal Reserve’s first rate hike.

However, they can breathe a little easier. The USD moved higher against Group of 10 currencies supported by Friday’s upbeat U.S. inflation data and comments by Fed Chair Janet Yellen. The dollar is looking to build upon its gains last week in which it saw its best weekly performance in four years.

With U.S. markets and most of Europe on holiday today, the thinned trading conditions will have most investors looking ahead to tomorrow’s forward-looking U.S. durables data, and Friday’s release of second estimate of U.S. gross domestic product (GDP) as key fundamental touch points for the dollar’s direction. Obviously, any news on Greece or of a potential Grexit will have an immediate impact on the EUR, similar to what happened in the overnight session in Asia.

Greece’s Cupboard is Bare

The single currency (€1.0970) saw some early session weakness, as the standoff between Athens and its European creditors appears to have gone from bad to worse with Greece announcing that it does not have the money to repay the €1.6 billion it owes to the International Monetary Fund next month. Greece remains steadfast with Prime Minister Alexis Tsipras reiterating that there is a limit to what the Greek government is prepared to accept from the creditors. Even if the standoff does result in a stalemate, a national referendum in Greece is not likely to break the situation — a weekend poll voters shows that +59% support the government’s position, but +71% still want to keep the EUR. The rest of Europe doesn’t want to talk alternatives, as Athens needs to deliver what it promised.

Investors should expect the EUR to remain vulnerable to Greek rhetoric, at least until there is clarity around what’s real or not. The currency is likely to trade with risks to the downside this week as long as the EUR/USD stays below Friday’s high of €1.1208. A breach through €1.0920 on the downside would expose the single unit to last month’s low of €1.0819.

Rising US Core Inflation Makes Fed’s Job Harder

The +0.3% month-over-month increase in U.S. core-consumer prices in April pushed the three-month annualized rate of core inflation up to a four-year high of +2.6%. That leaves Yellen and company with less scope to delay raising interest rates.

With the employment cost index suggesting that U.S. wage growth is accelerating, and the consumer-price index indicating that underlying price inflation is rising, the Fed really cannot wait much longer to raise interest rates from where they are today near zero.

Since the Federal Open Market Committee’s (FOMC) April meeting, U.S. economic news has been generally mixed, keeping rate hike odds favoring a September liftoff or possibly December. Last week’s FOMC minutes contained a lengthy discussion about the possibility that the recent weakness in economic growth may persist. A number of Fed officials suggested that the earlier impact of the dollar’s strength and weak oil prices could be longer lasting than anticipated.

But Friday’s data has influenced a number of fixed-income traders to consider pulling in the timing of the first Fed hike. September is still the most likely liftoff date, but July is not out of the question; not if there are another couple of robust rises in core-consumer prices.

Fixed Income Hangs on Yellen’s Every Word

On Friday, Yellen argued that the slowdown in first-quarter GDP growth was “largely” due to temporary factors, such as the record cold weather and a port dispute. The market took “largely” as being more important or convincing than Yellen’s “in part” verbiage that was used in the most recent FOMC statement (there will be a rebound in growth in the second quarter).

Yellen also seems to be warming up to the idea that some of this “apparent” first-quarter slowdown “may just be statistical noise.” The market is looking to the U.S. Bureau of Economic Analysis to revise the GDP figures to eradicate any “residual seasonality.”

Yellen repeated her assessment that “it will be appropriate at some point this year to take the initial step to raise the federal funds target.” Not a very transparent statement on timing, but if you include rebounding economic growth, plus a pickup in consumer prices that’s supported by wage growth, you have a fixed-income market now pricing in a rate hike no later than September.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell