US Yields Hit Fresh Cyclical Highs Offering More Support for USD
The US dollar has maintained its strength in overnight trading, bolstered by increasing US yields observed yesterday. The sell-off in the US Treasury market has regained momentum, propelling the 10-year yield closer to 5.00% for the first time since July 2007. To provide some context, the peak just before the Global Financial Crisis hit was 5.32% in June of that year. Since the end of July, the yield has risen by nearly 100 basis points. This upward trajectory has been encouraged by compelling evidence of robust Q3 economic expansion in the United States. The release of the US retail sales report for September, which exceeded expectations, prompted a further revision of GDP forecasts upwards. Bloomberg's GDP Nowcast model for the current quarter, tracking high-frequency data releases, currently indicates a growth rate of 5.3%. While we don't anticipate growth to be that strong in Q3, it certainly underscores the current positive cyclical momentum of the US economy. This strong growth momentum has kept expectations alive that the Federal Reserve (Fed) might implement one more rate hike either later this year or in early the next year.
However, a timely reminder was delivered by the Fed's latest Beige Book survey, cautioning against overly enthusiastic extrapolations of strong growth into the next year. The Beige Book revealed that there was "little to no change" in economic activity in most districts and that labour market conditions had further eased. This represented a downgrade from the previous Beige Book, which had described economic growth as "modest." The districts also described the near-term outlook as "stable or indicating slightly weaker growth." More specifically, consumer spending was characterized as "mixed," especially among general retailers and auto dealers. The Beige Book noted that "labour market tightness continued to ease," with job candidates being "less inclined to negotiate" offers on terms and wages. Wage growth was described as "modest to moderate," while prices continued to "increase at a modest pace overall." This discrepancy between robust hard data and softer survey data casts doubts on the sustainability of this strong growth.
All eyes were on Fed Chair Powell as he spoke at the Economic Club of New York, and he confirmed the Fed's readiness to adopt a pause on further rate hikes. This message aligns with what other Fed officials have been suggesting over the past week, emphasizing a cautious, wait-and-see approach before deciding on additional rate increases. The recent tightening in US financial conditions, driven by the rise in market yields, has alleviated the pressure on the Fed to respond immediately to the recent string of robust economic data. This patient stance allows the Fed to gain a better understanding of the sustainability of the economic growth and the factors contributing to the significant increase in US yields.
In addition, Bloomberg highlights that Chinese investor sold the most US securities in August in four years, with net sales totalling USD 21.2 billion, including USD 5.1 billion in US equities and USD 14.9 billion in US Treasury bonds. This brings the cumulative net sales of US Treasury bonds to USD 51.4 billion in the first eight months of the year, the highest amount since the first half of 2020 when the COVID shock initially struck. This report contributes to the prevailing bearish sentiment towards US Treasuries. The US rate market has nearly fully priced out another rate hike at the upcoming FOMC meeting on November 1st, which should limit the downside for the US dollar stemming from Fed Chair Powell's comments today, unless he strongly indicates a reduced inclination to hike rates again in the current tightening cycle.
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