Have hawks finally lost altitude?
Time and time again in the past five weeks US Treasuries and the S&P 500 have sold off and the Dollar rallied in the wake of hawkish US surprises only for markets to quickly unwind these moves.
Volatility in US financial markets has ultimately remained subdued and directionality has been limited. In the month to 3rd June US Treasury yields rose only very marginally and the S&P 500 was broadly unchanged. Notably the Dollar NEER weakened a further 1%, suggesting that markets’ appetite to short the Dollar was not significantly curtailed by these bouts of inflation-concerns.
Moreover, quasi-dormant US financial markets have since come to life (or at least a semblance of life), with the 10-year Treasury yield down 13bp to a 3-month low of 1.49% and the until-recently stagnant S&P 500 up 0.8% to a new record-high of 4,227 on 8th June.
The erosion of the Dollar’s long-term real yield and rally in riskier assets have resulted in the “safe-haven” Dollar NEER depreciating a further 0.8% to its weakest level since late-April 2018. The Dollar NEER has now weakened over 2% since 19th April, to a 37-month low, in line with our bearish Dollar outlook.
Our take is that markets’ belief that the current spike in year-on-year US inflation above the Federal Reserve’s medium-term target will be permanent has further eroded.
As we argued a fortnight ago, markets are rightly in our view not (yet) buying into the notion that the Federal Reserve is “behind the curve” and will have no choice but to announce in the near-term a tightening of US monetary policy.
The bottom line is that “wait-and-see” is still seemingly the default setting for most developed central banks, including the Federal Reserve and European Central Bank.
Some analysts have argued that the release tomorrow of US CPI-inflation data for May, even if in line with consensus forecasts, could prove to be the straw that finally breaks the markets’ dovish back. Based on precedent we do not think this will the case.
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Olivier is an economist and rates & FX strategist with over 22 years experience in financial markets. He is Director and Founder of 4X Global Research, an independent, London-based consultancy which provides institutional and corporate clients with substantive research, high-quality analysis and insight on emerging and G20 economies and financial markets.