DXY support and rich rate rates curves

The DXY is finding support. Yields are resistant to moving lower
Philip Wee, Eugene Leow10 Jun 2019
    Photo credit: AFP Photo

    FX: Markets discounting Fed cuts more than trade war risks

    The USD Index (DXY) has found support around 96.5, which is the floor of its ascending price channel and 200-day moving average. Despite last Friday’s disappointing May US nonfarm payrolls (75k actual vs 175k consensus), no one expects the Fed to lower rates at its next FOMC meeting on June 19. The market has been too aggressive in discounting 2-3 Fed cuts this year, in our view. The implied yield for Fed Fund Futures maturing in December has fallen 1.82% last Friday, well below the 2.25-2.50% target range. Keeping its power dry, the Fed has signaled rate cuts as an insurance against the global growth risks from heightened trade tensions.

    The Xi-Trump meeting at G20 Summit on June 28-29 is shaping up to be a binary event. China has been keeping its USDCNY parity stable just below 6.90, a sign that the door remains open for both countries to resume trade talks. On the other hand, the export-dependent South Korean won has remained weak around 1180, wary that if further negotiations are not possible, Trump would proceed to hit the remainder USD325bn worth of Chinese goods with a 25% tariff. If so, further yuan depreciation past 7 against the USD cannot be ruled out as part of China’s policy responses to cushion its economy.
    Rates: Resistant to lower USD rates   

    Weak payrolls (actual: 75k, consensus: 175k) provided the perfect excuse for the market to take USD rates another leg lower last Friday. However, USD rates closed off their session lows. Notably, 2Y yields closed at 1.85%, representing a bounce of 8bps off its low. The rally in longer-tenor US Treasuries proved to be more durable with yields just 1-3bps off lows in the 10Y-30Y segment. We think that USD rates have already aggressively discounted Fed easing, pricing in 3-4 cuts by end-2020. Moreover, inflation expectations have also tumbled. 10Y breakeven is at 1.75%, just a few notches above the low registered in early January. We think a lot of the bad news has been reflected in the USD rates space and it would require a sizable shock before 10Y yields breach 2%.

    In any case, payrolls have historically been volatile, and it might be better to review other labour market indicators. With the US unemployment rate stuck at 3.6%, a slowdown in jobs creation is inevitable as the available pool of free labour dries up. Initial and continuing jobless claims are not showing any meaningful spikes while job openings are still close to all-time highs. Signs of weakness are more apparent in the manufacturing PMIs but we reckon it may be more sector specific with data in the segment generally still-weak across the globe. Inflation, which has been coming off elevated levels, bears watching. With oil prices sliding, attention will be paid to PPI and CPI figures due later this week.

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

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