Dollar Caught Between Inverted Curves and Equities: FX Daily

FX Daily: Dollar trapped between inverted curves and rallying equities

There has been little follow-through from the dollar selling we saw late last week. Currently, global markets present a curious picture of steeply inverting yield curves – which occasionally forewarn recession – but bid equity markets. Which market has it right? We tend to think the dollar will come lower in the second half, but again timing is everything.

 

USD: Dollar trapped in the middle of inverted curves and risk rally

FX markets are relatively quiet following yesterday's public holiday in the US. Risk assets are marginally softer after Chinese authorities only cut the 5-year Loan Prime Rate by 10bps – disappointing those looking for more aggressive support from lower mortgage rates to China's property sector. USD/CNH pushing back up to 7.18 has kept USD/Asia bid and provides a mildly bullish undercurrent to the dollar as the European session gets underway.

Softening the lens a little we see the dollar trapped between two stories and reflected in its 2% gains against the yen and 2% losses against sterling and commodity currencies over the last month. Those two stories are: i) steeply inverting yield curves as central banks try to squeeze inflation out of economies and ii) rallying equities on the view that recessions will be mild (perhaps because of low unemployment). Our big picture call here is that US disinflation comes through in the third quarter, bearish US yield curve inversion switches to bullish steepening, and the dollar falls more broadly. But we are not there yet.

Back to the short term, there is only second-tier US data today in the form of housing starts and we have the Fed's James Bullard speaking at 1230CET today. He is one of the most hawkish Fed governors, but not an FOMC voter this year. Presumably, he may shed some light on why the Fed could hike by another 50bp this year (consistent with the latest Dot Plots), but that may not move the dollar needle much.

DXY is to trade well within a 102.00-103.00 range and expect USD/JPY to continue nudging higher. It increasingly looks as though Japanese authorities will be called into FX intervention again near the 145 level.