Navigating the Inverted Yield Curve: Implications for Currencies and Central Banks User
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FX Daily: The perks of an inverted yield curve
The Bank of England surprised markets with a 50bp rate hike on Thursday, and we think a reserve currency like the pound may be kept afloat by a sharply inverted domestic yield curve. This is what is happening with the dollar, which has rebounded despite hawkish surprises elsewhere. Today, the focus will be on PMI releases.
USD: Powell talking up the Dot Plot
The dollar found some support yesterday and this morning despite two major hawkish surprises in Europe that might have lured investors further away from the greenback and fuelled a rotation to European currencies. What has likely offered backing to the dollar has been the hawkish message pushed by Fed Chair Jerome Powell in the two days of Congress testimonies. While the overall rhetoric has been nearly identical to last week’s press conference, Powell seemed to add more weight on the near-term prospects of further rate hikes compared to last week – implicitly encouraging markets to close the gap with the Dot Plot projections.
For now, that gap is still present. The Fed Fund rate curve is fully pricing in one hike by November, but there are only 18bp factored in by July and – above all – no signs of the other hike included in the latest median FOMC projections. It is clear that investors are awaiting the cue from data to align with the Dot Plot, but Powell’s hawkish rhetoric is a warning signal against jumping too early on a bearish dollar trend given the risks of a further inversion of the US yield curve.
Data-wise, the focus will be on PMIs across developed countries today. While being of secondary relevance to the ISM in the US, we can see some higher-than-normal market impact given the elevated market sensitivity to data at this juncture. 102/103 appears to be the holding-pattern range for DXY at the moment and we could see that hold into next week.
USD/JPY has continued to press higher, with a dovish Bank of Japan still leaving the yen more vulnerable than other G10 peers. We are now close to the 145 area, where Japanese officials started FX intervention last September.
