Awesome growth numbers from the US yesterday fuelled the bullish dollar trend, we saw new recent highs for the dollar vs several currencies, indeed DXY, the dollar index, achieved 10 month highs. Economists had expected 3.1% growth for Q2, but in fact the numbers came it at 4%! Not surprisingly there were sharp spikes in fixed income yields following the data, and Emerging market currencies weakened accordingly. One has to wonder about whether a US leveraged currency like the Mexican peso won’t eventually be a beneficiary of a stronger US economy. But for now, with the rate outlook at a possible inflection point, the safe course is to be wary of risky currencies. We all need to get a better understanding of which economies, indeed which corporates have unwisely feasted on a low rate environment, and not taken adequate precautionary steps to cope with a normalisation process. Still, one sobering note on the GDP data… we should expect revisions in coming months, and recently those revisions have had a downward bias. Later revisions tend to have better data on sectors like housing, exports and healthcare which are initially factored into the estimates as assumptions derived from historic trends. But who cares, we view the market now and we observe the price action as it unfolds!
FOMC didn’t supply anything new really. The pace of bond purchases slowed, but that was expected, and the Fed reiterated its plan to keep rates low “for a considerable time” after the purchases end. There were tweaks in the language as we’ve come to expect.. they did acknowledge that the unemployment rate has fallen steadily but they observed that there are still unspecified weaknesses in the labour market. The Fed also noted that their concerns about deflation have receded, although they aren’t afraid of inflation as of yet.
What does this all mean? Risk markets have to adjust to a world of potentially higher yields, and so we should probably exercise caution where beneficiaries of carry are concerned – emerging market currencies and bonds spring to mind, as do corporate bonds; it’s not my wheelhouse, but I wouldn’t be surprised if corporate bonds come under some pressure, and spreads widen. Ironically this sort of environment will add a bid to treasuries. In the short term we’ve seen decent dollar moves so pullbacks wouldn’t be a surprise. I would favour the majors over emerging markets in this type of scenario though.
Jobless claims in the US this afternoon and Eurozone unemployment later this morning are amongst the data points to watch for. I’m not sure anything is bigger than non-farm payrolls on Friday though. That’s one to watch for