TD Securities

Summer malaise, but a shift is underway.

As much as the summertime has had a lulling effect on markets, the most recent season has presented some notable market shifts that raise the prospect that the USD may have bottomed for this cycle. This began with a hawkish FOMC pivot in June, which triggered an abrupt bear-flattening in the 5s30s curve. The timing of this shift was a bit unfortunate as the transition came at a time when the delta variant became more wide spread amid a peak in growth and inflation. This sparked concern that the Fed shift was premature and caused a significant rally in Treasuries, in what we have dubbed as the counterintuitive taper tantrum.

Fed policy risks are more fluid from here on. Despite this, neither the Fed nor the several other central banks that have also made hawkish pivots have softened their stances. If anything, they have become more resolute even in the face of the delta variant(which we think is less of a threat to the economic outlook as mandatory vaccinations broaden).

The Fed is no exception. Powell's Jackson Hole remarks emphasized that taper is "likely" this year. Meanwhile, Clarida — a noted centrist on the Board — has openly agreed. More interestingly, he also revealed where he is on the dot-plot in noting that the economy could warrant an increase by early 2023. Even if the Fed does not deliver a hike by then, the issue of lift-off is likely to dominate the market lexicon in 2022 just as taper did for much of 2021.

This is part of the natural evolution of policy. But this could also be aided by a more hawkish FOMC next year. George, Mester, Rosengren and Bullard rotate in as voters next year while Evans and Daly, reliable moderate doves, are shuffled out. Of course, this could be offset by potential replacements of Clarida and Quarles. Nonetheless, we may see more dissents in 2022.

Standard Chartered Bank

Well? What do we do?... Let's not do anything. It’s safer.

Since 20 August, the USD has experienced its biggest sustained loss since late April but is still 1.4% higher than at the beginning of the year. The drop is linked to Fed Chair Powell’s lack of tapering urgency and a stabilisation of COVID concerns, in our view. However, USD selling is limited by concerns that inflation risk is not much lower now than in May when the Delta variant risk was not yet a major market factor. Economic surprises have come off sharply, especially since early August, but unlike in Q2-2020, investors are not treating indications of weaker activity as reducing inflation risks. Empirically, the USD’s key drivers are COVID fears (proxied by the ratio of COVID-sensitive stocks to tech stocks), the overall S&P, and US interest rates. 5Y UST yields have a slightly stronger statistical relationship than 10Y yields. When5Y and 10Y yields are included together, there is some indication that a flatter slopes associated with a stronger USD, but the significance of the slope varies.