Bonds Selloff Gives the Dollar Short Term Strength

GBP

The unrivalled strength of the Pound driven by the vaccine rollout now looks to have come to an end as the bond and equity markets had a difficult week. Sterling ended the week 0.6% lower against the dollar, most of this move came after the equity sell off in the United States on Thursday evening as investors looked to hold the greenback as a safe haven. It was a mirror image against the euro with the Pound increasing 0.6%, this was driven by the bond sell off in the United States which resulted in a weaker single currency as its lower yield offering and investors’ concerns about the short-term Eurozone economic outlook. Rishi Sunak’s budget failed to move the Pound but showed the markets agree that his stance matches the potential economic recovery fuelled by the vaccine so did not trigger a selloff in the Pound. Data wise, the UK had a quiet week with the only data of note coming on Monday with Manufacturing PMI which just beat expectations.

Sterling is expected to continue to strengthen against the Dollar once the dust settles from the recent turmoil in the bond and equity markets. As for the following week, the possible further rise in US Treasury yields remains a risk to GBP/USD. The 50-day moving average level of 1.3750 is the next key support level to watch. Against the euro, the key driver in the pair will be the ECB next week with the Pound in for quieter week. The only data of note is UK GDP on Friday expected at -4.9% driven predominantly by the closure of service sectors. This is a backward-looking indicator and should have a limited impact on the Pound, particularly in light of the fast vaccination and the anticipated strong economic rebound in 2Q.

USD

The dollar finally found some strength after a difficult start to 2021 but not necessarily for the right reasons. Yields rose for US bonds and prices tumbled as the inflationary pressure on the US dollar mounts. Jerome Powell failed to calm the panicked bond market that lifted U.S. yields to pre-pandemic highs. He insisted the bank feels no need to adapt policy and continued to pour scepticism over market concerns about a possible bout of runaway inflation ahead. No change in policy is expected from the Fed any time soon, which should mean a weaker dollar in the long run. The jobs report smashed expectation of 187K as non-farms hit a four-month high of 379K giving hope to the start of the economic recovery in the US.

The US treasury sell off will remain the key driver for the dollar next week though we might not see the kind of volatility that we had at the end of last week. Both CPI and PPI are key data releases this week. Both have the potential to either drive or calm the selloff in bonds. CPI YoY is expected to rise to 1.7% from 1.4% on Wednesday and PPI to 2.6% from 1.7% on Friday. The 10yr and 30yr treasury auctions will also cause a headwind for bond markets due to the increase supply, taking place on Wednesday and Friday, respectively. Many analysts believe that the selloff in bonds is only short term and once the market has settled at the “right level” the dollar will then continue to weaken.

EUR

The Euro had a tough week as it fell against both the Dollar and the Pound, 1.4% and 0.4% respectively. EUR/USD finally fell below 1.20 after the significant Dollar strength seen on Thursday evening, there has seen talk from some analysts that 1.15 may be possible in the near future before the Dollar backs off. On the data front, CPI was released on Tuesday at 0.9% just missing expectations of 1%. Thursday saw dismal Retail Sales for the EU at -6.4% versus expectations of -1.2%, showing the economic recovery is still some way off compared to both the UK and the US.
The ECB rate decision on Thursday is the main event for the euro this week even if no change in policy is expected. Investors will be more interested in the following press conference and whether Christine Lagarde will act on the bond sell off. Initially the ECB seemed to be prepared to front-load PEPP purchases to contain the rise in yields, although most recently ECB speakers have backed away a little from this concern. Monday’s APP report will be scrutinised to see if PEPP activity did increase in the prior reporting week. Data wise GDP for the eurozone is released on Tuesday expected at -5% year on year and -0.6% month on month.