Higher US yields and rising Covid risks putting a bid back into USD

Higher US yields and rising Covid risks putting a bid back into USD         

• USD: Headwinds to current vaccine timelines and Q1 growth expectations materializing – the overnight session sees USD almost universally bid with interbank volumes roughly 35% above average as the broad based USD Index (DXY) trades 0.66% higher towards 90.70 alongside higher US bonds yields and (paradoxically) stronger risk averse sentiment on rising headwinds to current vaccine timelines and spreading Covid-19 infections.         

• USD: Headwinds to current vaccine timelines and Q1 growth expectations appear to be materializing against the backdrop of a market already discounting a positive risk environment in 2021. UK and South Africa variants of the Covid-19 infection in particular leads UK officials to voice concerns about vaccine effectiveness as the new variants seem to be more infectious and could exacerbate near term risks – sharply rising hospitalization rates and leading to a rise in double dip recession probability in UK which other countries risk following. Additionally, the threshold to achieve herd immunity by mass inoculation could rise, so new outbreaks could be a bigger risk in H2’2021 than previously anticipated – the number of mutations suggest that the virus may be around for the long-haul. Vaccine rollout race is key to the outlook but even here, rollout challenges seem to be emerging with the US and EU starting to see distribution challenges and supply shortfalls.        

• USD: Fed speak overnight is defined by cautious optimism amid rising prospects for inflation in H2’2021 with President Bostic expecting rates to remain on hold throughout 2021 but would consider rate hikes in 2H’22. That said, Bostic says he would reconsider hiking earlier if the US economy significantly outperforms relative to expectations, but thinks the odds as low. Barkin sees a turbulent first half in 2021, followed by strong growth in Q3 and beyond on the back of widespread vaccine distribution. The comments echo some of the more hawkish thoughts from Vice Chair Clarida on Friday that seem to be contributing to rising US bond yields. Citi analysts expect the Fed to lay out the timeline for QE tapering at the September 2021 FOMC meeting (and commence tapering in October) with Fed hikes in H2’2022. Thus, market attention is likely to increasingly refocus on month inflation prints, potentially as early as this week’s release of December CPI (refer to Week Ahead), where Citi’s higher-than-consensus expectation could send US Treasuries yields (and USD) even higher. While the next few months are likely too soon to see signs of sustainably firmer inflation, a number of factors can support core PCE returning to 2%YoY this year.                

BoC - details of strong Q4 BOS signal firming inflationary pressures                

• CAD: Details of BoC’s Q4 Business Outlook Survey show continued improvement in business sentiment despite remaining constraints on activity due to the ongoing pandemic. The overall BOS indicator rises to +1.3 from -2.2 in Q3 with the balance of firms expecting stronger future sales growth up notably to 48% as expectations of activity rebound from previously very low levels. Expectations of future employment levels and investment also rise.

• CAD: One of the more interesting and potentially consequential details of the Q4 BOS are indications of strengthening price pressures. More firms indicate difficulty meeting demand, a loose proxy for a closing “output gap” that in the past has led trends in core inflation by a few quarters. This supports the Citi analysts view that core inflation measures in Canada have likely bottomed not-too-far below 2% (around 1.6-1.7% currently) and will rise back closer to 2% later in 2021.               

Week Ahead                     

• USD: Market attention will remain on prospects for further stimulus with President-elect Biden set to detail his economic proposal on Thursday. But attention will also be paid to a series of Fed speak starting with Bostic followed by Kaplan, Rosengren and Harker speaking on the US economic outlook and monetary policy before the Federal Reserve releases its Beige Book . Finally, Fed Chair Powell takes part in Princeton webinar late in the week.  

• USD: December CPI MoM Citi: 0.4%, median: 0.4%, prior: 0.2%; CPI YoY Citi: 1.4%, median: 1.3%, prior: 1.2%; CPI ex food, energy MoM Citi: 0.2%, median: 0.1%, prior: 0.2%; CPI ex food, energy YoY Citi: 1.7%, median: 1.6%, prior: 1.6% Citi analysts expect Fed’s preferred core PCE measure to return more sustainably to 2% by 2021 end. Firmer inflation is likely to solidify expectations for the start of Fed QE tapering in H2’21 with Citi analysts expecting the first Fed hike at 2022 end. 

• USD: December Retail Sales Citi: 0.4%, median: 0.0%, prior: 1.1%; Retail Sales ex Auto Citi: 0.1%, median: 0.2%, prior: 0.9%; Retail Sales ex Auto, Gas Citi: 0.3%, median: 0.7%, prior: 0.8%; Retail Sales Control Group Citi: 0.8%, median: 0.2%, prior: 0.5% - Citi analysts expect a solid 0.4% increase in total retail sales , with a stronger 0.8% increase in sales in the retail control group though with substantial downside risks around the estimates. 

• GBP: UK GDP Quarterly Estimate, Sep-Nov Forecast: 2.7% 3M/3M Prior: 10.2% 3M/3M; GDP Monthly Estimate, Nov Forecast: -5.8% MM Prior: 0.4% MM - November saw all regions of UK subject to new, stricter, lockdown rules – with England (85% of UK’s economy) subject to the rules for nearly all of November. Citi analysts expect this to weigh heavily on GDP at levels between July and June and also expect the recovery in December to prove relatively tepid. With even stricter rules now in place for the first two months of 2021, the near-term outlook remains very challenging.

• CNY : China Exports (%YoY) December: Citi 11.2, Consensus 14.7, Prior 21.1; Imports (%YoY): Citi 5.1, Consensus 5.4, Prior 4.5; Trade Balance ( US$bn ): Citi 64.2, Consensus 70.0, Prior 75.4 Citi analysts expect exports to decelerate from 21.1%YoY previously to 11.2%YoY and envisage import growth to improve by 0.5ppt to 5.1%YoY in December.

This is an extract from the Daily Currency Update, dated January 12, 2021. Please approach a Citigold Relationship Manager if you would like more information.