From Marc to Market:
The US dollar is being sold across the board today. The US Dollar Index is off 0.65% late in the European
morning, which, if sustained, would make it the largest drop in two weeks.
The proximate
cause being cited by participants and the media is weak US data that is
prompting a Fed re-think. However, we are a bit skeptical.
It is not that the US data has been strong,
or that Fed officials have been touting the need to hike like many regional Fed
Presidents did earlier this year. Rather our skepticism is based in the prices themselves.
Begin with the
widely cited Bloomberg calculation of the odds interpolated by the Fed funds
futures strip. Presently, its calculations shows an
18% chance that Fed funds will be at 50-75 bp at the end of September, 20.7% in
November and 37.9% in December. After the disappointing retail
sales report at the end of last week, the probability was all lower at 16%,
17.5%, and 36.8% respectively. Moreover,
on August 1, Bloomberg calculated the probability at 18%, 19.4%, and 31.5% respectively.
This sampling
does not suggest that the market's expectations of Fed policy have changed much
over the past fortnight, and to the extent,
they have changed, the odds are a little greater not less. The performance of the US two-year note also suggests
that, if anything, the market has moved in the opposite direction of the
narrative widely offered. The two-year note is yielding 70 bp, the same as at the end of last week and two
basis points higher than on August 1.
So if shifting
views on Fed policy does not seem like the most likely explanation, is there a
better one? First,
we note that the US dollar technical condition seems vulnerable to us (Dollar's
Downside Beckons in the Week Ahead). Second, a fundamental case may be found with the $37.45 bln coupon payment
that the US Treasury makes this month and the $54.56 bln in bond maturities.
That is $92 bln of capital looking for a home. The new issuance of
$62 bln in securities absorbs nearly two-thirds of it. That still leaves
$30 bln to be invested. Due to the
cost of hedging new US-dollar denominated investments, the hypothesis is that a
chunk of this money is being repatriated or invested in other higher yielding
bond markets, with Japan, a key player....
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