US treasury yield rally and BOJ intervention impact forex landscape

Bunds and US Treasuries parted ways yesterday. Yields on the latter surged more than 8 bps at the long end of the curve. That had little to do with the Fitch rating downgrade, though it was related to one reasons for the decision: the deterioration fiscal situation. US Treasury for the first time in over two years raised the amount on offer for several tenors in the August-October quarter. Next week’s mid-month refinancing operation for example will be $7bn higher ($103bn in total) than in the first month of the previous quarter. In addition, shortly before the announcement ADP’s employment report crushed a 190k consensus by adding 324k new jobs in July. Meanwhile, market talk is moving from a “soft landing” to “no landing” at all in the US. German yields, by contrast, fell 1.8 (30-y) to 6 (2-y) bps. They did close well off intraday lows though, especially longer maturities. Yield differentials as well as a sour equity mood (EuroStoxx50 -1.6%, Wall Street ended more than 2% lower in case of the Nasdaq) favoured the US dollar over the euro. EUR/USD extended its recent correction towards 1.094 after having traded north of 1.10 in earlier dealings. The trade-weighted dollar index closed around 102.59, the highest since early July. Risk-off also supported the yen while currencies with a riskier profile (AUD, NZD, SEK, NOK) suffered. Sterling too declined but managed a close off the lows. EUR/GBP ended north of 0.86.

The Bank of Japan for a second time this week intervened with an unscheduled bond buying programme. That happened as the 10-y moved beyond 0.65%. It is still trading around that level currently. The yen loses marginally even as sentiment is mixed, at best. Japan underperforms (-1.3%). EUR/USD stabilizes around yesterday’s closing levels. US yields extend their ascent. The 10-y yield tested 4.09% resistance yesterday but is now moving past that important level. Apart from intermediate resistance at 4.24%, it was the final hurdle before a return to the 4.33% cycle high. The drop in core bonds isn’t a UST exclusive. Bund yields are set for a higher open as well. 2.55-2.58% serves as an important level in the 10-y yield. Today’s economic calendar could be of importance in sustaining that move as well as the recent dollar comeback. The US services ISM is expected to ease from 53.9 to 53. Strong demand (new orders in June picked up three points) at least suggests no imminent collapse in activity. The Bank of England also convenes today. The jury is still out whether the central bank will make use of one lower-than-expected June CPI reading to ease the tightening pace from 50 to 25 bps. There is also growing talk of a potential speedier rundown of the balance sheet. If the BoE opts for that, it will probably complement a 25 bps rate hike (to 5.25%).

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Brazil’s central bank declared the fight against inflation over by cutting the policy rate yesterday 50 bps to 13.25%. The dovish shift came as inflation eased from a 12.1% peak in April 2022 to 3.2% in June this year. That’s below this year’s 3.25% target. The steep deceleration was the result of the central bank acting swiftly on the post Covid-19 inflation surge. It started hiking early in 2021. By contrast, the likes of the Fed and ECB only began in March and July 2022. The Banco de Brasil together with other Latin American counterparts were lauded for their quick response of which they are now reaping the benefits. The central bank said that if the scenario evolves as expected, more rate reductions of the same magnitude will follow. Analysts and markets were leaning more towards a 25 bps rate reduction, so there might be some price adjustment in the Brazilian real when market reopens today. USD/BRL started bottoming out end of July after hitting the 4.70 barrier. A first meaningful resistance pops up at 4.90.

Spain’s ERC leader Aragones said the socialist PSOE should not take support from Catalonia’s separatist parties to form a new government for granted. Its his first interview after the July national elections yielded no clear majority for the left nor the right blocs. That made the likes of the ERC and Junts kingmakers in the government formation. ERC supported Sanchez’ PSOE in the last parliament, Junts didn’t. But this time around, Sanchez needs them both. Aragones wants further talks on Catalonia’s political future, cut the region’s contributions to the national public fincanes and to take control of local train services. Junts for its part demands a referendum on independence and amnesty for all separatists facing legal charges related to the failed 2017 independence bid.

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