By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Dissonance between exuberant US data and recoiling UST yields is admittedly a headscratcher. But it does not turn optimism about US economic prospects on its head.
After all, to say US economic data was upbeat is an understatement given the degree and breath of positive economic surprises with respect to already optimistic expectations.
From jobs (sharp pullback in jobless claims), to retail sales (upbeat even after factoring in mid-March $1,400 Covid relief cheques), to industrial production, right across to sentiment data, the US economy appeared to be firing on all cylinders. Against this backdrop, the pullback in UST yields (10Y down ~7bps to 1.57%, 5Y easing 4-5bps to 0.81% and 2Y down fractionally to below 0.16%) in bull flattening fashion is counter-intuitive.
But this dissonance may merely be fleeting quirk of lop-sided positioning being forced into short-covering of USTs (resulting in a slip on yields as bonds are bought back).
In addition markets simultaneously digesting dovish Fed remarks, notably with San Francisco Fed Daly declaring “we are not there yet” with regards to “taper”, squares with bond markets trying to price the monetary-economic wedge from flexible average inflation targeting.
Meanwhile, blockbuster US economic data and markedly softer UST yields made for a very conducive backdrop for US equities to resume unambiguous rallies led by tech stocks (Nasdaq surging some 1.3%, S&P500 being lifted 1.1% and Dow 0.9% higher).
Although equity markets ostensibly have no qualms about, if not relish, the data-yield dissonance, there is evidence of tensions from this dissonance spilling over into the Dollar.
This showed up as EUR pick-up peaking out ahead of 1.20, gently moderating back closer to mid-1.19 while AUD eased back from mid-0.77 surge into the European session yesterday.
USD/JPY’s measured slip inching closer to mid-108 has also partly reversed. This has had some resonance with USD/SGD, regaining modest traction after slipping below mid-1.33.
Overall, as gauged by USD Index, skimmed off earlier declines in slightly more halting moves; suggesting a version of ‘USD Smile’ dilemma imposed by the data-yield dissonance.
Specifically, the USD appears to be caught between;
i) rallying on widening US out-performance amid wider global economic improvement that is consistent with more mature right-half of the ‘USD Smile’, and;
ii) and retreating on “risk on” and improved sentiments , which is in line with the left-half of the ‘USD Smile’, typical of early-cycle upturns.
Our observation is that the ‘USD Smile’ may be at an inflection point, and so a stable USD dynamic (with respect to economic outcomes/sentiments) may be hard to pin down.
Meanwhile, data-yield dissonance, while not in and of itself a durable phenomenon, may be prone to re-emergence from time to time; at least in part as a by-product of the upstream dissonance between monetary policy calculus and economic realities.
But dissonance is not a feature peculiar to US markets as Asia grapples with its fair share.
China’s Stellar Q1 GDP, while obviously exaggerated by low base effect, is a distraction to more urgent worries about the policy dissonance between worries of frothy asset markets and financial stability on one hand, and the need to get “dual circulation” to gain traction by boosting consumption as well as investments in new technologies.
For now, a resolution to this dissonance may elude. Instead, the reality may be one of recognising, and dealing with, the resultant latent volatility.
Source: Mizuho Bank Ltd