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Summary
- Since US yields peaked across the curve in October, subsequent countertrend rises have been short-lived, and the trend of broadly lower yields has been building over the past three months.
- Buying dips (in futures terms) in the US rates space has been a winning strategy.
- The USD Index (DXY) has also been trending strongly, falling alongside US yields.
Market Implications
- We favour fading rises in US yields, still seeing them as temporary and corrective. We prefer going into the US CPI report today with partial positioning, looking to scale into a bigger long position on an upside surprise.
- The DXY is trickier. The USD’s status as a haven and beneficiary of risk-off sentiment offsets its tendency to follow US yields lower. We have less conviction on further USD weakness than on US yield downside so are neutral the greenback.
US Yields Trend Lower for Over Three Months
Since peaking in October, US yields have been in a strong downward trend across the curve.
The 2-year US Treasury (UST) yield peaked (on an intraday basis) at ~5.26% on 19 October, and now trades about 95bps lower at 4.34%.
The 10-year UST yield peaked intraday on 23 October at ~5.02% and now trades just over 100bps lower at 3.98%.
The same is true for the 30-year UST yield – it also peaked on 23 October (at ~5.18%) and is also about 100bps lower now, trading at 4.16%.
Corrections Have Been Violent, and Worth Fading
Although the trend of lower yields across the curve is robust and established, the price rally in USTs has not been one-way traffic. The decline in yields has been subject to material and sometimes violent corrections higher.
These countertrend moves have been relatively short-lived (and worth fading) in every instance.
In the 2-year, these three sharp corrections and subsequent drops have stood out (all moves on a closing-to-closing basis):
- From 3 November to 10 November, the yield jumped 23bps. It then fell 53bps.
- From 1 December to 12 December, the yield jumped 19bps. It then fell 49bps.
- From 27 December to 4 January, the yield jumped 14bps. It has since fallen 5bps (so far).
In the 10-year:
- From 8 November to 10 November, the yield jumped 16bps. It then fell 55bps.
- From 6 December to 11 December, the yield jumped 13bps. It then fell 49bps.
- From 27 December to 5 January, the yield jumped 26bps. It has since fallen 6bps (so far).
In the 30-year:
- From 8 November to 9 November, the yield jumped 15bps. It then fell 55bps.
- From 6 December to 11 December, the yield jumped 12bps. It then fell 38bps.
- From 27 December to 5 January, the yield jumped 25bps. It has since fallen 4bps (so far).
Each of these yield spikes, across the curve, has proven temporary, and fading them has worked. We think this will continue in the coming weeks.
Will US CPI Catalyse the Next Move Lower?
If recent history repeats, the 2-, 10-, and 30-year yields are probably starting the next material leg lower.
Each has declined slightly since last week’s spike across the curve, and US December CPI data today could be the trigger for the next leg to really kick off.
The data is expected to be steady (in the m/m core reading) and tick slightly higher (in the m/m headline reading). Any weakness could see additional downside for US yields.
Scaling in to a Long Futures Position Makes Sense
However, it may make sense to keep some powder dry in case today’s CPI is stronger than expected.
Macro Hive’s US CPI Model flagged the possibility of a modest upside surprise against consensus.
As such, this may lead to a rise in US yields, which would present an opportunity to fade the move and improve the entry level on any long futures positions.
The Next Move for the USD Is Less Clear
Since hitting its 2023 peak on 3 October, like UST yields, the DXY has fallen materially. It dropped as much as ~5.6% before recovering slightly in the past fortnight to sit ~4.5% off the October high.
The USD selloff has largely coincided with the decline in US yields. The market’s dovish pricing of the Fed and the futures rally across the curve have weighed on the DXY.
Given we expect a further decline in US yields, it is tempting to anticipate more USD downside ahead.
Buoyant Equities in Q4 Were Another Key Factor in USD Selloff
However, the missing element for further USD downside may be further upside in equities. In Q4, the S&P 500 rallied almost 500 points, a little over 11%.
This stellar performance, when combined with lower US yields, provided a strong backdrop for a weaker USD.
Equities Are Due a Period of Range-Trading…
My colleague John Tierney recently argued US equities will range-trade after the strong end to 2023.
Investor expectations are buoyant, with forward P/E ratios well above pre-pandemic levels. As John sees it, investors are clearly pricing in high expectations for earnings, rate cuts, and the economy in 2024.
Given this bullish backdrop, the is scope for disappointment is high. And with Q4 earnings season kicking off tomorrow, this may serve as a reality check on investor bullishness.
…Which Makes Further DXY Downside Elusive
Without the bullish equity backdrop, one key catalyst for further USD downside is missing.
While lower US yields have weighed on the USD, the strong risk-on dynamics from Q4 have also contributed significantly to greenback weakness. This is especially true for the DXY, of which EUR/USD is the biggest constituent.
As my colleague Bilal Hafeez pointed out this week, it is risk sentiment driving EUR/USD, rather than other cyclical factors such as rate differentials.
EUR/USD has been trading in a ~1.06/1.11 range throughout 2023 and is expected to continue to do so for the foreseeable future.
In fact, Bilal sees scope for the USD to strengthen marginally against the EUR in the near term, with modest downside to 1.07 in EUR/USD.
When combined with John Tierney’s caution on equities, we therefore have low conviction in USD downside. Overall, we are neutral USD and refrain from entering a position.