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Dollar retreats as Fed restores calm


25 February 2021

All that was needed to restore order in financial markets were some soothing words from the Fed’s top brass and some encouraging vaccine news. Wall Street came back to life after the Fed chief and vice-chief reassured investors that they won’t overreact to any inflation episode this year and that the ocean of liquidity they’ve unleashed won’t be withdrawn anytime soon.

Promises that cheap money will remain ample and news that Johnson & Johnson’s vaccine will likely be approved for use in America soon were all the doctor ordered for global stocks to resume their ascent, even as bond yields marched higher as well.

The comeback in risk appetite was even clearer in the FX playground. The commodity-linked currencies powered to fresh multi-year highs while defensive plays like the yen and franc were crushed as rate differentials became the dominant FX force again.

Bond yields are rising everywhere as investors position for a sustained global recovery, but they are rising much faster in Australia, Canada, and New Zealand. In contrast, the Bank of Japan keeps a ceiling on Japanese yields, so rate differentials between the commodity-linked economies and Japan keep widening to the yen’s detriment.

Dollar caught in the middle, oil roars


The dollar was another casualty of the Fed’s dismissive attitude towards normalization and the calmer market mood. It fell across the board, with the losses being heavier against its commodity-linked rivals. The striking part is that the dollar is also losing ground against the euro, even though bond yields in the Eurozone have not risen as much as American ones. In other words, euro/dollar is marching higher despite diminishing support from relative interest rates.

This suggests that the dollar is back to behaving as a defensive asset, even though the inverse correlation with stock markets has weakened quite substantially lately. While the dollar seems to be realigning with US fundamentals overall, this is a process that takes time to play out. The link with risk appetite is unlikely to vanish overnight.

In the energy arena, crude oil continues its bullish conquest. Weekly data released yesterday showed a drop in US output as the snowstorms kneecapped production, while the positive vaccine news reaffirmed the brighter picture for demand. That said, oil prices have already come a very long way, so the risk of a corrective pullback seems elevated here, especially if OPEC+ raises its production limits next week.

Pound cools, parade of Fed speakers coming up


The British pound has been trading like a runaway freight train lately despite the wobbles in risk sentiment and relatively soft data, demonstrating that a cheerful vaccine story can work wonders for a currency. Sterling’s ability to absorb negative headlines with nothing but a scratch has been nothing short of remarkable. Even news that Chancellor Rishi Sunak is considering an increase in the nation’s corporation tax rate was not enough to shoot down the high-flying pound yesterday, although the currency did surrender most of its earlier gains.

At some point, the breathtaking rally will be subject to a reality check – especially if Brexit risks relating to financial services come back to the spotlight – but that moment might not be imminent. For now, it’s all about the vaccines and a booming post-covid economy.

As for today, the data highlight will be US durable goods orders, which are seen as a proxy for capital expenditure. Beyond that, there’s a parade of Fed speakers on the agenda, including Bostic at 13:30 GMT, Quarles at 16:10 GMT, and Williams at 20:00 GMT.

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