FUNDAMENTAL ANALYSIS

Dollar Bounces Back

22 Feb 2017

Some profit-taking in the middle of last week pushed the dollar lower and gave rise in some quarters that the run was over. However, the greenback has come back the bid. It is gaining against all the major currencies and most of the emerging market currencies.

Much of the coverage attributes the gains to comments by the Philadelphia Fed President Harker. He joined the chorus of officials who have refused to rule out a March hike. Yet the market is not biting. The Fed funds have been averaging 66 bp. The March contract implies 69.5 bp, and the April contract implies 71.5 bp. Our work suggests this is consistent with about a one-in-four chance of a hike. Bloomberg puts the odds at 36% compared with 34% a week ago. The implied yield of the March and April contracts have risen by half of a basis point over the past week.

Leaving aside the New Zealand dollar, which is being dragged lower apparently by the continued weakness in milk prices (off five consecutive sessions through yesterday) ahead of Tuesday’s auction, the euro is the weakest of the majors. We suspect the euro is an important driver of the broad dollar gains.  The latest polls have support for Le Pen ticking up, while the Left continues to hampered by sectarianism, and the two main candidates Fillon and Macron appear to have lost some momentum.

The 10-year French premium over Germany has widened to 80 bp, the most since August 2012. It has risen nearly 14 bp since the middle of last week. The two-year spread is also widening. It is at 44 bp today, the widest since May 2012. It is up about 16 bp over the last four sessions. The five-year credit-default swap was at 68 bp yesterday, up from 38 bp at the end of last year and 42 bp at the of January. The sell-off in French debt instruments has reportedly come on high volume.

The demand for German paper, not only emanating from flows out of France but the periphery more general, has seen the German two-year note fell to a new record low (~-88 bp). This in turn has widened the spread between the US and Germany. The US two-year premium took out the end of last year's high (~205 bp) today to make a new post-2000 high. The US 10-year premium is near 330 bp today, which is the widest so far this year, but still a little below peak from the end of last year near 339 bp, which is the widest since at least 1990.

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