U.S. Tax Reform Fails To Send USD Higher

The primary focus overnight was the US yield curve which continues to steepen as US 10-year yields are trading at a nine-month high in the wake of the tax reform bill.

A combination of anticipated economic positivity and robust US data suggests the bond markets are banking on some level of financial boost which could flow through and accelerate doggedly low inflation. But the pace of the move over the past 24 hours also suggests a rapid unwinding of the past month’s fashionable yield curve flatteners as growth optimism appears to be finally kicking in and focus returns to all things inflationary.

Is it a trend or merely a year-end position related distortion as it’s difficult to price this move in as the tax bill passage has come with no unforeseen developments. Interesting observation from CITI NY G-10 desk: “Over the past three years, the average yield gain in US 10y from mid-December to year-end has been ~20bps.”

Friday’s PCE release will warrant attention and could very well be the primary dollar event of the week after the tax reform bounce failed to ignite a stronger dollar response. Profiled from last weeks CPI, PCE is expected to be another weaker print. However, given the surging US bond yields, a miss may not weigh that dollar negative as the market has soundly positioned the USD negativity following the dovish Fed hike, Doug Jones victory and tepid CPI. But given that subdued inflation readings have been capping interest rate expectations, an unlikely positive interpretation could elicit a significant response as dollar short bets head for the exits. Keep in mind that any minor shift in sentiment could trigger outsized moves in thin, year-end markets

Equity Markets

For the most part, US equity markets brushed aside higher 10-year Treasury yields as the energy sector was boosted by a lift in crude following the latest US inventory data, but the spillover into forex markets has been non-existent.

Energy Markets

The DoE US inventory drawdown was more significant than expected. And sentiment remains upbeat while WTI prices continue to benefit from the Forties pipeline shutdown as pipeline repairs could drag on for a month or possibly longer.


The New Zealand Dollar

The Kiwi bounced aggressively higher on a solid last quarter GDP revision. The gradual unwind of political risk has the Kiwi is better placed to benefit from stronger economic data

The Euro

The market is ignoring any potential fallout from Catalonia elections and focusing on the yield curve and ECB chatter. The euro surged higher at yesterday’s London open, driven by a bund sell-off. But the focus was really on EURJPY which broke through multi-month highs before profit-taking set in. Not a great deal to add to yesterday’s note as eurozone money markets are steepening and given the outstanding economic prints coming out of the EU it’s easy to rationalize that the EU economy is leaps and bounds ahead of where the US economy was sitting when the Fed began to normalize. The euro should move constructively higher on this storyline.

The Japanese Yen

The USDJPY was boosted by US yields and traded tick for tick vs the UST 10-year yields. Focus shifts to today to the BoJ meeting, but frankly not much is expected although all ears and eyes will be on Kuroda’s presser. The markets expect Kuroda to reaffirm the current BoJ policy which should be slightly positive for USDJPY.

Higher US yields are keeping the dollar bears at bay. They have been much less aggressive in fading the tax reform dollar bump than expected but with no significant dollar bounce either, FX traders continue to doubt any significant economic impact of the bill

Asia FX

Asian currencies staged an impressive year-end display yesterday in the face of a resilient USD, likely taking cues from reports from the China Economic work conference which has raised expectations that regulators will ease deleveraging efforts in 2018 delivering an unexpected holiday season gift for EM Asia investors. Also, the yuan traded at 15-week highs as traders unwound long dollar bets heading into year-end, compounded by seasonal factors.

The Malaysian Ringgit

The Malaysian ringgit closed stronger but fell against regional peers. Unlike other ASEAN currencies, the KRW for example, the MYR does not see the same level of equity inflow to offset the negative from higher global yields. One of the significant headwinds for ringgit appreciation is higher US interest rates, and while the MYR is better positioned than regional peers to withstand a steeper US yield curve, holiday thinned-trading conditions have long-term investors taking to the sidelines until early 2018 which is likely tempering optimism. But the ringgit remains constructive, and one can only suspect year-end market conditions are holding the local note back from testing this year’s USDMYR lows.

The Korean Won

Local currencies were pushed higher by proprietary participants liquidating their dollar long positions after US tax reform failed to send the USD higher. According to Q4 IMM NDF rollover data, the markets were still holding long USDKRW. But with USDCNH toppling through 6.60 yesterday we could see the won drift lower given the BOK sensitivity to the RMB complex.

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