The US dollar recovers as yields inch higher (Daily analysis 22.10.2021)

The EUR/USD pair did not return above the August low and has not settled above 1.1650, with capital broadly avoiding emerging economies over the past few days.

On the global markets, the yield on US Treasury bonds clearly increased, with the yield on 10-year bonds breaching 1.70% and, therefore, was for a moment the highest since the spring. The debt market situation helped the dollar recover from several days of weakness and make up for a modest part of the downward correction of recent days.

In the face of all this, the best series of this half-year on Wall Street is coming to an end. As part of it, the S&P500 index rose yesterday for the seventh consecutive day and set new all-time highs. The fuel for the rally is the booming quarterly earnings season. Next week, companies accounting for about 50% of the index's capitalisation will report their results for the third quarter. It is also worth noting that Chinese property developer Evergrande made delayed payments of almost $85 million with a delay of fewer than 30 days (30 day grace period). Although its crisis is far from being resolved, the threats to the stability of China's financial system appear to be under control.

The pound is at risk of correction; the Norwegian krone has lost momentum

Since the beginning of the quarter, the pound has performed well, yielding only to currencies lifted by increases in oil and other commodity prices. It gained 2-3% against the euro and the dollar, and the GBP/USD pair exceeded 1.38. This movement was caused by a wave of speculation that the Bank of England may raise interest rates later this year (or even in November). This is due to the return of employment to pre-pandemic levels and piling up inflationary risks. The market has started to price in the prospect of the cost of money being raised by more than 100 bps from the current 0.1%.

Just a few months ago, it was believed that those currencies would be the strongest whose central banks were the first to be willing to abandon crisis policies. Today, it would be fair to say that the currencies that will lead the way will be those whose monetary authorities will be most able to cope with highly inflated valuations and the high-set bar of investor expectations. A scenario in which the Bank of England normalises policy long before the Federal Reserve (not to mention the European Central Bank) would be unambiguously positive for the pound. However, the recent slowdown in inflation growth from 3.2 to 3.1% y/y (and in the core index from 3.1 to 2.9% y/y) reduces the chances of a quick reaction. In addition, expectations are cooled by former members of the monetary authorities. As a result, the pound is at risk of a correction of the recent rally.

Even now, the Norwegian krone, which had rallied strongly in previous weeks, has lost momentum. The rally in oil prices has slowed down in recent days. The price of a barrel of Brent in London is backing away from the around 85 USD level. In the emerging market currencies basket, the strengthening of the ruble was interrupted for the same reasons. The forint and the Czech koruna also weakened on an almost identical scale as the Polish zloty. The Turkish lira was again heavily depreciated, this time after President Erdogan pushed through a cut in interest rates (from 18 to 16%). Since the beginning of the quarter, the Turkish currency has lost 7% against the dollar, and the USD/TRY exchange rate has just exceeded 9.50. This is nothing new: in five years, the lira's value has collapsed by two thirds.