Bonds Skittish ahead of Fed

US 2-year yields rose to the highest level since 2011 on Tuesday as a solid retail sales report caused speculation about hawkish talk from the Fed. The kiwi was the top performer in a late rally while the Swiss franc lagged ahead of Thursday's SNB decision. The BOJ monthly economic report is due later but the Asia-Pacific schedule is light. A new note and set of charts has been issued for the existing DAX Premium trades.

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US retail sales have improved at an impressive clip over the past few months and it continued with a good report for August. Sales excluding autos, gas and building supplies were up 0.4% compared to 0.3% but the better news was in the July data where that metric was raised to +0.6% from 0.3%. It was part of a larger set of upward revisions that has pushed the annualized pace of retail sales growth over the past 3 months to more than 5%.

The US dollar was slow to react at first but eventually pushed to substantial gains, especially against the yen and pound. USD/JPY rose to 120.50 from 119.50 while the pound sank to 1.5340 from 1.5400.

A big part of the dollar climb was due to a major push higher in yields. Across the curve, they were up 8-11 basis points. Short-dated Treasuries are the most sensitive to interest rates so it was particularly interesting that 2-year yields rose to the highest in 4 years.

We're not sure it argues for a higher chance of a Fed hike on Thursday but it definitely raises the risk of some hawkish talk from the central bank. US inflation is seen emerging via: 1) job market tightening, something that's largely been played out; 2) workers feel more confident in jobs and economic prospects so they spend more 3) rise in wages; 4) rise in prices.

If the Fed believes the second stage has been reachedm then it will gain confidence that the US economy is firmly on the path to #4.

The danger for the US economy is that the strong dollar snuffs out exports, inflation and manufacturing jobs to undercut the recovery. The Empire Fed and industrial production numbers both missed estimates Tuesday in a sign that will encourage Yellen to wait and see.

Looking towards Asia-Pacific trading, the calendar is light. The highlight is the BOJ monthly report for September at 0500 GMT followed by final revisions to the Japanese machine tool orders report an hour later.