Intraday Market Thoughts

Dollar Yield Differential Crumbles

by Adam Button
Mar 5, 2020 22:38

Equity indices fell by more than 3%, but it was the damage to the US dollar that gets our attention as the USD yield advantage crumbled further. The yen was the top performer while AUD and CAD narrowly underperformed USD. US non-farm payrolls is due up on Friday, but it will have little relevance as it captures no effect from the Corona virus. Meanwhile, the jump in the 10-2 spread is a typical occurence of an economy nearing recession after inversion. As the USD yield differential becomes fashionable,  Premium members got an FX trade last Friday, based on 20-year cyclical time lags in FX-yield spreads, currently more than 200 pips in the green.

اليورو و الداو: الركوب او الانتظار؟ (فيديو المشتركين)

The virus reasserted itself as a dominant headwind for risk assets on Thursday and prompted a rush into safe-haven bonds and gold. US 10-year yields fell 13 basis points to 0.92%, just shy of the weekly low.  The front end hit a new low with 2s touching 0.55% in the continued remarkable fall from 1.4% just two weeks ago.

That huge drop has deeply eroded the US dollar's yield advantage even as other central banks ponder easing. Given the high volatility in markets, carry trades are also more risk than market participants want to take. Those factors underpinned the continued rebound in EUR/USD and a fresh fall in USD/JPY to below 106.00.

With safe-haven yield now essentially extinct, gold is shining more brightly than ever. Last week's drop has been erased and the close on Thursday was a cycle high. There remains the risk of isolated liquidation as risk assets crumble but the extreme uncertainty around the virus makes gold particularly attractive.

Everyone is focus on the virus itself but the lasting impact is more likely to be the political and social faults it exposes. India's central bank took over its fourth-largest private bank on Thursday and Delhi shut down primary schools due to virus fears. The mix of political instability, extreme population density and a developing-world heathcare system is a massive risk in India and it was already grapping with slowdown before the virus. Whether it's there or somewhere else, a global pandemic is sure to topple some governments and gold-buying will be one response.

Looking ahead, the non-farm payrolls report along with Canadian jobs are due. All economic data does at the moment is set a baseline to measure how hard coronavirus hits when we get March numbers and beyond. Interestingly, BoC president Poloz hinted Thursday that they may have cut anyway even without the virus, so there may be a negative surprise in the Canadian number, and that could put some pressure on CAD.


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