Given all of the unprecedented developments over the past year, it shouldn’t be a surprise that the U.S. election saga delivered one last twist in January, giving the Democrats the narrowest of margins in the Senate. As such, market focus is now on how much fiscal stimulus the Biden administration will be able to deliver and what impact additional stimulus will have on potential U.S. exceptionalism and the increase in yields. To this point, expectation for more fiscal spending has pushed U.S. 10-year yields up roughly 20 basis points higher on the year, with the U.S. dollar also higher, but in index terms, to a lesser extent than the move in rate spreads.
Regarding fiscal spending, President Biden’s $1.9 trillion fiscal plan that will be followed by an infrastructure package came out earlier and higher than most people expected. While the expectation is that moderates, who now hold the ability to sway the outcome, will push for a smaller package, the final plan should still be big enough for further upside on U.S. growth and yields. As a result, U.S. dollar weakness in 2021 should be less uniform and less forceful than what we saw last year following the initial sharp rebound in growth. Furthermore, a U.S.-led rebound in yields should become an increasingly likely risk factor toward the back half of the year. Looking ahead, there are two primary factors that have offsetting implications on the U.S. dollar to keep an eye on.
The first factor is the tug-of-war between the U.S. yields moving higher against the Fed’s desire to maintain an accommodative stance. Clearly the risk from fiscal spending is to the upside for U.S. growth and rates. As such, the issue of higher U.S. yields should continue to linger over the markets as fiscal negotiations unfold and especially as we move closer to Fed tapering. Given this, it’s still premature to call an end to near-term U.S. dollar weakness on this argument alone, as the absolute level of U.S. real yields remains very low and a highly accommodative Fed is very likely to remain patient on its asset purchasing pace.
The second factor is the global recovery outside the U.S. that should determine broad U.S. dollar direction. Thus far, growth metrics outside of the U.S. remain strong, with aggregate rest-of-the-world growth being revised up modestly. However, increased infection rates and renewed lockdowns are a persistent source of tension to a full global recovery, as seen by a pullback in mobility data, especially in Europe.
Bottom line: Positioning for a global rebound remains prudent but earlier-than-expected focus on rising U.S. yields makes the case for selective rather than broad-based U.S. dollar weakness. | |
| HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: | |
- Joe Biden will be sworn in as the 46th president today, and Kamala Harris will become the nation’s first female vice president. As president, Biden will hit the ground running by issuing a series of executive orders that include, but are not limited to, rejoining the World Health Organization and Paris climate accords, stopping the border wall construction, revoking the permit for the Keystone XL pipeline, imposing a mask mandate on federal property and ending a travel ban on some mainly Muslim countries. Biden is also expected to extend the moratorium on student loan payments, foreclosures and evictions and send immigration reform to Congress.
- Janet Yellen, at her confirmation hearing, pushed back against a weak dollar policy and reaffirmed her commitment to market-determined exchange rates where comments on the dollar are limited and measured. This is a return to a pre-Trump norm that has been around for decades under both Republican and Democratic administrations.
- The Bank of Canada (BoC) left its policy rate and QE program unchanged. Additionally, the bank issued guidance that was stronger and more secure than in the October projection.
- In Italy, Prime Minister Conte won votes of confidence in both houses of parliament, but he fell short of an outright majority in the Senate. Conte will now meet with President Mattarella to discuss his options going forward. Conte will likely be given two weeks to build a new coalition, with reports indicating a new group of senators preparing to announce support for Conte as soon as today.
- The German government has extended its lockdown period from the end of January to mid-February. Non-essential businesses will also be closed, with a border closure also possible.
- The People’s Bank of China left its policy rate unchanged as widely expected. With China’s economy continuing to perform, market expectations for a removal of accommodation are rising. Thus far Chinese officials have stressed the desire to support growth, so any change in policy stance should be slow and well telegraphed.
- A new study shows that the Pfizer-BioNTech vaccine remains effective against the new strain of the COVID-19 virus found in the U.K.
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