Rising US Yields Continue to Offer More Support for the USD

USD: China currency support and higher US yields

Overnight, the foreign exchange market exhibited stability, with most major FX pairs showing minimal changes. The USD/CNY pair, which reached a peak of 6.3155 during the previous day, retraced below the 6.3000 mark in the overnight trading session. Reports from Bloomberg indicate that China is intensifying its efforts to curb the depreciation of the renminbi by elevating funding costs in the offshore market. This strategy aims to put pressure on short positions while the Chinese central bank (PBoC) continues to establish daily reference rates that are stronger than anticipated. Notably, the PBoC set the daily reference rate at 7.1992, contrasting with Bloomberg's survey average of 7.3103.

Bloomberg's sources reveal that funding costs in offshore markets have risen in recent days due to local banks' reluctance to provide more currency in the swap market. Consequently, this has led to a substantial surge in renminbi one-month forward points—marking the most significant increase in offshore trading since 2017. Although these measures are effectively moderating the pace of renminbi depreciation in the short term, their potential to fully reverse the trend of weakening is limited until there is a substantial enhancement in investor confidence regarding China's economic prospects.

LONG-TERM US YIELDS CONTINUE TO MOVE HIGHER

Source: Bloomberg, Macro bond & MUFG GMR

At the commencement of this week, another notable development in the market has been the ongoing decline in the long end of the bond market. The yield on the 10-year US Treasury bond surged to a fresh peak of 4.36% overnight, surpassing last year's November high of 4.34%. This recent upward adjustment in long-term US yields has coincided with a robust resurgence of the US dollar. From its intraday low of 3.94% on August 10th, the 10-year US Treasury yield has risen by slightly over 40 basis points in the past few weeks. Concurrently, the dollar index has advanced by approximately 1.5%. Notably, the increase in US yields has been primarily influenced by the longer end of the yield curve, while shorter-term yields have remained relatively stable, resulting in a bearish steepening of the curve.

Over the past couple of months, there has been a noteworthy string of positive surprises in US economic data, quelling concerns of a more pronounced slowdown in the US economy. This positive trend is reflected in upward revisions to the US economic outlook. The consensus forecast for US GDP growth this year, according to Bloomberg, has nearly doubled, rising from around 1.1% in early June to its current 2.0%. The US economy's resilience in the face of higher interest rates has consistently caught market participants off guard, leading them to scale back their expectations for future rate cuts. The implied yield on the December 2024 Fed Fund futures contract has increased by approximately 35 basis points to 4.41%, compared to the low earlier this month.

Despite the recent adjustment in rate cut expectations, market participants are still anticipating a reduction of around 100 basis points in the coming year. This projection is based on the anticipation of a more significant slowdown in US inflation than initially expected and the delayed effects of monetary tightening. These factors are likely to create space for the Federal Reserve to implement less restrictive policies in 2024. However, in the short term, the US dollar is finding support from the resilience of the US economy and the elevated long-term US yields.

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