Surge in US Yields Fails to Take USD Higher

China data helps improve global growth sentiment

China has seen a series of troubling developments in recent months, particularly originating from its real estate sector, which has significantly dampened investor confidence. This trend intensified during the summer as conditions in the property market worsened. However, today's release of China's real GDP data presents a glimmer of hope for those concerned about the economy's ability to withstand the adverse effects of the real estate downturn.

In the third quarter, China's real GDP expanded by 4.9% year-on-year and by 1.3% quarter-on-quarter, driven by an upswing in consumer spending. This data strongly suggests that the government's policy support measures are starting to take effect, making the 5.0% real GDP growth target for 2023 seem attainable. Notably, retail sales growth accelerated from 4.6% year-on-year in August to 5.5%, offering a substantial counterbalance to the real estate sector's weakness. Meanwhile, property investment took a further hit, declining from -8.8% to -9.1% year-on-year.

The positive data did initially lead to a notable drop in the USD/CNY exchange rate, moving from approximately 7.3120 to a low of 7.2980. However, much of the initial optimism sparked by this data has since reversed. The shadow of uncertainty looms large over Chinese property stocks, particularly with the Country Garden issue still unresolved and the spectre of a potential formal default looming. In fact, a Bloomberg index tracking Chinese property developer shares today reached a level not witnessed since 2009. As a result, the broader Chinese stock market is down today, exerting pressure on authorities to take further action to mitigate the anticipated negative impact on economic growth arising from the real estate downturn.

At its zenith, the real estate sector accounted for 25% to 30% of China's GDP growth. Now, the challenge is to replace this lost economic activity, and the sustainability of consumer-driven growth remains in question.

Nevertheless, in the short term, financial markets perceive a silver lining in the data—indicating that China's economy may be stabilizing, or even modestly strengthening. This perception plays a crucial role in curbing the ongoing appreciation of the US dollar, especially in a global environment marked by weak growth prospects. Small shifts in the global macroeconomic landscape can have a significant impact on momentum, especially when the dollar is seen as overvalued.

Resilience in the face of surging US yields

The recent price action in the foreign exchange market has been quite intriguing. Despite the release of a robust US retail sales report and a surge in US yields, the US dollar unexpectedly weakened. This deviation from the usual market response has raised eyebrows. The 2-year US Treasury (UST) bond yield, for instance, shot up by 14 basis points to reach a new cyclical high of 5.24% on the previous day. Normally, such a spike in yields would have spurred a strengthening of the US dollar. However, the DXY index, which initially saw a modest uptick following the retail sales data, subsequently fell by 0.5%, closing 0.2% weaker compared to the previous days open. This is particularly noteworthy considering the escalating tensions caused by the hospital bombing in Gaza, which led to higher crude oil prices today.

The lack of a straightforward explanation for this unusual dollar behaviour has left market participants puzzled. Some suggest that there may have been position liquidation ahead of a deluge of important data from China, with speculation that the results could surpass expectations. Additionally, recent developments have contributed to the dollar's lacklustre performance. The release of minutes from the Reserve Bank of Australia (RBA) suggested a greater likelihood of another rate hike, while European Central Bank (ECB) officials voiced concerns about rising energy prices and the associated risks to inflation. While short-end yields did increase in Germany, the magnitude was not as pronounced as in the United States.

Another factor potentially eroding the US dollar's positive momentum is the heightened attention on political gridlock in Washington. This gridlock is increasingly pointing towards a government shutdown expected to commence on the 17th of November. Representative Jim Jordan's failed bid to become House Speaker, coupled with irreconcilable divisions among 20 staunch Republicans, has impeded progress in passing budget legislation. These political uncertainties could further discourage investors, leading to the liquidation of long US dollar positions.

In summary, the recent dynamics in the foreign exchange market, characterized by the dollar's surprising weakness despite favourable economic indicators, are perplexing. It is unclear why the dollar has failed to respond in its typical fashion, but it may encourage continued selling as momentum traders seek to reduce their long positions.

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