Will uncertainty about the seriousness of the US to fulfill its debt obligations harm the dollar?

Outlook: This is a week you can go mad trying to absorb and understand so much data. It seems improbable, but Japan is front and center. Japan reports CPI on Friday, but before then, we get the Bank of Japan updated economic forecasts and any fresh changes to the monetary policy regime on Wednesday. The WSJ reports “The 10-year JGB yield could rise as high as 1% if the BOJ abandons yield curve control this week, according to estimates by Daiwa Securities strategist Eiichiro Tani. But he said the yield would likely decline toward the latter half of 2023 owing to the slowing economy and declines in global interest rates.”  

Adding to the sense of crisis, Reuters reports there are rumors of a BoJ emergency meeting today “as it struggles to defend its new yield ceiling in the face of massive selling, sending the dollar to a seven-month low.” 

 We say abandoning curve control would be out of character for the BoJ after it modified it only a few weeks ago. Allowing a giant move from 25 bp to 1% in under a month is too wild for any central bank, let alone the staid BoJ. So, abandonment is almost certainly out of the question, but that doesn’t mean the market will not be expecting it and testing prices, forcing the bank to buy more bonds. We expect a whole lot of backroom arm twisting.

Reuters reports the pressure is already on full-bore. “… speculation is rife [the BoJ] will make changes to its yield curve control (YCC) policy given the market has pushed 10-year yields above its new ceiling of 0.5%. The BOJ bought almost 5 trillion yen ($39.12 billion) of bonds on Friday in its largest daily operation on record, yet 10-year yields still ended the session up at 0.51%. Early on Monday, the bank offered to buy another 1.3 trillion yen of JGBs, but the yield stuck at 0.51%.  

“‘There is still some possibility that market pressure will force the BOJ to further adjust or exit the YCC,’ JPMorgan analysts said in a note. ‘We can’t ignore this possibility, but at this stage we do not consider it a main scenario.'”

In other words, Japan and its central bank would no doubt prefer to appear dignified and in control.  

As for the rst of the world, also on Friday are the US PCE price indices, generally far lower than the CPI we just suffered through, but by how much this time? We also get housing prices and starts, consumer confidence, new home sales and durables. Canada reports the biggies–retail sales (Tuesday), CPI (Wednesday), and GDP (Friday). The eurozone reports preliminary consumer confidence tomorrow.  

To disrupt the flow of data that is what we are supposed to watch for FX influences, we get a ton of political hoo-ha, including the debt ceiling talk in the US, Biden’s classified papers, important Russians criticizing the conduct of the war (and not standing too close to windows), and ongoing worries about Covid in China. So far the one happy note is that the Chinese health service says it hasn’t found any scary new variants.

Unless there is some weird surprise from left field, sentiment focuses on US inflation falling nicely, allowing the Fed to do 25 bp on Feb 1, not 50 bp, and perhaps starting talk of a soft landing again. On Wednesday we get the Beige Book and also the Atlanta Fed’s GDPNow, last at a boomy 4.1% in Q4. This raises the issue of which is more important to FX traders, hawkishness and yields or growth? History tells us traders neglect growth and favor crystal ball readings of central bank intentions. If that’s what we have now, the dollar can continue to slide downhill, with the usual pushbacks fairly minor and little sign of profit-taking.  

Almost half of our Readers are not in the US, so may not be familiar with the reason for today’s holiday honoring Martin Luther King, Jr. He said “I have a dream” of racial equality. Equally quoted is:

“The arc of the moral universe is long, but it bends toward justice.”  

Tidbit: The Economist opines that China’s reopening will be the biggest economic event of 2023. Prominent among effects will be Chinese demand for commodities, including oil–and gas. Brent oil can easily go back to $100. Natgas can easily eat into Europe’s now-absolute need to buy it before next winter.  

Tidbit: On Saturday, the UK announced it will send Ukraine tanks, after France, Germany and the US said they will send armored fighting vehicles, whatever those are. It seems clear that plenty of stuff is needed that is non-military–plumbing supplies, stove and refrigerators to replace those the Russians bombed to smithereens. No information on that side of things. Meanwhile, we make fun of Elon Musk but the fact remains that his Starlink satellites–hundreds of them–are what is keeping Ukrainians wired to one another and the world.    

Tidbit: The House playing with the debt ceiling is becoming a real worry. One idea is that they will “prioritize” spending items like Social Security and the military, but not fund the rest–as though that would not result in default and break “full faith and credit.” Newscasters everywhere are calling the Republicans stupid, incompetent and just plain asinine. Government financial professionals like TreasSec Yellen are more polite.  

We suggest bringing them all into one room, playing an educational lecture on the sovereign bond market thousands of times, and not letting them out until they pass the bill. Yellen has some tricks up her sleeve to keep the ball rolling, but in the end, the House must relent or bring down the roof. Technically this doesn’t happen until June, but of course the effects of failure will be seen well ahead of time.

Is it worse this time than other times? Yes, because the divisiveness is more toxic and some of the players are just plain crazy, whereas in past incidents, they did have a strategy. For FX, will uncertainty about the seriousness of the US to fulfill its debt obligations harm the dollar? It should, but it hasn’t in the past. Maybe this time will be different.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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