Dollar Grows Stronger Everyday

Market Undercurrents

Core bonds are feeling the squeeze as Brent crude stubbornly remains above $100 per barrel, defying efforts to bring it down. A recent U.S. Treasury initiative to allow countries to purchase stranded Russian oil hasn't eased the pressure. The ongoing back-and-forth between the U.S. and Iran, particularly the latter's impact on supply chains, suggests oil prices are unlikely to retreat soon.

Adding to the tension, former U.S. President Trump issued a warning regarding the conflict with Iran.

The German yield curve continues its bear flattening trend, with front-end yields rising as much as 4 bps. The German 10-year yield closed at 2.96%, its second-highest level since 2011, now eyeing the critical 3% resistance level.

Across the Channel, the UK experienced a shift from bear flattening to slight bear steepening. Rising inflation expectations are beginning to impact the long end of the curve, particularly in the absence of strong monetary policy responses. UK yields saw increases ranging from 8.8 bps (2-year) to 9.6 bps (30-year).

For the first time, U.S. Treasuries are also facing significant selling pressure at the front end. U.S. money markets are starting to price out potential rate cuts for the year. The U.S. yield curve bear flattened, with yields increasing from 0.3 bps (30-year) to 9 bps (2-year).

Technically speaking, the 2-year yield has broken through the 3.6% resistance, a barrier that had contained trading since September of last year. This breakout coincides with a longer-term downward trend line and the 200-day moving average, marking a technically significant development.

Dollar's Dominance

The dollar's strength is becoming increasingly pronounced. The trade-weighted dollar index has moved past its year-to-date high of 99.70 and is now targeting the November peak at 100.40. This morning, the EUR/USD pair breached the 1.15 level, with the August low at 1.1392 now the next key target. A weaker euro further complicates matters for the ECB, potentially exacerbating upward inflation risks ahead of their upcoming meeting.

The USD/JPY pair has returned to January levels, trading just below 160, a level that previously triggered rate checks by the NY Fed and discussions of potential coordinated interventions. Currently, only verbal warnings are emanating from Japan.

Risk sentiment is suffering as a result of the ongoing conflict. Key European indices experienced losses of 0.5% to 1% yesterday, while losses in the U.S. exceeded 1.5%.

These underlying market dynamics high oil prices, rising interest rates, a stronger dollar, and weaker equities are expected to persist into the weekend.

Today's economic calendar includes January PCE deflators, where goods inflation will be closely watched. The University of Michigan's March consumer survey could prove to be more impactful from a market perspective. Interviews conducted leading up to the release suggest inflation expectations could be influenced by the Middle East conflict, potentially further dampening bond sentiment. January durable goods orders and JOLTS job openings will also be released today, but are expected to take a backseat.

Geopolitical Risks and Financial Stability

Rating agency S&P has cautioned that a sustained increase in energy prices could lead to a downgrade of Hungary's credit rating. Hungary currently holds a BBB- rating with a negative outlook (confirmed in October). A downgrade would result in the country losing its investment grade status. S&P analysts suggest that a gas price surge similar to 2022 could significantly deteriorate Hungary's current account, increase inflation, and dramatically depreciate the forint, putting pressure on fiscal indicators and the country's rating.

The risk of a downgrade is compounded by pre-election fiscal stimulus measures, which are expected to have a longer-lasting fiscal impact than those implemented in 2022. Hungary's budget deficit reached HUF2.1tn by the end of February, already 40% of the full-year target. The next S&P rating review is scheduled for May 29.

Fed vice-chair Michelle Bowman announced that U.S. banks will receive relaxed capital proposals from regulators in the coming week. While adopting the final package of Basel III rules would result in a slight increase in capital requirements, Bowman indicated that other proposed changes to surcharges for global systemically important banks would more than offset that. The reform package aims to encourage bank lending and reverse the trend of mortgage activity being increasingly handled by non-banks.

What Smart Money Is Watching

This confluence of factors creates a challenging environment for investors. The strong dollar puts pressure on emerging markets and companies with dollar-denominated debt. Rising yields impact fixed-income portfolios, and volatile equity markets demand a cautious approach. The oil price surge adds inflationary pressure, complicating central bank policies.

Several asset classes are directly affected:

• EUR/USD: Further downside pressure is likely as the dollar strengthens.
• USD/JPY: Monitor for intervention risks as the pair approaches key levels.
• Brent Crude: Geopolitical developments will continue to drive price action.
• Emerging Market Currencies: Expect increased volatility and potential depreciation against the dollar.

  Traders should closely monitor geopolitical developments, central bank communications, and key economic data releases. Risk management is crucial in this uncertain climate. Consider hedging currency exposure and diversifying portfolios to mitigate potential losses. The 3% level on the German 10-year yield and the 100.40 level on the dollar index are key levels to watch for potential breakouts.