Powell to set the tone for a more optimistic US outlook

DBS FX/Rates Overnighter and Day Ahead - Philip Wee, FX Strategist, DBS Bank and Eugene Leow, Rates Strategist, DBS Bank

FX

Fed Chairman Jerome Powell's semi-annual testimonies to US lawmakers today will set the tone for the US dollar and currency markets. The euro has been vacillating around 1.23 since 22 February. As the largest component in the global benchmark US dollar Index, the euro has, together with a US 10-year bond yield below 3%, capped the upside for the DXY Index at 90. To extend the recovery in the US dollar, Powell needs to set the stage for the Fed to upgrade its economic outlook at its next FOMC meeting on 21 March, affirm the stance for US inflation to rise towards its 2% target this year, and open the door for the Fed to consider a gradual path of one hike per quarter.

The euro, meanwhile, will not receive a boost from the European Central Bank (ECB). Consensus is looking for tomorrow's Eurozone CPI estimate for February to retreat, for a third straight month, to 1.2% YoY from 1.3% the previous month. ECB President Mario Draghi told the European Parliament yesterday that economic slack may be larger than initially thought, and that inflation needs continued monetary stimulus to return inflation to its 2% target. This has lowered the odds for the ECB to tweak its guidance for a policy shift at its next governing council meeting on 8 March. Until it is sure that the euro will not push above 1.25 towards 1.30, the ECB will not want to confirm that its asset purchase programme ends in September, and will instead, keep the door open for another extension to December.

30Y SGS auction fared well

The 30Y SGS auction fared reasonably well considering heightened concerns over duration risks. The cuffoff yield stood at 2.94% (average 2.89%) with a bid-to-cover ratio of 2.20. Demand improved from the previous 30Y auction in 2017 where the bid-to-cover ratio was lower at 1.57 (cutoff yield 2.55%). A combination of factors likely contributed to auction demand. Since the start of the year, 30Y SGSs have cheapened by 47bps (more than the 10Y tenor) in the lead up to the auction. With the 10Y/30Y segment of the curve looking steep, 30Y SGSs offers relative value versus 10Y SGSs. Compared to the UST curve, the 30Y tenor of the SGS curve also appears to be the most attractive. It also helped that 30Y UST yields were stable on Friday.

The 30Y tenor may outperform the 10Y tenor in the coming few months. With the 30Y auction out of the way, the market will be focusing on the 10Y issue in April. We reckon that the 10Y tenor is rich and investors may be willing to extend duration to the 30Y tenor to get an extra 50bps pickup (levels not seen since mid-2016). Beyond the immediate few months, we think that the upcoming supply of infrastructure bonds will weigh on SGSs (see here). We suspect that these bonds are likely to be in the 10Y-20Y tenors (depending on the expected completion time). Accordingly, these issuances are likely to weigh more heavily on 10Y SGSs. 30Y SGSs (with yields already close to 3%) may be able to sidestep the worst of the impending supply overhang.

Source : Equity Bulls

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