The Daily Prophet: Dollar Looking Up, Bond Fuss and China

Robert Burgess is editor of Bloomberg Prophets.
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With all the talk about a strong dollar, it's hard to believe that this was the first time this year that the greenback posted back-to-back gains. Although the cumulative 0.5 percent jump in the Bloomberg Dollar Spot Index is minuscule, some strategists say the factors that weighed on the currency in January, when the index fell 2.61 percent, are starting to dissipate.

Among the tailwinds for the dollar are Federal Reserve officials who doing their best to make investors believe that the March policy meeting is "live,'' and that an interest-rate increase is possible. Also, Citigroup Inc. says the continued drop in China's foreign-exchange reserves may limit commodity imports, hitting emerging-market currencies to the benefit of the dollar. Finally, Europe's political situation, led by France, looks increasingly uncertain.

"There is nothing directly (dollar) positive right now, but very concentrated position unwinds leave it vulnerable to the upside on any good news, whether on fiscal policy, growth or the Fed,'' Steven Englander, Citigroup's global head of Group of 10 currency strategy, wrote in a note to clients. "By contrast, the plusses for currencies abroad seem to be fading, so we may end up with some (dollar) bounce by default, or continued stalemate at worst.''

China is having trouble stopping the slide in its foreign-exchange reserves despite new efforts to stem the flow of capital out of the country. The People's Bank of China said reserves dipped just below the psychologically important $3 trillion level in January, falling to the lowest since early 2011 after the yuan capped its steepest annual decline in two decades. The central bank's intervention in foreign-exchange markets drove the drop, as did seasonal factors such as high demand for other currencies during the weeklong Lunar New Year holiday, the State Administration of Foreign Exchange said in a statement. Further erosion may prompt policy makers to again tighten measures for controlling outflows and on companies transferring money to other countries. 

What's all the fuss about inflation? The one group that should be worried the most is showing almost no concern. That can be seen in demand for Strips, or securities created by stripping the interest and principal payments from Treasuries and selling them separately. Data just released by the Treasury Department show $239.9 billion of Strips were outstanding at the end of January, a new record. The 2.6 percent monthly increase was the biggest since June. Strips are more sensitive to changes in the outlook for inflation because they have a greater duration than regular Treasuries, meaning they suffer steeper losses when rates rise.

Maybe the drop in oil has a lot to do with bond traders' complacency toward inflation. Crude has fallen to the lowest in more than two weeks amid estimates that U.S. inventories continue to climb. Crude stockpiles probably rose for a fifth week while gasoline supplies approached a record, according to a Bloomberg survey before an Energy Information Administration report on Wednesday. While OPEC implements pledged cuts and Russia says its own reductions are ahead of schedule, U.S. production has risen as drillers boosted rig counts to the most since October 2015.

Evidence is mounting that investors have very little confidence in U.S. stocks following the big surge in the weeks after Donald Trump's election. Not only has the S&P 500 been stuck in one of its tightest trading ranges over the last six weeks, but borrowing to buy equities has a long way to go before signaling "animal spirits," Jefferies Group LLC chief global equity strategist Sean Darby said in a report. Darby cited the New York Stock Exchange's data on margin debt, which has yet to break a February 2015 record of $507 billion. December's total of $489.5 billion was 6.1 percent higher than a year ago, far below a peak of 38 percent growth in July 2013, according to Bloomberg News's David Wilson.


So far, so good. There are few days more important to the bond market than those when the Treasury Department auctions notes and bonds. This week, the government is selling $62 billion of three-, 10- and 30-year securities in its quarterly refunding. In today's auction of three-year notes, a class of bidders that includes foreign investors bought 57.2 percent of the $24 billion of securities offered, the most since May. That's a good signal because foreigners led by China had pulled back from U.S. debt in recent months. The auctions continue tomorrow with the sale of $23 billion in 10-year notes.     

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