The dollar continued to rise today, with the index up about 60 bps to 98.45, extending yesterday’s gains. It also pushed above relative strength index resistance around 51, signaling that bullish momentum is building and a trend reversal is underway. The dollar could very well climb to around 100, where it would test the summer highs. That will be the point at which we learn whether this move is genuine or just another fake-out.
Also helping to push the dollar higher are rising rates, with the 10-year climbing nearly 3 bps today to finish at 4.17%. The PCE report tomorrow could play a role in whether this momentum continues. Core PCE is expected to rise by 0.2% m/m and 2.9% y/y. I asked ChatGPT to estimate the outcome based on CPI, PPI, and import prices, and it suggested core could come in between 0.2%–0.25% m/m and 2.9% y/y. Meanwhile, Grok sees core PCE at 0.3% m/m and 3% y/y. It seems like a fun experiment to compare.
Regardless of PCE, the 10-year rate is likely to rebound further because the curve simply remains too flat, with the 3-month Treasury at 3.99%. A move back to 4.3% on the 10-year, based purely on technicals, looks like a reasonable near-term target.
Higher rates and a stronger dollar should make dollar funding costs more expensive as interest rate differentials narrow. This will add to the existing headwinds for liquidity, which is already tightening due to falling reserve balances and higher overnight repo rates. One useful gauge of these conditions is the USDJPY 5-year cross-currency basis swap, which tracks shifts in dollar funding. At the moment, there hasn’t been a change in trend, but it’s hard to imagine conditions staying this easy for much longer.
Speaking of overnight repo rates, today the average rate was 4.21%, which is near the upper end of the Fed Funds target range of 4.00% to 4.25%. With quarter-end approaching, reserve balances draining, and Treasury settlements ahead, it’s possible that institutions may tap the Standing Repo Facility before September 30.
Speaking of reserve balances, those fell to $3.0 trillion as of 9/24, down from $3.02 trillion last week. Reserves should continue to move lower into quarter-end on September 30, with the extent of the decline depending on how much activity the Reverse Repo Facility absorbs between now and then.
None of this is good for risk assets. The S&P 500 gapped below the 10-day exponential moving average, and the longer it stays below that level — and the further it moves away — the greater the likelihood that we are witnessing a significant market top that could persist, especially if liquidity conditions continue to tighten.
-Mike
Glossary by ChatGPT
Basis Swap: A derivative contract exchanging floating interest payments in different currencies or benchmarks to manage funding risk.
bps (basis points): A unit equal to one-hundredth of a percentage point, commonly used to express changes in interest rates or yields.
Core PCE (Personal Consumption Expenditures Price Index): A measure of inflation that excludes food and energy prices, closely watched by the Federal Reserve.
Curve (Yield Curve): A graph showing the relationship between interest rates and maturities of government bonds.
Exponential Moving Average (EMA): A technical indicator that assigns greater weight to recent prices to track trends more sensitively.
Fake-out: A market move that appears to confirm a trend but quickly reverses, trapping traders on the wrong side.
Fed Funds Target Range: The interest rate range set by the Federal Reserve for overnight lending between banks.
Overnight Repo Rate: The interest rate at which institutions borrow cash overnight by pledging securities as collateral.
Relative Strength Index (RSI): A momentum oscillator measuring the speed and change of price movements to identify overbought or oversold conditions.
Reserve Balances: The cash deposits that commercial banks hold at the Federal Reserve, used to meet reserve requirements and manage liquidity.
Reverse Repo Facility: A Federal Reserve tool allowing counterparties to lend cash overnight in exchange for securities, absorbing excess liquidity.
Standing Repo Facility: A permanent Federal Reserve facility providing overnight loans to eligible institutions against high-quality collateral to stabilize funding markets.
Treasury Settlement: The process of delivering U.S. Treasury securities to buyers and receiving payment, which affects system liquidity.
USDJPY 5-year Cross-Currency Basis Swap: A measure of the cost difference between borrowing in U.S. dollars and Japanese yen over five years, reflecting dollar funding conditions.
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