US stocks dropped for the third day in a row, adding pressure on carry trades. Interestingly enough the US dollar rebounded strongly today as 10 year yields shot to a 10 month high above 5 percent.
Traditionally when stock prices fall, bond prices rise (yields fall) as investors rush to safety of bonds. Today however both stocks and bond prices fell in tandem which only happens when the market needs to reprice rate hike expectations. This is the first time in almost a year that the entire yield curve is normalized and above 5 percent. Federal Reserve officials refuse to downgrade their degree of hawkish which is nothing new. What triggered the latest move in the markets was actually the jump in oil prices. Refinery shutdowns and a cyclone in the Middle East sent oil prices to a 9 month high today. With inflation creeping back into the picture, there is now a next to zero chance that the Federal Reserve will be cutting interest rates this year. In fact, the futures curve is pricing in a greater chance of a rate hike than a rate cut at this point. In a yield seeking world, higher rates or at least the prospect that rates will remain unchanged is of course positive for the dollar. The stock market however does not like higher interest rates because it hurts corporate profitability. So keep watching the Dow as it will continue to be the biggest driver of price action in the currency market. As for data, jobless claims continued to remain low while wholesale inventories dropped slightly. The trade balance is due for release tomorrow. We expect the weak dollar to help reduce the trade deficit by more than the 0.3B improvement that the market is currently looking for.