With US dollar hedging costs high, EUR/USD closer to fair value and the ECB story on hold, European corporates may be reconsidering their high hedge ratios on USD receivables
We may be a little premature in discussing this topic, but in speaking to some customers we are getting a sense that high US dollar hedge ratios are being reconsidered. In other words, corporates are possibly becoming less convinced about a further large dollar decline and, where hedging mandates allow, over coming months could be scaling back some of their more aggressive USD hedging.
While most corporate FX hedging decisions do sit within clear mandates, there is typically a little room for discretion. For example, when EUR/USD was below 1.10 in late 2016 and early 2017, larger European corporates typically held the view that the USD was overvalued (most fair value readings were in the 1.25 area) and that hedge ratios on expected USD receivables should be higher, e.g. closer to the top end of the 50-100% range and should cover longer tenors. Here, treasurers made special requests from the board to extend the horizon for USD hedging.
The sharp 2% bounceback in the broad US dollar index has raised some eyebrows and led to questions whether this is a new trend. But FX positioning data shows this has all the hallmarks of being another short USD squeeze - which has historically been short-lived
US GDP readings for the first quarter are by far the weakest in any given year. Given our 2.4% forecast for 1Q18, this trend suggests 2018 will be fantastic
As with most economic data, GDP is also seasonally adjusted to take account of the influence of things such as predictable weather patterns, school term dates or national holidays. For example, severe weather in the winter means construction work grinds to a halt while consumer spending typically gets a lift in the build-up to Christmas. Economists prefer to try and eliminate these patterns to make it easier to observe the "true" underlying cyclical trend.
Yet, looking at quarterly GDP growth rates, there is a clear pattern of underperformance in the first quarter of a year. Going back over 30 years, we find the average quarter on quarter (QoQ) annualised growth rate for a Q1 is 1.7% versus 3.2% for Q2 and 2.5% each for Q3 and Q4. Since the start of the financial crisis, the problem seems to have worsened with Q1 averaging 0.17% versus 2.4% for Q2, 1.9% for Q3 and 1.4% for Q4. Seasonal adjustment means Q1 growth should not be consistently different from any other quarter, so there is clearly some "residual seasonality".
Has the US 10-year Treasury yield peaked? We’re not convinced and think it's likely to breach 3%, possibly within the next few weeks
Getting a good steer on the US 10yr Treasury yield is important, for a few reasons.
It is the global benchmark market rate; movements in it cause reverberations across rates and bond markets extending from core rates to corporates and emerging markets. Crucially, it also provides a long-term nose for where the Fed funds rate may eventually converge towards (compensated by term premium). So, it matters.
The big question is, has the 10yr rate peaked? We’re not convinced it has. Currently, 2.98%, we expect it to cross 3% perhaps within the next few weeks, with fundamentals, positioning and technicals as the key drivers. We employ our model for interest rates, to get an unbiased handle on a fair valuation of market rates.
The US yield curve keeps getting flatter with growing concern it could turn negative. Such a development preceeded all nine recessions since 1955. How worried should we be?
The US yield curve is currently the flattest it has been for a decade. With the Fed looking set to hike rates another three times this year a growing number of voices are warning we could soon see the yield curve actually invert, meaning it is cheaper for the government to borrow over ten years that it is over 2 years. This is a huge story. When the yield curve has inverted previously it’s been an early warning signal of impending doom - the US has typically fallen into recession within 2 years.
The 10-year Treasury yield has finally hit 3% after four years, the dollar rally is showing all the hallmarks of a short squeeze, European companies might be scaling back some of their more aggressive dollar hedges and we still expect the Fed to hike three times this year with a further two, possibly three in 2019