USD backed by surge in yields - Westpac

According to Sean Callow, Research Analyst at Westpac, it turns out the rise in the US 10 year Treasury note yield that began on 18 April was the start of something big or at least big enough to loom over FX, rates and arguably other markets for some weeks.

Key Quotes

“The poor performance of the US dollar in Dec and Jan even as US yields headed sharply higher was the cause of much debate. Those of us with longer term bullish US dollar views were understandably questioned over how the dollar would strengthen in 2018 if a hawkish Fed and rising long term yields were occurring as Dollar Index fell to lows since late 2014.”

“The debate will continue. But it does seem that the US dollar rally over the past week could be more than a blip. The breadth of the move is impressive, with all G10 currencies falling against USD over the past week and many emerging market currencies sharply lower e.g. Brazilian real -2.9%, South African rand -3.8%. Positioning indicators reinforce the prospects of momentum remaining in USD’s favour.”

“Moreover, the 10 year Treasury note yield’s long-awaited break of 3.00% isn’t simply due to increased investor concern over widening US budget deficits. As the chart across shows, there has been a sizeable move in market pricing for Fed tightening, with the implied yield for July 2019 up 15bp since early April.”

“What’s not so clear is whether there was a particular catalyst for this increased confidence in ongoing Fed tightening. As noted last week, trade tensions are mostly on the backburner until late May deadlines for US action. But US data momentum has faltered, with Westpac’s data pulse dropping below 40% last week.”

“Perhaps with a tight US labour market taken as given, the focus is more on the balance of risks on inflation. Crude oil prices this week reached highs since – again – late 2014. At the very least, this will support headline inflation rates around the world.”