Treasuries Fluster Dollar Bears as Yields Rise Toward 2%
(Bloomberg) -- The dollar’s rapid comeback on Thursday is derailing bearish bets as a surge in Treasury yields fuels conviction on more gains for the greenback.
A day after a dovish message from Federal Reserve boss Jerome Powell sent the currency reeling along with short-end U.S. interest rates, the greenback is again in the ascendant against most of its global peers. U.S. bond yields are climbing -- with the 10-year rate near 1.75% -- widening its advantage over major counterparts. In addition to that, there’s the rollout of coronavirus vaccines and the Biden administration’s stimulus measures bolstering expectations of faster economic growth. The Bloomberg Dollar Spot Index rose 0.4% at 3 p.m. in New York.
The dollar’s resilience continues to stun many who had forecast it would wane this year. Instead of sapping demand for the currency, the stimulus-fueled explosion in the U.S. budget deficit is actually helping the greenback because it’s driven up bond yields relative to other nations. And the Fed’s reluctance to tame that rise has only emboldened those betting on higher Treasury yields, and discouraged those who had been looking for the dollar to weaken.
“We are officially bearish on the dollar -- but this near disorderly selloff in Treasuries could delay that decline, as higher U.S. yields prompt a re-pricing of risk assets,” said Chris Turner, a currency strategist at ING. “With the dovish Fed leaving the long end of the U.S. Treasury market unprotected, the market is wary of just how quickly U.S. 10-year yields hit 2%.”
Strategists are still divided on the outlook for the greenback, and while dollar bears have been capitulating in droves -- with pension funds, insurers and mutual funds cutting their net-short position by a record last week -- positioning continues to show traders looking for a weaker greenback.
For Sebastien Galy of Nordea Investment, the underlying question is whether foreign-reserve managers “will look at the U.S. and see it inflate away its debt,” or whether the U.S. yield curve will steepen and lure those international investors.
“The Fed is credible enough for the second path to dominate,” Galy said, adding that he sees the euro-dollar pair dropping to $1.15 by year-end, from about $1.19 now.
While yield curves around the world have steepened, the 5- to 30-year Treasury yield spread is hovering around 161 basis points amid expectations of higher inflation. That compares with the German yield curve, which is around 90 basis points.
Despite the greenback’s strength, however, there’s still much appetite for select commodity-linked currencies, according to Kristen Macleod, co-head of global currency sales at Barclays. She expects the Australian dollar, the Canadian dollar and the Norwegian krone to appreciate versus the greenback. The “low yielders,” such as the euro and the yen, “are likely to underperform on a more medium-term horizon given the widening of rate differentials,” Macleod added.
For Viraj Patel, global macro strategist at Vanda Research, wider U.S.-euro zone rate differentials could trigger an “unwind” in bullish euro-dollar bets. In a tweet Thursday, he added that the past three major bearish positioning shifts have seen between 40% and 50% of the unwind occur in the first three months.
The first “stop” for the euro-dollar pair is between $1.1700 and $1.1750 on an initial positioning unwind, he noted.
The dollar’s strength continues to pressure emerging markets, with losses in 15 of the 24 developing-nation currencies tracked by Bloomberg on Thursday. The reality of higher Treasury yields halted a relief rally by traders who had feared a hawkish turn from the Fed.
The volatility in U.S. rates is “likely to remain elevated, and that is bad news for emerging-market currencies,” said Ilya Gofshteyn, a senior strategist at Standard Chartered.
And then there’s the question of how U.S. policy makers will react to a stronger economy, with investors not ruling out the prospect of higher rates.
“Actual growth exceeding expected growth, leading to a more robust labor market, will ultimately lead to higher sustained inflation,” according to Chris Osmond, chief investment officer at Prime Capital Investment Advisors, which oversees $11.2 billion of assets in Overland Park, Kansas.
“Should this happen, the Fed is almost certain to change their current rhetoric, and look to start normalizing sooner than what is currently being telegraphed.”
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