Rising yields lift troubled dollar

By David Morrison  |  05/02/2018 16:17

This article considers the dollar's recent sell-off despite rising bond yields and also looks at the Japanese yen. 

A pause in the sell-off

At the end of last week, the US dollar staged an overdue, yet modest, recovery against most of the other majors. This saw the EURUSD take a pause in a rally which, in little more than a year, has seen the pair rise from a fourteen-year low to a three-year high. The recovery also brought a halt in the near-relentless sell-off in the Dollar Index, although the basket continues to hover around three-year lows.

Inflation fears

Friday’s pick-up in the dollar was triggered by a spike in US Treasury yields following the release of key employment data, including Non-Farm Payrolls. Average Hourly Earnings rose 2.9% year-on-year, taking it to its highest level since June 2009 and a long way above the +2.6% anticipated. This unexpected jump raised concerns that inflation is picking up, possibly forcing the Federal Reserve to accelerate its programme of monetary tightening. The yield on the 10-year Treasury note burst above 2.8% to hit its highest level in four years. In the last couple of weeks, the 10-year yield has broken above a number of key levels, leading some prominent voices in the bond market to opine that the 35-year bull run is finally over.

Weaken your currency

Yet the dollar continued to make a succession of multi-year lows, effectively ignoring the pick-up in bond yields. This was despite the fact that the US Federal Reserve has been ahead of other central banks when it comes to raising rates. Rather, there has been a growing feeling that other central banks (the European Central Bank in particular) are on the verge of tightening monetary policy as well. This comes as evidence piles up to show a synchronised pick-up in global growth and inflationary pressures. At the same time, it’s also clear that the Trump administration favours a weaker dollar as this helps US exporters and gives a boost to the president’s “Make America Great Again” policy. US Treasury Secretary Steve Mnuchin pretty much declared the administration’s “benign neglect” for the greenback when he stated in Davos that there were obvious advantages in having a weaker currency.

Dollar consolidates

Yet there was a noticeable shift in sentiment on Friday as the dollar responded positively to the pick-up in yields. Nevertheless, this move certainly wasn’t enough on its own to suggest that the current downtrend in the greenback is over, and we need to keep a close eye on some key levels. The Dollar Index continues to consolidate around 89.00 with key support coming in around 88.00. A break below here would open up the possibility of another lurch lower while we can expect any bounce to be met with initial resistance around 90.00. Correspondingly, the EURUSD remains close to 3-year highs with the next level of resistance coming in around 1.2600. A break above here puts 1.3200 in the frame as an upside target, while a failure could see a pull-back to support around 1.2200 or even 1.2100.

Yen gains capped

But whereas the market perception (rightly or wrongly) is that the European Central Bank (ECB) is preparing to tighten monetary policy, the majority of investors expect the Bank of Japan (BOJ) to continue to provide monetary stimulus. This has helped to keep a lid on the yen’s advance which is just as well for Japanese exporters. While the dollar has lost ground against the yen since the beginning of 2017, the USDJPY is currently in a trading range which began to establish itself between April and May last year. The area around 114.00 has held as resistance since then while support comes in anywhere between 108.00 and 109.00. At the end of last month, the pair came close to retesting 108.00 - a break below here opening up the prospect of a tumble back towards 100.00. This followed the unexpected news that there was a reduction in the BOJ’s balance sheet in December. Japanese exporters would really struggle to deal with such yen strength and the BOJ soon stepped in to cap the yield on 10-year Japanese Government bonds. Despite this, it has been unable to weaken the yen to an appreciable degree. Fortunately, Friday’s US jobs data helped to lift the dollar and this saw the USDJPY break back above 110.00 – a level which previously acted as support. But considering the yen going forward, much depends on the market’s confidence (or lack of it) in the BOJ’s ability to keep control of the yield curve. Any failure here could see the yen strengthen appreciably which would have serious repercussions for all financial markets.

EURJPY

As far as the EURJPY is concerned, the pair hit a four-year low in the aftermath of the Brexit vote in the summer of 2016. It has rallied ever since but the rate of the rally has faded since the first half of 2017. The first area of support comes in around 134.50 which marks the 61.8% Fibonacci Retracement of the Dec 2014 to June 2016 sell-off and acted as resistance throughout the last quarter of 2017.  There’s some resistance which comes in around 140.00 and overall the euro looks as if it has further upside. However, that would quickly change if the ECB resumed its dovish rhetoric.

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