| The sharp rise in nominal U.S. 10-year yields has been a key market narrative over the past week, with the 10-year Treasury yield now sitting around a one-year high. |
While U.S. yields tend to grab most of the attention, the move higher in long-term yields is actually a global phenomenon. Swiss, German and even Japanese long-term yields have all moved higher, albeit with a lag. In the case of the U.K., the pace of its yield increase has exceeded that seen in the U.S. and has given support to the pound.
This correlated move in yields is most likely connected to the belief that rapidly falling infections and hospitalization rates in countries that lead in mass vaccinations such as the U.S. and the U.K. will allow for a quicker re-emergence of global growth. Recently, the U.S. announced that it would increase vaccine supplies to 13.5 million doses a week from 11 million doses previously. Even the EU and other areas that have been vaccine laggards are starting to catch up in the vaccine race.
So while yields are rising at the long end of the yield curve, the supply-and-demand dynamic at the short end of the yield curve is strikingly different. Specifically, markets are focused on the possibility of an influx of U.S. dollar liquidity should the Treasury run down its $1.5 trillion deposit at the Federal Reserve to pay for stimulus measures in the coming months. As a result, the U.S. dollar, relative to many G10 currencies, has actually been losing short-term rate support. From a currency standpoint, this is important, as exchange rates tend to be more supported by short-term interest rate differentials than anything else and help to explain why the U.S. dollar index has given up its February gains despite the steady rise in nominal 10-year yields.
Intuitively, higher yields in the U.S. should mean a stronger dollar, but in the currency markets, interest rate differentials matter more than absolute levels. As long as the reflation-driven move higher in U.S. yields is matched by rising yields in other countries, the argument for a sustained reversal of broad U.S. dollar weakness becomes unclear. Instead, expect dollar support to be expressed through individual currency pairs due to those pairs’ individual dynamics.
Speaking of individual dynamics, recent Fed comments have done little to suggest an imminent move to push back against the rise in long-term yields. If anything, the Fed might be taking the opposite view, as Kansas City Fed President Esther George recently said the rise in bond yields is “not concerning,” as it is tied to growing optimism about future economic activity and shouldn’t lead to tighter financial conditions. This opens up the possibility for a much bigger rise in U.S. rates, relative to the negative yield bloc, down the line and is a key factor arguing against the appreciation of the euro and yen.
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