Me and just about everyone else on the planet who follows these things has pointed out the fact that the dollar has lost track of the reflation narrative in the new year and especially following the inauguration.
Sure, we got some greenback strength on Friday and yields came down on Thursday following a decent foreign bid at the Treasury’s 7Y auction, but generally speaking, the story has been “divergence.”
There have been no shortage of attempts to try and explain why one leg of the reflation trinity seems to have come off. Certainly Trump and his inner circle have contributed with “inadvertent” verbal intervention.
Still, we lack a definitive answer and no doubt we’ll all be interested to find out what the new positioning data says about USD longs.
In any event, Bloomberg’s Richard Breslow is out this morning with his take, which you’ll find below.
Via Bloomberg’s Richard Breslow
(Bloomberg) — Creating almost as much interest as the Trump trends, and their forecast longevity, has been the curious case of why the very neat correlation between U.S. Treasury prices and the level of the dollar hasn’t been working so well. This is a big deal for a whole host of reasons. Not the least of which it has driven simple models to distraction, spilling a lot of blood on the way. But also brought into question the whole theory on which trading has been based since the election. If the dollar isn’t buying it, why should stocks and bonds?
- That’s actually looking at things in an entirely wrong way. Investors are making the mistake of thinking that just because the dollar and bonds tend to react, as they must, to many of the same factors, they are the same thing. And always tell the same story
- The end-of-year trends were predicated on the belief that fiscal stimulus and deregulation would lead to higher rates, faster growth, more bond issuance. A big push to an economy already doing OK. Yields, equities and the dollar flew
- Since the end of December, the dollar stopped responding to the story, even as equities have never looked back and bond yields are threatening to violate one of the great trend lines of all time
- So what changed? Higher U.S. bond yields fed the story of global reflation, causing global bond yields to start rising in a big way
- After the election, everyone was focused on the U.S. effects. And the yield spread of USTs to other sovereign curves galloped wider. U.S. to German 10-year yields widened over 60bps! But then global yields rose and quickly, such that the spread narrowed by 30bps. Not because U.S. yields were coming off. This pattern played out globally
- Lo and behold, that spread narrowing fit the timing of the dollar index’s travails with uncanny precision. And has largely driven it ever since
- It had nothing to do with the Trump story petering out. It was just going global. Currencies use two-sided coins. Meanwhile, global equities are higher as well
- So if you want to get a sense of where the dollar goes from here, you have to have a view on where these spreads are headed. See, bonds and currencies still do have something to do with each other
- The U.S. can withstand higher and rising rates. They’re justified, anyway. Can Asia or Europe? Far less well. The knock-on effects on their economies is likely to become severe. Economy-to-yields have a much higher beta outside the U.S.
- Avoid losing the big picture just because a correlation ebbs and flows