Market Overview

14 April 2021

Inflation May Negatively Affect the Dollar via Bond Yield Drive Belts

The U.S. Dollar index (DXY) June futures slid under the lowest levels since March 18, reaching as deep as 91.65 points mark today. The soft landing of the Greenback continues step by step almost every day during the last two weeks. That intermediary result is in no way, of course, summarizing a long discussion on the ability of higher Treasury's yields to make the Dollar more attractive in principle. But it may leave the whole conception in serious doubt, at least. So, what could be the catch here? 

The main rational argument could be that the broad market's expectations could be that the Treasury bonds' yield could inevitably raise much higher, at least up to the inferred 2.0-2.5% range well before the end of 2022, if not in nearest months. So now, when the global stocks have not even started to hint to a chance of deep correction what could be the realistic reasons to buy safe haven Treasury assets right now if the later use of this risk-hedging idea may bring more of both annual and instant income? 

It looks especially healthy judgement just a day after the U.S. consumer price index (CPI) surged 2.6% year-on-year, which was the largest inflation value since August 2018 following a 1.7% step up just a month ago. The month-by-month pace has also accelerated giving the indication of as much as 0.6% in March, the biggest gain since August 2012. Probably, a higher prime costs of general services and goods for most producers during the time of pandemic, in combination with hopes for rising vaccinations, plus governmental stimulus packages released some pent-up demand. 

If the tendency is also confirmed by an increase in retail sales, then inflationary sentiment may even strengthen. The corresponding figure on the U.S. retail sales are due to be published on Thursday, March 15, and is expected at 5.9% month by month according to Bloomberg's expert poll. At this inflation juncture, funds and banks, or even private investors would not be satisfied with the current yield of 10-year Treasury bonds, which is ranging just a little bit above 1.6% vs a local 1.77% peak just registered on March 30. 

Bond yields have not jumped to any new heights yet, after both the CPI data and the producer price statistics, which came at 4.2% year-on-year exceeding even the high average 3.8% according to preliminary expert assessments. This fact differs from the prevailing concept of the investment community, on what kind of yields could draw big money to the growing public debt. Therefore, even if U.S. bond rates would start to rise to 1.8% or slightly higher, this may first cause even an additional sell-off of those bonds leading to a limited capital outflow from the Greenback, since the investment community may want to buy fixed-income assets issued by the U.S Treasuries only at a higher premium and just hit the pause button for the time being. This may be even more true in the face of new Wall Street records, when funds and banks see good alternatives. 

Inflation numbers are unlikely to change the point of view of Jerome Powell, the Federal Reserve (Fed) Chairman, who has said many times that higher inflation in coming months will be transitory, so the Fed will allow inflation to exceed the 2.0% theoretical target levels for an indefinite period of time until another full employment target will be finally achieved. The combination of easy available money for banks from the Fed with the release of part of the bank's reserves as the credit threats from borrowers recede, make the placement of "extra" capital on the stock exchanges more likely, at least until the whole situation may drive those banks into some out-of-the-way corner. 

The current mood seems to be inspiring banks and funds to rather move away from the "inflation-infected" U.S. bonds in favour of the Australian or New Zealand similar AAA quality assets. This process has already led to a technical breakout of the April's resistance of 0.70 for NZD/USD and may also drag a breakout of the important 0.77 resistance for AUD/USD with an opportunity then for further progress to the annual ceiling of 0.80 or higher. 

Even EUR/USD is going up for the second week in a row, almost reaching the psychological 1.20 landmark, despite Germany just extended its lockdown period by another three weeks on Monday after the country still vaccinated less than 25% of its population. If the single currency keeps above the landmark of 1.20 at least for a couple of days, it may change the target for 1.23-1.25, while the probability of coming down to test 1.17 before the beginning of summer could not be that much. Even the Japanese yen has begun to add a little in price, although the printing press in Japan is working powerfully, and seems to not help at all to the strengthening of the national currency. 

Perhaps the main bitter exception from the common trend is the British Pound, which is subject to new selling waves at any small tops which results in staying within the narrow 1.3650-1.38 range. But this is relatively easy to explain with the weak U.K. gross domestic product figures released yesterday, which are still down 7.8% year-on-year compared to March 2020, and up only 0.4% month-on-month against average expectations of 0.6%. Moreover, as British industrial production grows by 1.0% month-on-month, the M3 money supply has shrunk by 1.6% over the past 3 months, which confirms the shortage of inflation signs and the lack of demand. The retail sales of the U.K. Tesco supermarket big chain reported a 20% drop in full-year pre-tax profit, which may also reflect the decline of consuming potential on the Isles. But even the Pound may not be able to resist the general pressure at some point.

 

Disclaimer:

Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.

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