US Dollar Being Wagged by Bond Market Dog, Tipped to Remain Under Pressure

A multitude of factors have conspired to drive the US Dollar lower in the last 24 hours and, with a litany of event risks up ahead volatility is expected to remain high.

The US Dollar is being wagged by the 'bond market dog', according to one strategist, having observed a recent fall in the value of the US currency in reaction to the fall in yield on US Treasuries.

There is little consensus on the exact cause of recent price action in the bond market.

There are multiple suspects that could have been behind recent movements in bond prices that drove the yield on the 10 year US Treasury to its lowest level since the November election.

The fall takes the US Dollar index - a measure of Dollar valued based on a basket of USD-based currency pairs - back toward a 15 month low.

The Dollar tends to be lead by the yield on US Treasuries as global investors funnel capital towards Treasuries when their yield is high in order to seek greater returns. Falling yields tend to result in capital funneling out of the market.

“To be honest we’re struggling to pinpoint the root cause of the price action... it feels like you could take your pick from any combination of the following catalysts,” says Deutsche Bank macro strategist Craig Nicol.

Dovish comments from two Federal Reserve speakers, continued and increasing tensions over North Korea, as well as another extreme weather event threatening the US seaboard were all felt across markets in the 24 hours to London’s Wednesday morning.

“A December hike is now just a 24% probability event, the lowest since May and reason for the Dollar to remain under downward pressure,” says Derek Halpenny, European head of global markets research at MUFG.

The US Dollar index touched a low point of 92.07, not far from the 15 month low set on August 29, while the Euro-to-US-Dollar pair rose 0.20% during the Wednesday morning to trade above 1.1950 for the first time in a week.

This is while the Pound-to-US-Dollar rate rose more than 100 points, to 1.3237, during the Tuesday session and held onto its gains Wednesday morning.

“In the last twenty-four hours, bond bears have been caught in a three-pronged trap by Hurricane Irma, North Korean belligerence and the dovish comments of Minneapolis Fed President Neel Kashkari and Fed Governor Lael Brainard,” says Kit Juckes, a strategist at Societe Generale.

Juckes noted how low bond yields have been a catalyst in the past for a rotation out of lower yielding currencies and into higher yielders, - which are currencies like the South African Rand and New Zealand Dollar.

“To the extent that the drop in yields is capitulation by a market which heard Brainard and Kashkari and is wondering if the peak in Fed Funds might not even be above 2%, any dip in higher-yielding currencies is going to be very short-lived,” he wrote in a note to clients. “To the extent it’s about North Korean belligerence, it can trigger another period of risk-aversion but probably (hopefully) a short-lived one.”

Bond market gains and their accompanying US Dollar sell off come ahead of a Federal Reserve meeting on September 20 and the debt ceiling debacle that is likely to occupy an increasing number of column inches as October approaches.

Markets once priced an additional hike from the Fed in 2017 but the conviction of traders has faded inversely to a recent increase in concerns over subdued inflation, legislative inertia and political dysfunction in Washington, rising geopolitical risks and a plethora of other issues.

Now, with key central bank meetings in Europe and Canada that could yield big changes to current policies still due over the rest of the week, and with the Fed not until the end of the month, the Dollar could remain volatile in the near term.

The US Dollar has been among the worst performers in the G10 group of currencies in 2017, falling more than 13% against the Euro, 12% against the Swedish Krona and nearly 10% against the Australian and Canadian Dollars.

It has lost 5% to the British pound since January, which has itself been under the cosh from rising inflation combined with a slowing economy.

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