U.S. Dollar Pushes Higher as Markets Eye T-Bill Auction + Iran Deal but Analysts Question Sustainability of Rally

- US Dollar trades higher ahead of White House decision on Iran deal.

- Bond market and USD eye $73 billion US Treasury auction this week.

- Strategists are increasingly questioning sustainability of USD rally.

© Nazli Sart, Adobe Stock

The US Dollar extended a multi-week long advanced on its rivals Tuesday as traders positioned for an action packed week that looks sure to see American bond yields rise further and may offer further incentive for markets to bid the greenback higher this month.

The Greenback forced the Euro-Dollar exchange rate to fresh 2018 lows at 1.1851, while at the same time prompting Sterling to relinquish all GBP/USD's 2018 gains with a new four-month low at 1.3487 being recorded.

Uncertainty over an eagerly-awaited decision on the future of the Iranian nuclear agreement has offered some support to the US unit at the opening of the week, although a crammed auction schedule at the US Treasury and the looming release of April inflation figures will also be key to the greenback's performance.

President Donald Trump will speak at 19:00 London time Tuesday about the White House view on the so-called Iran nuclear agreement. A possible decision to pull out of the pact and reimpose sanctions on the Gulf nation could raise tensions across the Middle East, sending oil prices higher, and already has the safe-haven Dollar on the front foot Tuesday.

"If Trump were to cancel the deal today, which cannot be excluded by any means, this could have considerable consequences for the Dollar beyond an initial USD-positive risk-off movement," says Esther Maria Reichelt, an analyst at Commerzbank. "What is at stake is nothing less than the status of the dollar as the world’s reserve currency."

Beyond this, currency traders will look to the bond market, US Treasury and Bureau of Labor Statistics for a steer on where the Dollar is headed next.

Above: 10 Year US Government Bond Yield.

"10Y UST yield was relatively steady at 2.94% ahead of US CPI data release on Thu and this week’s auction of $73bn in US government papers. Note that this is up from Feb’s offer of $66bn," says Saktiandi Supaat, an FX strategist at Maybank in Singapore. "This could keep UST yields and USD broadly supported."

The US Treasury will tap the market for around $35 billion of three year bonds this week and an additional $25 billion of 10 year debt and $17 billion of 30 year bonds. All of these amounts are higher than they were at the same time last quarter and highlight has been, and will continue to be, a key theme for markets going forward.

This comes after President Donald Trump's tax cuts left the Treasury with a revenue shortfall that can only be plugged through either fiscal constraint or increased borrowing - and the White House has shown little appetite for tightening its belt. That largesse drove the 10 year US bond yield to a multi-year high last month, at a time when other developed world yields had turned lower.

Questioning the Rally

Accordingly, US yields are now more attractive than their peers, which prompted expectations investors would sell other currencies in order to buy the Dollar and US bonds during April and early May.

The greenback was among the best performing developed world currencies for the last two weeks, although some now suggest it will not be able to draw support from the Treasury's growing appetite for debt for much longer.

"Rising [yields] driven by increased supply are a weak reason to be long a currency. Consider the performance of several Latin American currencies over the past several years where budget deficits are in excess of 5%. Nobody was out rushing to buy those currencies then," says Bipan Rai, an FX strategist at CIBC Capital Markets. "We are bearish on the USD unless real policy rates extend higher. For now, we don’t see that as a likely scenario."

Rai and the CIBC team say for the Dollar rally to become sustainable the Federal Reserve would need to drive "real rates" higher by raising its interest rate further than the central bank seems willing to. They are not alone in being sceptical of the US Dollar rally either, particularly in the wake of last week's Federal Reserve meeting, which saw the central bank suggest that it could allow inflation to run above the 2% target for a period of time.

Above: US Dollar effective exchange rate - a measure of broad-based Dollar strength against a basket of currencies.

"We remain of the view that in the wake of the Fed's introduction of "symmetric" language higher inflation is likely to push the dollar lower - not higher. Indeed, as the Fed looks past higher CPI in the near-term, the outcome is US real rates should be contained, which should tug it lower again. Recall, lower US real rates are good for global reflation but bad for the USD," says Mark McCormick, North American head of FX strategy at TD Securities.

US inflation, the latest reading of which is due Thursday, is currently running above the Fed's 2% target. If it rises further, without an equal or greater increase in the Fed Funds rate, then it will reduce "real interest rates" and support for the US Dollar will be undermined. Both McCormick and CIBC's Rai are conscious of this although they stop short of saying that Thursday's inflation figures will bring an end to the US Dollar rally.

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