US: Mighty US yield curve important in setting the tone for stronger USD - Rabobank

Jane Foley, Research Analyst at Rabobank, suggests that while hopes for tax cuts and a reduction in regulation are the main elements behind the recent boost in the USD and the US bond yields, this is a trend which had commenced in October.

Key Quotes

“US inflation expectations and bond yields had been ticking higher in the weeks ahead of the election.  This was partly attributed to the sharp rises in the prices of commodities such as coal and industrial metals this year.  It was also linked to speculation that central banks were becoming more aware of the side effects of extra-ordinary policy measures such as negative interest rates and bond buying programmes.”

“This year we have repeatedly stressed the importance of the mighty US yield curve in setting the tone for the USD.  In the first nine months of this year, US bond yields were bias lower to levels that had triggered talk of bond market bubbles.   The incentive for that move was the re-pricing of US inflationary risk and the perception that the pace of Fed policy tightening would be slower than had previously been expected.   As yields dropped the market shortened its USD exposure drastically.  The move appears to have left the USD ripe for a rebound.”

“It may not be clear for some months whether the market has correctly anticipated a sea change in the inflationary prospects of the US economy, or whether this month’s move has been overdone.  While it is reasonable to expect a loosening in fiscal policy in the US, there are downside risks to inflation potentially from the same set of factors that have been pressuring inflation in recent years. Income inequality, low productivity and wage growth may continue to limit the pass through of expansionary policies to demand and inflation.  It is our view that US bond yield will move lower on a 12 mth view and for this reason we see the USD giving up some of its recent gains in the coming months.”