Yield divergence a dollar favourite, says OANDA’s Popplewell

Although US yields are on the rise, the dollar is not spiking, OANDA’s director of Currency Analysis and Research Dean Popplewell explains.

With US yields on the rise, one would expect the mighty dollar to get a leg up on its largest trading partner currencies. So far, that has not been the case. It has not been an easy time for the world’s reserve currency of choice. Due to the nature of the month that’s in it, December historically is considered one of the most unpredictable annual periods in forex where both lack of liquidity and forex volume are collectively the trading theme.

US 10-year yields rallied almost +5bps in New York yesterday and now sits straddling +2.8424% in Asia and Europe this morning. For the fixed income trader the only solid investment ploy is to apply steepeners (long shorted dated securities while short long dated bonds). These ‘bear’ steepeners continues to gather momentum after yesterday’s strong ADP report and on imminent Fed tapering fears.

Bond investors this morning lifted the 2’s/10 up at +251bp before the market found some solace ahead of the summer resistance levels. The US 5’s/10’s play has been even more aggressive, up +137bp on both legs. Similar to the 17-member single currency, moves have been painfully slow. This may change somewhat, especially after today’s monetary policy rate announcements from the “Old Lady,” and the ECB in a few hours. Any “whippy” moves today would suggest that year-end liquidity is already becoming an issue. A plethora of rate announcements do not make it an easier task either.

The ECB policy decision and follow-up press conference (which will include economic projections for 2014 and 2015) will be closely watched in a couple of hours. Having already cut the main refinancing operations rate to +0.25% in November, the market does not expect any changes from Draghi and company this morning. However, the projections for 2014 and 2015 will give a clearer focus on the ECB’s expectations for inflation. Currently, the market is trying to remain bearish the EUR outright, consistently selling EUR upticks. The market duration depends on how Draghi spins his rhetoric and how quickly expectation of ECB-Fed policy divergences plays out.

Governor Carney at the Bank of England is expected to keep rates +0.50%. Analysts are anticipating that Carney’s Autumn Statement will garner the bulk of market attention. It’s not out of realm of possibility that policy makers will deliver a marked decline in borrowing forecasts. For the governor, it remains to be seen whether some of this improvement will be used to undertake a looser fiscal policy.

Although this can be expected to support gilts versus swaps, it is widely expected and should already be priced in. Sterling continues to be well supported by the market (1.6350) mostly on the back of UK strong growth momentum and the prospects of monetary policy divergences driving FX markets going into next year.

The single currency’s move this morning has been mostly about the weak EUR short positions and how they have been stopped out just north of €1.3600. Without new news or a change of fundamentals it’s the lure of “stop-losses” by dealers that has the single currency being hunted down. The market will want to be focusing on any possible cuts to inflation or growth forecasts. Draghi may even mention the higher EUR – however, the currency played no part in last month’s easing decision. Staying the course will have the market shifting their focus to tomorrow’s important US employment report.

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