USD: Down But Not Out: Keep An Eye On Yield

The US dollar suffered from Trump’s first days in office. However, things might not continue this way.

Here is their view, courtesy of eFXnews:

We entered 2017 with long USD positioning seemingly much less extreme than was the case at the start of 2015 and 2016. As such,the decline in the dollar on the narrow DXY Index since the start of the year is slightly surprising.  Yet when we look at the strength of various cross-market correlations and the extent to which they have tightened further since Mr Trump’s election victory, the fall-back in the dollar appears much less surprising.

In particular, while long USD positioning may not have started the year anywhere near record extremes, short US rates market positioning certainly has. US yields have been on a downwards drift since mid-December while the dollar continued to advance into year-end. With a (variable) time lag, it is the volatility in bond yields that has by and large led FX market volatility and, broadly speaking, makes the scale of the dollar’s decline quite readily justified.

Yield volatility will remain a key dollar FX factor this years, in which respect we’d note it doesn’t necessarily need ‘Trump-enomics’ to support higher yields and a stronger dollar if – as the Fed is suggesting – the US economy is already operating close to full capacity and the Fed’s inflation mandate almost met. Anything Trump does may simply add to upside risks.

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