Yields are boosting the dollar

• Rising Treasury yields are drawing capital away from equities and into the dollar.
• Verbal interventions and expectations of a BoJ rate hike have supported the yen.

The US dollar is gaining ground on the back of increasingly hawkish expectations for the Fed’s rate hikes, pushing up bond yields as investors scale back expectations of a swift end to the conflict in the Middle East. The Strait of Hormuz is closed, and global oil reserves are dwindling. Brent has been trading near the upper end of its range since March, risking a return to an upward trend. Against this backdrop, inflation expectations and Treasury yields are rising. As a result, share valuations are shifting, corporate costs are rising, and profits are falling. The S&P 500’s retreat from record highs is strengthening the greenback.

The market is pricing in a 4.65% yield at the 10-year horizon, which is almost 100 basis points above the current Fed rate. The higher inflation rises, the greater the risk premium investors will demand. In such a situation, the Fed needs to adopt a hawkish tone to bring yields down. Only then will the market’s fear that inflation will spiral out of control subside.

However, Anna Paulson, Atlanta Fed President, insists on keeping rates at their current level, describing the current policy as moderately restrictive. Signs of a slowdown in inflation would provide the impetus for a return to rate cuts. Unfortunately, such signs are becoming increasingly scarce. The US economy would have to face a recession for the Fed to cut rates.

This makes Kevin Warsh’s task of easing monetary policy extremely difficult. Donald Trump has previously stated that he would be disappointed if the new Fed chair did not cut rates.

The approach of USDJPY to the 160 mark is forcing the Japanese government to resort to verbal intervention once again. On the sidelines of the G7 finance ministers and central bank governors meeting, Satsuki Katayama stated that the authorities would take bold action as necessary.

Scott Bessent met with BoJ Governor Kazuo Ueda and noted that the strength of the economy allows the Bank of Japan to act decisively. The futures market is pricing in a 77% probability of an overnight rate hike at the June Policy Board meeting, which is supporting the yen.

The FxPro Analyst Team