- According to SC, the US 5-year yields are the tightest compared to peers in a year.
- Englander: Dollar is less responsive to yield-gap contraction
Although US bond yields have fallen relative to their overseas rivals, the dollar has not weakened as much as might be expected. This is due in large part to haven flows into the greenback.
According to Steve Englander of Standard Chartered, this is the case because the spread between the yield on the five-year Treasury and the weighted average of similar-maturity yields for the 16 currencies that make up the Bloomberg dollar index is at its tightest level in more than a year.
‘’ bank’s director of investigations for global Group-of-10 currencies stated in a letter to customers that a week ago, the USD was still responsive to risk appetite and spreads, roughly in line with the past three months. And now, the US dollar has not responded well to narrowing spreads, analysts say.’’
For the fourth day in a row, Wednesday saw a decline in the yield on the benchmark five-year Treasury, which now sits at 3.37% after a 31-basis-point reduction over the same time period. Yields on Australian assets of a similar maturity have dropped by less than 11 basis points during the same time period, while rates in Japan have risen by 6.
As for the Bloomberg Dollar Spot Index, it has lost less than 0.2% since March 30. That’s a continuation of a larger decline (2.7% since March 7), but according to Englander, it’s not as significant as the shift in the yield gap would suggest it should be.
“We believe that growing concern about where the US dollar is on the ‘dollar smile’ curve is diluting the effect of the US dollar’s much-reduced yield advantage,” Englander said, alluding to a theory that the US currency is prone to strengthening when the American economy is either exceptionally robust or very fragile, but declines when growth is mediocre. “The fear is that weakening growth and financial and economic uncertainty will drive safe-haven US Dollar demand, canceling out any yield moves.”
Market fluctuations on Wednesday shed a spotlight on the evolving relationship between the US dollar and interest rates. Following weaker-than-expected data on the US labor market and services sector, Treasury rates fell across the curve, while the Bloomberg dollar index saw its greatest rise since March 24.
The Effect of the Employment Report
This coming Friday, the United States will release a crucial employment report, and according to Englander, the worst case payrolls scenario for the dollar is if the number of jobs climbs by between 50,000 and 100,000 compared to the prior period. Such a figure would be much lower than the median projection of analysts, which is now about 235,000 based on a Bloomberg survey, “but not so low that fears of economic freefall begin to emerge,” according to Englander.
The most unfavorable consequence for the USD, according to Englander, would be an increase in the unemployment rate from 3.6% to 3.7%, while a rise to 3.9% would “recommend a rapidly approaching recession” and boost the value of the greenback.
