Why the US dollar is rallying for ‘bad’ reasons

This article was originally published on Wednesday, April 25, 2018 at 4:55 A.M. SGT. 

The U.S. dollar has climbed against the euro and the yen over the past week, with Nomura pointing to a negative backdrop spurred on by higher commodity prices and rising U.S. Treasury yields.

The 10-year U.S. Treasury yield has been flirting with the key technical and psychological level of 3 percent; it was trading at 2.99 percent at 10:56 P.M. SGT on Tuesday, but had topped the 3 percent level intraday.

Nomura said it was unlikely that the yield rise was due to “repricing” U.S. economic growth, noting the economic data have shown the U.S. economy was humming along for months, without affecting the greenback much.

“A better explanation for the jump in yields is perhaps the surge in commodity prices seen over April. Much of this has been driven by trade tensions and geopolitical worries, rather than global demand,” Nomura said in a note dated Tuesday.

Over the course of the past month, the Trump administration has pursued its protectionist agenda both aggressively and haphazardly, targeting China with a series of tit-for-tat tariff proposals. U.S. President Trump has also made threats against various other trading partners, including targeting the NAFTA deal. Fresh sanctions on Russia have also pushed up some metals’ prices.

Nomura said these commodity price dynamics are spilling over into the rates markets, with yield curves beginning to steepen.

“If anything this suggests rates markets are expecting the Fed to be forced into more hikes to curb these inflationary pressures. This provides a more negative backdrop for the dollar rally,” Nomura said, adding that the recent weakness in U.S. risks markets, including equities and credit, coinciding with the dollar rally supports its view of the reasons for higher yields.

“Even strong U.S. corporate earnings haven’t been enough to help stocks, instead higher U.S. yields could be de-rating stocks, and investor equity longs and fears on tech hardware seem to be weighing on stocks,” it said.

That means the dollar is rallying in a negative environment, a march higher that could continue for weeks amid many event risks, Nomura said.

Event risks Nomura has previously pointed to include the ongoing investigation of the Trump campaign’s Russia ties, Trump’s upcoming meeting with North Korea’s leader Kim Jong-Un, the May FOMC meeting and Trump potentially pulling the U.S. out of the Iran nuclear deal.

But Nomura added that it still saw a medium-term dollar downtrend. It tipped the “best way” to create a core short dollar position would be selling the greenback against the safe-haven yen.

The dollar was fetching 109.16 yen at 10:54 P.M. SGT on Tuesday, up from 105.89 yen at the start of April, and levels around 107 yen last week. The euro has lost ground against the greenback, fetching US$1.220 at 10:54 P.M. SGT on Tuesday, compared with around US$1.24 last week.