June 02, 2009
Posted by: Dave Bhagat
"Creditors have better memories than debtors."
- Benjamin Franklin
Bond markets around the world have had a rough month, as talk
of a global recovery and concerns about monetary and fiscal
stimulus have sent yields soaring. This is especially true at home,
where 10-year yields are up over 100 basis points since
quantitative easing (QE) was announced on March 18.
In "normal" times, higher yields led to currency strength and we
had seen that pattern play out until last month. Higher yields
traditionally increase a currency's relative attractiveness and
often reflect optimism about economic growth. In addition, yields
were going up because risk aversion was declining, leading to money
flowing out of bonds and into riskier asset classes, including
As the chart indicates, interest rates and the dollar fell sharply
on March 18 after the Fed announced the beginning of QE. For the
next month, rates edged higher and the dollar rose as well. The
dollar index hit a near-term high on April 21; however, since then
the dollar has fallen while rates have continued to climb. So what
There are many reasons for the spike in rates and I mentioned some
of them earlier: reduced risk aversion (which leads to money
flowing out of treasuries), hopes of an economic recovery, an
increase in inflationary expectations, increased issuance to fund
Treasury's expanded borrowing needs leading to excess supply and
reduced foreign demand. I believe most of them have been valid to
an extent at various points in time.
However, in early March the focus was on the positive reasons for
higher yields, such as reduced risk aversion and hopes for a
recovery, which is why the dollar was strengthening as rates rose.
Now the focus is largely on the negative: concerns about fiscal
policy, excessive supply, inflation and waning foreign demand.
There is also the growing recognition that higher yields could
choke off the recovery by hurting the housing market even further
through higher mortgage rates. There are already signs this is
happening and mortgage delinquencies are soaring. Partly because of
the dollar's weakness and partly for other reasons, oil prices are
going up, posing another challenge for consumers. These concerns
are combining to undermine the dollar.
I believe the concerns and the market's response are valid - our
economy remains fragile and higher rates could derail the recovery.
Out of the G10 currencies, the USD probably has the weakest
fundamentals, in my opinion, followed by the GBP, EUR and JPY, with
the AUD and CAD leading the pack. Asian currencies, including the
CNY, TWD, INR, MYR and others, have the brightest prospects. For
the stronger economies, higher rates are a vote of confidence and
act as a brake on economic growth, which is often welcomed. For a
struggling economy that is dependent on foreign capital to finance
its fiscal and external deficits, rising rates choke off a recovery
and scare away foreign investors - hardly a comforting thought for
I don't intend to single out our economy and the dollar when it
comes to challenges; other countries face similar circumstances.
Europe, Britain and Japan are in the same boat, though there are
some moderately optimistic signs for Japan recently. It is likely
that we will see significant additional QE from the Fed to keep
rates from spiking further and the ECB and BOE will probably do the
same. There is a key difference, though - our markets are larger,
which means the Fed is likely to have to really ramp up the size of
additional QE to make an impact. For Britain and Europe, smaller
amounts can be far more effective. In addition, the markets expect
both Europe and Britain to begin to raise rates next year (unlikely
in my opinion as far as Europe is concerned), while the expectation
is that the Fed will probably start raising rates in late 2010 or
2011 (I believe 2011). Those rate expectations are providing
relative support for those currencies at present and are hurting
The dollar is also currently suffering more than the EUR and GBP
because it is still the world's primary reserve currency, and
therefore, subject to greater scrutiny. There are rumblings from
the BRIC nations about reducing their exposure to the dollar and we
have heard similar comments from OPEC and some of the surplus Asian
countries in the past. China is likely to be a key player in
determining the direction of the dollar and interest rates. They
have huge investments in our markets and are concerned about the
impact of QE and the fate of the dollar. My belief is that they
will start to slowly liquidate a portion of their dollar bond
holdings and move some, if not all, those funds to other markets
and asset classes. This process may be under way already.
In conclusion, higher bond yields are not helping the dollar
currently. They may actually be hurting and I don't see that
dynamic changing. I do believe yields in the U.S. and elsewhere
will moderate in the near term (but rise again next year) once
investors come to terms with QE and realize that the current demand
gap virtually guarantees no inflation for the foreseeable future.
However, concerns about deficits and fiscal stimulus will probably
keep yields higher than fundamentals would otherwise dictate, here
and around the world. That hurts the weaker economies in particular
and the U.S. leads that group.
The dollar ought to remain under pressure as a result, until signs
of real, sustainable economic growth emerge. I expect growth to
pick up later this year in Asia, weak to moderate growth for the
other G10 countries until 2010 and U.S. growth to remain
non-existent to anemic until 2011. The dollar's weakness is welcome
in this context, as it is effectively a form of easing and helps
offset some of the tightening caused by higher yields. As a rule of
thumb, a 100-basis-point increase in long-term rates has
historically equated to 200 basis points of tightening in Fed
Funds, clearly not what the Fed wants or the economy needs at this
juncture. The likely policy response will be a juggling act: talk
up a future economic recovery while trying to ratchet down
inflation expectations, use QE to hold rates in check and let the
dollar slide. Going back to Mr. Franklin's comment above, though,
we are a debtor nation and our creditors might be less than
enthusiastic about the cocktail being concocted.
The following excerpt will be included in your message.
Soaring Bond Yields and the DollarOctober 22, 2012 Posted by: Dave Bhagat
"Creditors have better memories than debtors."
- Benjamin Franklin
Bond markets around the world have had a rough month, as talkof a global recovery and concerns about monetary and fiscalstimulus have sent yields soaring. This is especially true at home,where 10-year yields are up over 100 basis points sincequantitative easing (QE) was announced on March 18.
In "normal" times, higher yields led to currency strength and wehad seen that pattern play out until last month. Higher yieldstraditionally increase a currency's relative attractiveness andoften reflect optimism about economic growth. In addition, yieldswere going up because risk aversion was declining, leading to moneyflowing out of bonds and into riskier asset classes, includingequities.
As the chart indicates, interest rates and the dollar fell sharplyon March 18 after the Fed announced the beginning of QE. For thenext month, rates edged higher and the dollar rose as well. Thedollar index hit a near-term high on April 21; however, since thenthe dollar has fallen while rates have continued to climb. So whatchanged?
There are many reasons for the spike in rates and...Read More