By William Watts
Falling bond yields set the tone
It all comes down to bonds.
A closely watched U.S. dollar index fell sharply on Tuesday, accelerating the pullback from a 20-year high and giving stocks and commodities room to rebound. But the pace of the foreign exchange market, as well as other assets, remains largely a function of the bond market, Kit Juckes, global macro strategist at Societe Generale, said in a Tuesday note (see chart below).
Treasury yields, which had accelerated a rise following the Federal Reserve’s September 20-21 meeting, were down as investors weighed the prospect of a so-called pivot by policymakers away from its trajectory of rapid and aggressive rate increases.
“This is not the first time that an upward trend in US bond yields and a downward trend in equity indices has been interrupted by a correction in the former. US 10-year Treasury yields have suffered significant corrections in May and again in June/July, which all bear markets rally to the stock market,” Juckes wrote.
The following August-September rise in the 10-year Treasury yield, from 2.6% to almost 4%, gave the ICE US Dollar Index a nearly 10% increase and sent it plummeting the S&P 500 by more than 10%, with major indexes ending last month at their lowest levels since 2020, he noted.
The Treasury sell-off is taking a break, with yields falling sharply across the curve. The 10-year yield, which briefly topped 4% late last week, was trading near 3.623%. The ICE U.S. dollar index, which tracks the currency against a basket of six major rivals, fell 1.3% on Tuesday, leaving it down 1.6% in the past two days after hitting a low. 20+ year high last week. The pullback saw the index erase the strong gain it had seen following the Fed’s rate hike on Sept. 21.
Stocks rebounded strongly in early October and into the fourth quarter, with the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite each up more than 5% in the past two sessions.
See: ‘It’s not healthy’: Stocks’ latest advance could signal more trouble for markets. here’s why
A strong dollar was seen as a headwind for equities, especially large-cap multinationals that rely more on overseas sales. The strong dollar has also been blamed for helping send crude futures to eight-month lows in September and sinking gold. A stronger dollar is seen as a burden on commodities that are priced in the unit, making them more expensive for users of other currencies.
The U.S. crude benchmark jumped more than 8% this week on expectations that OPEC+ will lead to a major output cut and the dollar retreated. Gold futures rebounded 3.7%.
The dollar, of course, was seen as highly stretched against its main rivals. The pound plunged to an all-time low against the US dollar late last month as the UK government’s fiscal plans sparked a budget crisis that forced the Bank of England to start buying government bonds UK to avoid the collapse of pension funds.
The euro has rebounded 1.8% against the dollar this week, but remains down more than 12% so far this year and continues to trade below parity with the US dollar. Last month, the Japanese yen traded at its weakest against the dollar since 1998, ultimately prompting a rare intervention in the foreign exchange market by Japanese authorities.
The retracement of the dollar is due to factors likely to fade, said Bipan Rai, head of foreign exchange strategy at CIBC Capital Markets.
“The first is the profit taking in the tactical buys that have been building over the last few weeks. The second is the “peak rates” narrative that has taken a bit of life due to the softer ISM, [job openings data] and lower break-even/inflation swaps lately,” Rai told MarketWatch in an email.
Indeed, analysts cited expectations that the Fed could be nearing the end of its rate hike cycle as signs of cracks appear in global financial markets and U.S. data begins to soften as a factor. behind the rally in equities and bonds (bond yields move contrary to price).
Rai was skeptical that the dollar’s pullback would hold up.
“We suspect the market will start to fade again – as the data points that matter (employment + core CPI) still indicate that the Fed has work to do. terminal for the Fed will keep the USD supported on the dips,” Rai said. The terminal rate refers to where the federal funds rate will peak.
Meanwhile, the Reserve Bank of Australia fueled “pivotal” expectations on Tuesday by offering a lower-than-expected rate hike and saying future moves would depend on the data.
“Will the Fed follow the RBA and move toward a slower pace of policy tightening, lowering the dollar’s smile in the process and triggering a deeper wave of short hedging for other currencies? ” Juckes asked. The “dollar smile” refers to the tendency of the US currency to rally when the US economy significantly outperforms or underperforms its peers.
Read: What does a pivot look like? Here’s how Australia’s central bank framed a dovish surprise
Stocks extended their gains on Tuesday, while Treasury yields and the dollar fell further after a job vacancies and turnover survey, or JOLTS, indicated some easing in a tight labor market. Juckes, writing ahead of the JOLTS report, said this week’s data, including Friday’s September jobs report, will likely set the tone for weeks to come. But he was skeptical. Treasury prices have plenty of room to continue their rebound (yields move opposite to price).
“My bias is to think that this bond market rally has gone as far as it could go, and when yields come back up again, stocks will struggle and the dollar will regain its mojo,” Juckes said. “At that time, the forex market, after exhausting itself trading the pound in recent weeks, could return to selling the euro.”
–Joseph Adinolfi contributed to this article.
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