Yield Shoots, Dollar Leaves

by Ashraf Laidi
May 28, 2009 15:40 | 129 Comments

Talk of Fed Exit Strategy is Premature. Yesterdays 23-basis point jump in 10-year yields to 3.74% may have been helped by mortgage backed securities traders hedging, but the upward trend remains clearly intact. With Fed increasingly behind the curve in catching up with US Treasurys relentless bond issues, 10 year yields have now retraced over 50% of their decline from their 5.32% high of June 2007 to their record low of 2.03% in December. The path is now paved towards the 4.1% market, last attained in October 2008. We cannot imagine the Fed sticking with its current plan to purchase $300 bln in treasuries when their yields are exasperating the fragile jobless recovery and further endangering the value of their foreign holders. The only solution so far is for the FOMC to step up purchases towards the $500-700 billion target, the implications of which will flash the green-light for dollar selling.

"Green Shoots" optimists, credit rating pessimists and bonds-to-stocks rotation realists have all provided arguments for the jump in bond yields. The acceleration could be extended by reduced portfolio weightings in government bonds and onto metals and agriculture. Portfolio re-allocations from fixed income to commodities may be uncommon, but central banks reflationary policies leave little choice for investors to pursue seek capital preservation strategies.

Yield Shoots, Dollar Leaves - Usdyield (Chart 1)

The chart above illustrates the USD index/10 yr yield index ratio, highlighting the ensuing retracement in the value of the greenback relative to bond yields after the ratio shot up to a record high of 37 in November. A rising ratio reflects an appreciating greenback relative to bond prices, while a declining ratio highlights the bonds underperformance relative to the US currency. The overshoot in the USD/Yield ratio of Q4 reflected the combination of violent repatriation flows into US treasuries, which boosted the USD and dragged down yields. The ratio, currently at 22 (80.9/3.7) is above its 39-year average of 15 and is bound for further declinesin line with broader retreat in the greenback.

The EURUSD chart below supports the view for continued gains towards the $1.41, followed by $1.47 by end of quarter. Meanwhile we could see an interim retreat limited to $1.3720-30s. The same applies for AUDUSD, whose support holds at 0.7650, while paving the way for 0.820

Yield Shoots, Dollar Leaves - EUR May 28 (Chart 2)

More Speculative Dollar Shorts Ahead. Last week's data from currency futures showed euro longs vs. USD exceeded the shorts by 12,250 contractsthe highest level since the week of July 15 (the week when EURUSD hit its record high). Meanwhile, yen longs vs. USD exceeded the shorts by 6,000 contracts, the highest since March. Aussie net longs vs. USD also hit their highest since July, reflecting the extent of deepening anti-USD sentiment among the speculative (non-commercial) community. Considering that EUR and JPY net longs vs. USD are about 11 times lower than their record highs, speculators have plenty of upside against the USD in terms of quantity as well as price.

Click To Enlarge
Yield Shoots, Dollar Leaves - Futs May 26 (Chart 3)

For an 8-year view on Forex speculators' positions on euro, yen, sterling, aussie and loonie, click here.

Comments (Showing latest 10 of 129) View All Comments
speculator
Posted Anonymously
12 years ago
Jun 11, 2009 16:42
ashraf nice commentary on bnn today
cougr
Australia
Posts: 101
12 years ago
Jun 11, 2009 15:09
"Finally USD technically in over sold territory at the moment, and any farther decline is limited"

Forextrader ,I am with you on this point and believe that once we get a technical sell signal in equities the dollar could rise by at least 5% from current levels. I am anticipating that this will occur within the next month.
Qin
Jonkoping, Sweden
Posts: 492
12 years ago
Jun 11, 2009 12:52
Hey, guys
I hope your long USD position will be good......because I am waiting for the chance to short USD again....just like yesterday.

Cheers
forextrader
vologda, Russia
Posts: 127
12 years ago
Jun 11, 2009 12:11
People are bearish dollar for very will known reasons, risk appetite, expanding monetary policy. Sovereign risk.,,But they also have to look at the other side of the coin

1) Most central banks are very caution about the strength of there currencies ( i.e Canada last week, New Zealand yesterday and ECB,,ect)
2) There is no sign of US investors fleeing the US for emerging market as in between (2004-2007)
3) I still think there is value in other US asset such as equity and corporate bond which attract US and foreign investors..
4) Finally USD technically in over sold territory at the moment, and any farther decline is limited.

For these reasons I am bullish USD
speculator
Posted Anonymously
12 years ago
Jun 11, 2009 11:07
how can you be bullish for the pound at this stage with UK QE ( and its uncertainty), unstable and useless gorvernment, rising unemployment, huge risk to stock pullback and overvalued pound based on PPP $1.51/

btw, the euro seems to be overvalued by about 15% based on PPP. also looking rather bearish on the euro here.

it is no doubt as to why some sources expect sharp gains in dollar towards end of year. In the short term however dollar may look slightly bearish.
Qin
Jonkoping, Sweden
Posts: 492
12 years ago
Jun 11, 2009 10:32
Hey, Ashraf
I just closed all my positions.......looking forward to see the US report now.

What do you think about today's market?? Waiting for the chance to long AUD and CAD again.

By the way.....GBP is so strong......I personally very bearish GBP........


Best regards
Qin
Qin
Jonkoping, Sweden
Posts: 492
12 years ago
Jun 11, 2009 8:57
Hey, Ashraf
I agree with your opinion, FED has to print more and more money to flow its market. And they are losing control now because the inflation.....

I think we may see the high inflation before we see the economy recovering.

Best regards
Qin
speculator
Posted Anonymously
12 years ago
Jun 11, 2009 7:50
ashraf very good point. but what about issues in europe?
cougr
Australia
Posts: 101
12 years ago
Jun 11, 2009 5:23
Ashraf , from a purely technical perspective one may argue that the 10 year T bonds are due for a significant downwards correction ,hence applying upwards pressure to their yield . I am wondering ,can the government prop up the treasuries indefinitely or for longer than one dares to care because otherwise it appears that yields will sooner or later begin to rise in earnest.
Ashraf Laidi
London, UK
Posts: 0
12 years ago
Jun 11, 2009 1:56
speculator, the Fed is nearing its endgame as far as controlling both end of the curves and they will have no choice but to step up purchases of treasuries beyond the current target of $300 bln. either THAT (which is USD negative) or allow yields to overshoot and kill off the economy.

Ashraf