Analysis-Investors bank on real yields to boost dollar in months ahead
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[February 04, 2022] By
Saqib Iqbal Ahmed
NEW YORK (Reuters) - The dollar's choppy
start to the year has not dissuaded some investors from betting the U.S.
currency will soon resume its march higher, lifted by a hawkish Federal
Reserve and rising real yields.
The U.S. dollar index is flat on the year, masking a volatile ride in
which the greenback swung between gains and losses in January as
investors recalibrated how aggressively the Fed will tighten monetary
policy in coming months. Against a basket of currencies, the dollar is
up about 5% over the past year.
Investors say where the dollar goes from here will be determined in part
by real yields, or what a holder of U.S. government bonds expects to
receive adjusted for inflation - which have eased in recent days after
surging last month.
Rising real yields tend to boost the dollar’s allure to investors and
have been a source of support for the greenback in the past. Though they
have come off recent highs in the last few days, some are betting real
yields will continue rising in the months ahead if the Fed maintains its
hawkish stance, dragging the dollar higher.
"Since the pandemic, real rates have been driving the dollar ... that's
evident today as well," said John Velis, FX and macro strategist at BNY
Mellon.
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The yield on the 10-year Treasury Inflation-Protected Securities (TIPS)
recently stood at -0.66%, after touching a 19-month high of -0.539% on
Jan. 26. Fed Funds futures currently price a total increase of 118 basis
points by year-end. A rising dollar has far-reaching implications for
everything from corporate earnings to the fight against inflation. A
stronger dollar allows American consumers to buy goods, services and
resources from other countries at lower prices, but it can eat in to
profits of American companies that export or rely on global markets for
the bulk of their sales.
Nearly two-thirds of the strategists polled by Reuters last month said
interest rate differentials would dictate sentiment in major FX markets
in the near term.
Most currencies will struggle to gain against the dollar in coming
months, as monetary tightening expected from the Fed will provide the
greenback enough impetus to extend its dominance well into 2022,
strategists polled by Reuters said.
Thanos Bardas, senior portfolio manager at Neuberger Berman, expects the
yield on 10-year TIPS to reach 0% over time, from an average of -1% over
the last 18 months of so.
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A U.S. dollar note is seen in front of a stock graph in this
November 7, 2016 picture illustration. REUTERS/Dado Ruvic/Illustration/File
Photo
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"The dollar typically rallies versus other currencies during this adjustment,"
Bardas said.
Bardas, like other investors, is also watching the difference between the yields
in the United States and those in other major economies to get a clue on the
dollar’s direction.
On Wednesday, the gap in the U.S. and German 10-year government bond real yields
stood at about 115 basis points in the dollar's favor, close to the widest it
has been since March 2020.
That yield advantage may shrink if the European Central Bank and Bank of Japan
start accelerating their own efforts to tame inflation.
Euro zone inflation is set to burn hotter throughout 2022 than expected a month
ago, according to economists polled by Reuters in mid-January, which could
pressure the European Central Bank to tighten policy once the Omicron wave of
the pandemic passes.
Analysts at Morgan Stanley, meanwhile, believe the dollar will rise against the
Japanese yen, helped by expectations that the Bank of Japan will be dovish
compared with other central banks.
The greenback will likely struggle to make headway against other major
currencies, however, as accelerating global growth forces other central banks to
tighten monetary policy along with the Fed, they wrote in a report last week.
"Global growth outside of the U.S. could help those local currencies if you do
continue to see reopening plans taking hold," said Chuck Tomes, portfolio
manager at Manulife Investment Management in Boston.
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Still, Tomes, who has been guarding portfolios against a rise in the dollar
since the second half of 2021, is not taking those hedges off just yet.
"U.S. real rates are still not massively attractive but they have been
increasing and the expectation is that they will continue to get more
attractive," he said.
(Reporting by Saqib Iqbal Ahmed in New York; Editing by Matthew Lewis)
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