Tags: Real | Yields | Show | Dollar | Outperform | Fed | Printing

Real Yields Show Dollar Can Outperform With Fed Printing Money

Monday, 13 December 2010 09:30 AM

The U.S. bond market is giving dollar bulls more reason to be optimistic after driving the greenback higher against the other 16 major currencies since the first week of November.

Inflation-adjusted, or real, yields on benchmark 10-year Treasurys are higher than for similar-maturity notes in Germany, the U.K. and Japan, according to data compiled by Bloomberg. That may help the U.S. lure foreign capital to finance the $1 trillion budget deficit even as Federal Reserve Chairman Ben S. Bernanke floods the global financial system with cash by purchasing $600 billion of government debt.

“The yield story is important for the dollar,” said Derek Halpenny, European head of currency research at Bank of Tokyo-Mitsubishi UFJ Ltd. in London, who predicts a 9.3 percent gain versus the euro next year and a 9.6 percent advance against the yen. “If we continue to see an improvement in economic data, that’s going to push U.S. yields higher.”

IntercontinentalExchange Inc.’s U.S. Dollar Index, which measures its performance against those of six trading partners, has risen 2.6 percent since Nov. 12, when the Fed began purchasing Treasurys in its second round of so-called quantitative easing. The U.S. 10-year real yield was 2.15 percent at the end of last week after averaging 1.74 percent during the past decade.

Most Traded

The dollar is 3.4 percent stronger against the euro in the period to $1.3226, 1.7 percent higher versus the yen at 83.95 and up 1.9 percent against the pound, trading at $1.5802. The dollar is the world’s most-traded currency, followed by the euro, yen and pound, according to the Bank for International Settlements in Basel, Switzerland.

A survey by Ried Thunberg ICAP Inc. of 20 money managers controlling $1.34 trillion found that all forecast the dollar will be stronger or little changed versus the euro during the next three months and 90 percent project the same against the yen. The poll by the Jersey City, New Jersey-based Reid Thunberg, a unit of ICAP Plc is dated Dec. 13.

U.S. 10-year real yields are more than a percentage point higher than the Japanese equivalent, approaching the most since October 2009. The Japanese yield ended last week at 1 percent, down from this year’s high of 3.07 percent on Jan. 8. Euro real yields peaked at 2.49 percent on Jan. 4, before falling to 1.05 percent last week. They are 0.32 percent in the U.K.

Yield Help

Higher yields may help the dollar the most versus the yen, according to Ronald Leven, executive director and currency strategist at Morgan Stanley in New York.

It tends to climb against the yen as U.S. yields increase relative to Japanese rates. The correlation coefficient between dollar-yen and the spread between U.S. and Japanese two-year yields averaged 0.52 since 2005, Bloomberg data show. A correlation of one means the pair move in lock step, while minus one means they move in opposite directions.

Even after rallying almost 6 percent from an 11-month low on Nov. 4, the dollar remains undervalued against 10 of the 16 most-traded currencies, according to a measure of purchasing-power parity compiled by the Organization for Economic Cooperation and Development in Paris that measures the relative prices of goods across countries.

The dollar is 27 percent below fair value against the yen, 36 percent undervalued versus the Swiss franc, 33 percent against the Norwegian krone, 31 percent versus the Danish krone and 30 percent against the Australian dollar, the measure shows.

‘Best Value’

“Our fair-value estimates suggest that the U.S. dollar offers the best value amongst the G-3,” said Leven at Morgan Stanley, referring to the economies of the U.S., eurozone and Japan.

Real yields have had little effect on the euro rate this year. U.S. real yields were mainly below equivalent European rates when the dollar climbed to a four-year high against the region’s single currency in June.

The median forecast of at least 36 analyst estimates compiled by Bloomberg is for the dollar to trade at $1.35 per euro by the end of September 2011. The U.S. currency will climb to 90 yen by the end of next year, the data show.

Changes in the dollar against the euro in the past two years have been more influenced by stock-price movements, correlation data show. Declines in the Standard & Poor’s 500 Index accounted for almost 50 percent of the greenback’s gains versus the 16-nation currency in the 120 days to Dec. 10, according to the data.

Libor Comparisons

Shorter-term rates are working against the U.S. The three-month dollar London interbank offered rate was 0.3 percent last week, compared with 0.957 percent for the equivalent euro rate, 0.745 percent for Libor in sterling and 0.183 percent for yen Libor.

Rising U.S. yields have tended to coincide with a weaker dollar since the 2008 collapse of Lehman Brothers Holdings Inc., which drove demand for the greenback as a haven. An increase in 10-year Treasury yields was more strongly correlated with a falling dollar in September than at any time since 1998.

“Some of the tools that we use in the foreign-exchange community, such as interest-rate differentials, have become meaningless concepts,” said David Bloom, global head of currency strategy at HSBC Holdings Plc in London. “Risk-on, risk-off has driven everything.”

Gathering Pace

That relationship may be ending as the U.S. economic recovery gathers pace, according to Ian Stannard, a senior currency strategist in London at BNP Paribas SA, France’s biggest bank. The Dollar Index climbed 0.87 percent last week as U.S. 10-year yields jumped 31 basis points to 3.32, the biggest rise since the period ended Aug. 7, 2009.

“The risk-on, risk-off view has to change as economic divergence takes place, with the U.S. economy standing out,” he said. “As we see relative outperformance of U.S. assets, the dollars that are being generated will stay at home.”

U.S. gross domestic product will expand 2.6 percent in 2011, more than the 1.4 percent predicted for the euro region and the 1.4 percent forecast for Japan, according to the median estimate of at least 15 economists in Bloomberg surveys. The U.K. will grow 1.9 percent, another survey showed.

The agreement last week between President Barack Obama and the Senate to extend Bush-era income-tax cuts may add as much as half a percentage point to GDP next year, according to Michael Feroli, the chief U.S. economist at New York-based JPMorgan Chase & Co.

‘Far From Over’

“The situation in Europe remains troubling, and the future is more uncertain than ever,” International Monetary Fund Managing Director Dominique Strauss-Kahn said in Geneva the day the deal was announced. The effects of the global financial turmoil “are far from over,” he said.

Higher U.S. yields will give a boost to the dollar for as long as they reflect economic growth and not a concern about the U.S. budget deficit, according to Geoffrey Yu, a foreign-exchange strategist in London at UBS AG, the world’s second-biggest currency trader.

“For the greenback, favorable growth differentials and problems elsewhere will be helpful,” he said. “The eurozone is facing austerity next year, while Japan’s economy will likely remain stagnant. The dollar will be the outperformer next year in G-3.”

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The U.S. bond market is giving dollar bulls more reason to be optimistic after driving the greenback higher against the other 16 major currencies since the first week of November.Inflation-adjusted, or real, yields on benchmark 10-year Treasurys are higher than for...
Monday, 13 December 2010 09:30 AM
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