NEWS / Foreign Exchange

Bond Yields Slow Pace of Dollar Decline

Now that the suspense is over and US consumer confidence fell to its lowest level in over 6 months (to 107.2 in March from 111.3 in February), the market dynamics are falling into place in line with our morning call for a lower dollar across the board. The resulting dollar sell-off is particularly notable as the greenback??™s losses extend to the Japanese yen as US stocks shed losses following the decline in confidence. But the currency's decline is moderated by resiliency on the lond end of the yield curve.

Dollar decline stabilizes as 10-year still above 4.60%

Bond traders were not necessarily disturbed by the report, keeping 10-year yields above 4.60%. The 2 main reasons to this are: 1) consumer confidence was not as low as feared as well as the fact that present conditions index rose to a 6 1/2 year high; 2) traders are cautious that Fed Chairman Bernanke will offer Congressmen a shot of inflationary hawkishness tomorrow that could remind markets the Fed has not completely abandoned its tightening bias last week.

The question is: will lawmakers accept Bernanke??™s inflation preoccupation at a time when the Fed itself has indicated the ???adjustment in the housing sector is ongoing???, which is a mild phraseology to say that the deterioration is not over. The Fed would prefer to keep rates unchanged into the rest of the year but the accelerating loss of momentum from housing, construction and manufacturing increases the risks of impacting the consumer engine of the economy. A hawkish testimony from Bernanke tomorrow coupled with a rebound in durable goods orders above could further stabilize the US currency and bond yields.

Despite the 4.60% reading on the 10 year, the yields remain 3 bps above their 2-year counterpart, suggesting that the normalization of the yield curve is eliminating all chances of a rate hike and open the door for an easing on the short-end, i.e. a rate cut in the overnight rate as early as H1.

On the FX front, today??™s surprise increase in Germany??™s IFO survey coupled with hawkish comments from two key ECB officials (Garganas and Liebscher) have shown that not only the much feared VAT tax hike is having little impact on domestic demand, but there is also a growth argument for further normalizing Eurozone rates. $1.3400-1.3450 remains a realistic target as early as this week, but the incoming French elections in April could cast a spell on the currency at 1.36.

USDJPY??™s failure to breach above the 118.40 resistance suggests that risk appetite remains sketchy at best, with the bias firmly cemented towards risk aversion courtesy of the incomplete chapter in the US sub-prime developments as well as increasingly downcast data releases.