Central banks are engaging in unprecedented levels of stimulus and transparency. The US is one of the worst offenders, spending at a record pace while facing a drastic revenue shortfall. Budget and trade deficits are ballooning. The Fed’s framework shift raises questions about “too much inflation,” even if such a thing is not an immediate threat. Long story short: if the US was a person, it would be on limited hours at work, deep in debt, pulling out all the stops, printing its own money, but confident about a better future.
All of the above has reopened a conversation about the impact of the dollar. Back in 2009-2012, I didn’t hesitate to make fun of the old guard who lamented the weakening dollar as evidence of “something bad.” My opinion isn’t nearly as strong this time, but I will nonetheless contend that the value of the dollar doesn’t matter nearly as much as some journalists and market participants suggest–not at current levels anyway, and not in a world where the entire global economy is facing similar challenges.
Why does anyone care about this stuff anyway? To be fair, it makes sense. The more valuable your money is, the more you can buy. Having something with higher value is good, right? But there are fairly logical counterpoints as well (I won’t bore you with the details). What really matters is whether or not we see consistent correlation between the dollar and the bond market. This would make so much sense because US Treasuries are the national debt instruments of the US and the dollar is the currency of the US, so how could they NOT be related?!
If I think the dollar is going to get stronger, I might be eager to buy bonds because the US government will be paying me back with money that is worth more and more. In other words, the expected observation is that a stronger dollar coincides with lower yields. Does it hold up? Not exactly…
For the purposes of today’s charts, it will be easier to use the Euro (rather than “inverted dollars,” because dollars themselves would move in the opposite direction of bond yields, and it’s much easier to look for correlation when the lines are moving in the same direction). In order to justify the use of the Euro, here you go:
Now let’s throw a bone to those who say the currency market is a key consideration for bonds:
Case closed, right?! Well… not exactly. The 2008 drop in the Euro is deceptive on this chart because it was preceded by a big spike caused by US monetary policy. Long story short, the US cut rates bigger and sooner than the EU. This caused the Euro to soar. In late 2008, the EU finally got the memo, so the Euro returned to Earth as their central bank cut rates.
After that, 2010 was actually much less correlated than it seems. It wasn’t until 2011-2012 that correlation kicked into high gear, but currency wasn’t driving bonds. Rather, the EU crisis was driving EVERYTHING and it happened to have an effect that made the lines correlate.
2014 marked the dawn of post-crisis “global growth concerns” and official ECB QE deliberations. Combine that with the bond market’s friendly correction to the taper tantrum and there were once again reasons for the Euro and US yields to be moving in the same direction for exogenous reasons.
All of the above leads us to the big reveal on how things have panned out since 2014.
Yep, that’s about right. US yields spiked due to supply concerns after Trump was elected (and revenue shortfall owing to the tax bill roll-out). The dollar weakened and the Euro improved in 2017 for similar reasons (more Treasury issuance, less revenue). Then in 2018, the EU economy began facing much bigger headwinds than the US. The Fed was arguably too persistent in raising rates as Europe wasn’t remotely close to a hike. This had downward pressure on the Euro and upward pressure on the dollar.
Enter 2020 (as much as we’d prefer to skip it) and massive intervention, both monetary and fiscal, had clear implications for the dollar (thus the spike in the Euro). After a brief hiccup in bond yields in June, investors have doubled down on their belief that the stimulus won’t cause massive, irreversible inflation or overly strong economic growth. The scale of the chart above drives the point home that none of the noise in the smaller picture matters too much in the bigger picture. Rates are low and sideways until further notice.
For those that want to look at the smaller picture, here’s how the trends in yields have evolved.
Positive momentum has stalled out. We MIGHT be in the uptrend marked by the yellow lines. Or we could be attempting to defend a ceiling at .73% in 10yr yields and respecting a floor at .63% in the event of a rally. Such a range is LAUGHABLY small, though. Definitely plan on it getting a bit wider for better or worse. It would be a huge surprise if we weren’t actively discussing that widening of the range by next week’s Fed announcement.