Forex Analysis & Reviews: 03.02.2018

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03.02.2018 02:26 AM

Dollar scare auctions

Perhaps the most burning topic in 2018 is the sharp divergence in the yield of US Treasury bonds and the USD index. Over the past few years, they have united in one direction, but at the end of 2017 the situation has changed. And now it is seen as one of the main drivers of the weakening of the US dollar.

Dynamics of the USD index and the yield of 10-year US bonds

Source: Trading Economics.

Earlier, the main reason for the growth of rates of the US debt market was the tightening of the monetary policy of the Fed. At present, the risk of inflation's acceleration, the normalization of the Fed's balance and and the high demand for financing the budget deficit in connection with the implementation of the tax reform have been added.

Acceleration of the CPI and PCE reduces the real yield of bonds, making them less attractive than before, so it's no surprise that investors are dropping their bond holdings Moreover, the central bank has launched a process of reducing the balance sheet, and when a large buyer leaves the market, prices tend to fall and interest rates on debts grow.

Still, the main concern is the high need for financial resources due to the implementation of the package of fiscal incentives. According to the forecast of the Advisory Committee on debt under the US Treasury, the volume of bond issues will double in 2018/2019 and will continue to increase in 2019/2020. Such a dynamic last met during the height of the global economic crisis, but then the demand for safe haven assets was great, so the Treasury could not fear for the results of the auctions. At present, the situation has radically changed.

The IMF, the World Bank and other authoritative organizations predict the acceleration of global GDP, and in such circumstances, investors prefer to buy risky assets. In this regard, investing in bonds of developing countries looks more preferable than investing $14 trillion in the US debt market. If, of course, the yield of 10-year Treasury bonds does not rise markedly above 3% in the near future. Thus, the US may face a lack of demand and, accordingly, money, which puts pressure on the dollar.

In my opinion, it is not necessary to panic. The market is a self-regulatory mechanism. The growth of interest rates on loans contributes to the correction of US stock indices, that is, worsens the global appetite for risk. In such conditions there should be no problems with the auctions. Once investors understand this, the American dollar will start to win back losses against the main competitors. Of course, there is no question of changing the declining trend on the USD index, but the correction seems quite possible. Moreover, the euro is not really as strong as it seems. Even the "hawks" of the Governing Council began to use a "dovish" rhetoric, inflation in January slowed to 1.3%, and revaluation threatens to shift the timing of the ECB's target for a later period.

Technically, the fall in the EUR/USD quotations below the support at 1.2435 and 1.2335 will strengthen the risks of pullback.

EUR/USD, daily chart

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*Disclaimer: The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.