Debt Market Developments Don't Explain the Dollar's Slump

Many investors and observers are concerned about the implications of the aggressive monetary and fiscal policy in the US. The dollar's recent slide has come alongside a sharp rise in US interest rates. Many are connecting the dots in a causal fashion, but appear to be jumping to a hasty conclusion.

The euro has risen by 7% against the dollar over the past month. US bond yields have rates have backed up dramatically during this period. The US 10-year yield has risen 40 bp. The shorter end of the curve is more anchored by the zero-25 bp overnight interest rate target and the continued decline in LIBOR. The 2-year note yield has risen 3 bp over the past month. The yield curve has steepened as a result. Some fixed income analysts argue that the steepening of the curve is also dollar negative.

Yet it is important to place the rise of US rates within the context of what is happening to rates elsewhere and especially the eurozone. The German debt market for example has performed noticeably worse than the US Treasury market over the past month. The 10-year bund yield has risen by 46 bp and its two-year yield has risen by 10 bp.

Consequently, while many have focused on the rise in US rates, the differentials with Germany, the proxy for the eurozone, has actually moved against the US. The backing up of interest rates and the steepening of yield curves is not a unique US phenomenon, but is taking place throughout the industrialized countries. Nor is the US leading the move.

Although US officials are monitoring the rise in US interest rates, because it is a global development--seemingly having to do with signs that the world economy has moved away from the abyss to which it had appeared to be headed--. While some increase in rates may be due to supply concerns (recall indirect bidders were strong all last week at the record $101 bln Treasury sales, but were stronger for the shorter maturities (2-yr and 5-yr notes).