The US 2-year Yield Soon to Rise Above Germany

In our explanatory models of the dollar's movement, we tend to place greater weight on interest rate differentials, shapes of curves, etc than external imbalances per se.

During this crisis US rates fell well below Germany, the proxy for the euro zone. Just like we argue the dollar's bottom is a process and it often happens as a cascade effect, so to with the interest rate turn.

The US pays about 78 bp more than German on 30-year bonds. The US pays about 61 bp more on 10-year paper. The US pays about 30 bp more than Germany on 5-year bonds.

The 2-year has not turned yet. It was within a single basis point yesterday, but the US 2-year note is firm ahead of today's $44 bln sale. Many expect strong direct and indirect bids today so that today's sale may be the best received of this week's $118 bln of supply.

The yield on the 2-year has risen about 12 bp over the past month, as US money market rates have also firmed. The 2-10 curve remains near its flattest for thus far this year.

At last month's 2-year auction, the bid-to-cover was 3.33, above the recent average. Indirect bidders took down 53.6%, which was the most in around 8 months.

Thus far this year, the euro-dollar exchange rate is correlated with the 2-year German-US yield spread nearly 22% (correlations are run on daily data using percentage change). In the same 2009 period, the correlation was 14%.