US Yields Jump, Dollar Advances: Game Changer?

When I wrote in my first post of the day that I expected the euro, which was bid in Europe and appeared moving toward $1.3400, to come off to $1.3300 and possibly $1.3250 in North America and maybe into tomorrow, several readers dismissed this as unwarranted bullishness. In many ways I too am surprised that this objective was nearly met, with today's late afternoon low so far just below $1.3270.

However, I was dead wrong on the driver. It was not Europe, which is what I have been writing extensively about. It was the US side of the equation. It was, I think, the sharp rise in US interest rates. The two-year note yield finished up about 11 bp, the largest single day increase in nine months. The 10-year yield jumped 21 bp. Of course in there conditions, it is hardly surprising that the 3-year note auction was poorly received.

I continue to find the US-German and the US-Japan 2-year interest rate differential to be among the best trackers of the euro-dollar and dollar-yen exchange rates. The sharp rise in US rates saw the dollar rally across the board, including against emerging market currencies.

The sharp rise in US interest rates was not caused by the second monthly increase in consumer credit. It was not caused by the JOLT report or other economic data that were reported. Instead, it seems to be a direct result of the Obama-Republican fiscal compromise.

One of the criteria that Federal Reserve Chairman Bernanke cited in his "60-Minute" interview was the efficacy of the purchases to know whether they should be extended. The market's reaction to the government's fiscal intentions pushes in the opposite direction than the Fed intends. While one day is too soon to draw any hard judgments, the magnitude of the move must be unnerving to the Federal Reserve.