Morning Brief – If the Dollar’s not you

Charles Porter
Thu 5 Oct 2023

If the Dollar’s not you

If you’re seeing the financial world dominated by commentary on the US Dollar but it’s not a currency that affects you, fear not: this briefing is for you. The Dollar and related US assets are without question the most important variables in markets at the moment. The sell-off in treasuries into year-end will redefine both the outlook for financial markets and likely how the global economy bounces back from its post-Covid inflationary spike. Analysts and commentators are therefore quite right to afford it maximum attention. However, there are many likely consequences to non-USD assets that we can begin to expect following developments so far. 

The decline in the value of US treasuries since their peak in 2020 rivals some of the most severe developed-market asset repricings in modern history. In size, it is not dissimilar to the correction seen in major equity benchmarks in the immediate aftermath of the financial crisis. Unfortunately, as these are bonds, the consequences are not as straight forward as we might expect with an equity price decline. When the price of a bond declines, the yield implied by owning it goes up. Once the falling knife stops, investors will be seeing likely one of the highest treasury yields this millennium. I expect shortsightedness and the status of treasury benchmarks as a proxy for the market’s illusive concept of a ‘risk-free rate’ will lead investors to quickly and unquestioningly demand treasuries once again. 

The conclusion for the rest of the world is that the Dollar will crowd out any non-long USD carry trades. High yielding emerging market currency trades where investors attempt to benefit from interest rate differentials between currencies will be untenable. The forward/swap curves of Dollar-EM crosses with flatten sapping demand from the emerging market currencies. Outside of forward markets, this will have a significant impact upon spot pricing in EM currencies.

Emerging Market currency weakness is already playing out in the market, most notably within the Mexican Peso where a stellar post-pandemic performance is coming under review. So, if currencies on the long side of the carry trade are to expect a rough quarter, what about the funding currencies used for such former investments? In the present environment that largely exclusively concerns JPY and CHF, with a heavy skew towards the Yen. If carry trades are unwound, as I suggest they already are being, the BoJ could get some reprieve from the challenge of supporting the Yen as the market’s withdrawal of short Yen positions soaks up supply. This could mean that investors are slow to retest USDJPY 150.

Discussion and Analysis by Charles Porter

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