U.S. Dollar Surged Amid Rising Treasury Yields

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ByJin Dao Tai

 OCT 7, 2021

The rise in U.S. Treasury yields led to the soaring of the U.S. dollar last week. The benchmark 10-year U.S. Treasury yield rose to a 3-month high of 1.56%, pushing the U.S. Dollar Index to a 10-month high of 94.50.

What’s driving bond yields higher?

The main driver behind the strong rise in bond yields was the hawkish tone sent out by the Federal Reserve during their monetary policy meeting back in September. The central bank highlighted that if the ongoing progress towards employment and inflation “continues broadly as expected”, then a tapering of the current quantitative easing (QE) programme may be warranted. As a result, the market is now expecting a QE announcement to be made during the Fed’s next meeting in November.

Furthermore, the central bank’s Chairman Jerome Powell mentioned that the committee members expect QE tapering to end around mid-2022 “as long as the recovery remains on track”. And once QE ends, discussions on interest rate hike will be next in line for the Fed. In fact, as indicated in the quarterly projection materials, 9 out of 18 committee members projected interest rate to be increased in 2022, up from the previous 7 members back in June’s projection. Thus, market participants have brought forward their expectations for the first interest rate hike to be carried out next year.

So, with the expectation of an earlier interest rate hike from the Fed and the negative correlation between interest rates and bond prices, bond yields were driven higher.

Rising inflation further boosted the U.S. dollar.

In recent months, global inflation has been on the rise with countries facing multiyear high inflation levels. During the ECB Forum on Central Banking last Wednesday, Powell said that he expects current inflation pressures to last longer than expected. This is because the ongoing supply chain disruptions, deemed the main driver behind the recent inflation pressures, are expected to worsen and continue into next year. Despite the belief by the major central banks that inflation is likely going to be transitory and subsiding soon, it does not seem to be the case at the moment, leading to upwards revision of inflation projection by the central banks’ committee members. Furthermore, with the ongoing uncertainty caused by the COVID virus, the resumption of restrictions every now and then will likely have an impact on supply chain operations.

ECB President Christine Lagarde also highlighted that in addition to the ongoing supply chain constraints in the eurozone, some sectors are facing an acceleration in this issue, thus coinciding with what Powell mentioned on the expected worsening of this issue.

Therefore, with inflation likely to stay high for the time being as the supply chain issue is unlikely going to be resolved anytime soon, there is little need for an accommodative monetary policy like the current policy setting. Hence, the current situation is pushing towards a stronger U.S. dollar.

Will the Dollar Index break above its 10-month high?

At the moment, the Doller Index has retraced from the 94.5 level and is trading around the 94 level. The upcoming release of the nonfarm payroll jobs report this Friday is expected to indicate that 490,000 jobs were created in September, doubling the figure back in August. As Powell mentioned during the previous monetary policy meeting, a “reasonably good employment report” will be sufficient to convince him that employment has met the “substantial further progress” condition, thus leaning closer towards a QE tapering. If the jobs figure to be reported this Friday does not fall below the forecasted figure by too much, this may give the Dollar Index a boost towards 94.5 but unlikely will it break above this level for the time being. The Dollar Index may have to wait till the next Fed meeting in November before standing a chance to trade above this level.