Position On USD Key In 2021

by at Pepperstone.
Chris Weston
Chris Weston

The value of the USD is a crucial yardstick when comparing almost any tradable assets. If you can make the right call on the future of the USD, then other trades should fall into place. With the current bear run on the dollar well established, making a call on USd should be simple – but is it?

Chris Weston, Head of Research at Pepperstone, paints a more complex picture for the USD on 2021.

Weak Dollar Triggers Several Markets

A weaker USD has had a lit a fuse under commodity markets, and along with short 30-year US Treasuries and equity markets (such as the JPN225) has been the go-to hedge against rising inflation expectations.

In the bond market, we can look at the rise in longer duration US Treasuries, with the 10-year moving from 50bp in August to 111bp on Friday.

This has been driven in part by a reduction in term premium which has risen to -18bp and if this momentum continues term premium may turn positive for the first time since December 2018.”

‘Breakeven’ Rate

We also see 10-year inflation expectations, or the so-called ‘breakeven’ rate, moving to 2.07%. This is effectively the difference seen between nominal 10-year Treasuries and 10-year TIPS (Treasury inflation-protected securities) – ‘breakevens’ measure expectations of average inflation over that defined period.

At 2.07% the market is sensing impending inflation and this, in turn, has had a positive feedback loop into equities and commodities, and as equities have rallied then the risk-on vibe has pushed the USD lower.”

Bond Yields

If nominal Treasury yields continue to gravitate higher, and we see inflation expectations (breakevens) flatlining or even falling then real yields are going to turn higher and I suspect this will be the case in the coming weeks and traders should be prepared for it.

A rise in real US Treasury yields would have a pronounced effect on the USD and would negatively impact the second derivatives of the weaker USD trade, and represent a temporary set-back for the inflation trade that has become a major consensus position.

Biden Stimulus Priced In

Chris also talks about the potential impact of the Biden administration. A huge stimulus package is expected, but what of other policy decisions?

If the Biden administration looks at measures post-inauguration (20 January) to forge a far more stringent stance to control the virus then this could cause a risk-off theme through markets – again promoting higher real yields and a wave of USD short covering.

Its moves in US real Treasury yields that interests most here. We saw on Friday a mere 6bp rise in real US yields (or TIPS) and the USD rallied 0.3% and gold had its biggest fall since 9 November with silver losing 6.3% and copper falling 0.6%.

Is this a sign of things to come? I suspect it is and equities, while incredibly strong and resilient, may also see higher volatility.

Conclusion

While Chris remains bearish on USD, he has warned readers of the signs to watch for any kind of reversal. Keeping an eye on real yields and their impact on Gold and Copper in particular, should flag up any likely reversal. Read the entire analysis here.

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