The Greenback Loses Steam Despite Soaring Short-Term Yields

October 22, 2021 at 10:05 PM

The US dollar seems to be struggling recently, and the dollar index is down for four consecutive days on Monday. It looks like the recent bullish trend might be running out of steam. We can say the same thing about long US yields, as the 10-year Benchmark yield posted a bearish reversal candle on Monday. At the time of writing, the 10-year yield stood at 1.58%, down from the daily highs at 1.62%.

The Curve Flattening is Usual a Negative Sign

The yield curve continues to flatten dramatically as short-term yields go vertically higher and market participants expect rate hikes to begin by September 2022. However, the 10-year or the 30-year yields are consolidating and not rising to new highs. 

That could be interpreted as a policy error by the Federal Reserve (Fed) as the central bank will have to raise rates, possibly crippling the current weakening economy. Therefore, short-term yields are spiking higher, and at the same time, investors are buying longer-dated bonds, which are usually taken as a safe haven instrument.

Since short-term yields are usually a better driver for the US dollar, it is somewhat surprising that the greenback has declined recently, despite a sharp increase in short-term yields. 

Nevertheless, the US dollar should remain supported as the Fed is expected to tighten its monetary policy and reduce the monthly amount of bonds it buys, also known as the tapering process. The tapering process is likely to end in July 2022, and it will likely begin in November or December this year.

The View Remains Bullish

In the view of economists at HSBC, the USD will likely remain resilient amid slowing global growth and the Fed’s forward guidance on rate hikes. 

“In our view, ‘stagflation lite’ – a lighter version of the 1970s stagflation – is occurring. We believe that this still plays to the advantage of the USD – one of the ‘hardest’ currencies.” they concluded.

The daily chart of the Dollar Index is still looking bullish. But a short-term correction toward previous highs near 93.50 cannot be ruled out. Bulls are expected to step in and buy the dip in that scenario, especially if yields continue rising. However, if that support is not held and defended, we could see a larger and more significant correction toward the 50-day moving average, currently near 93.20.

Alternatively, if the bulls regain control of the market, the first target lies at the current cycle highs near 94.50. Should the index rise above and close beyond it on a daily chart, the long-term uptrend would be confirmed, most likely sending the USD toward 95, or possibly to 96 levels. 

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