Dollar Gains as Inflation Fears Push Yields Higher

© Reuters

By Peter Nurse

Investing.com - The dollar climbed higher in early European trading Friday, lifted by a sharp rise in U.S. Treasury yields, while riskier currencies were hit hard amid fears central banks will have to tighten sooner than previously expected.

At 3:55 AM ET (0755 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, was up 0.4% at 90.468, also higher for the week and only 0.2% lower this month.

EUR/USD fell 0.3% to 1.2137, after touching a seven-week high Thursday, GBP/USD fell 0.6% to 1.3933, USD/JPY was down 0.1% at 106.07, after earlier touching 106.43 for the first time since September. 

The risk-sensitive AUD/USD fell 0.6% to 0.7823, after earlier trading near a three-year high, NZD/USD dropped 0.5% to 0.7338 after reaching 0.7463 Thursday, a level not seen since August 2017, while USD/CAD climbed 0.3% to 1.2632.

Government bonds, and particularly U.S. Treasuries, have started to become the focal point of markets globally, as traders now expect inflation to rise aggressively as economies recover on the back of extreme levels of fiscal stimulus and very loose monetary policies. As such, the fact that a Treasury auction on Thursday drew the weakest ratio ever of bids relative to the intended sale volume was the catalyst for a broad collapse in risk sentiment across markets.  The yield on the benchmark 10-year U.S. Treasury note briefly crossed the 1.6% level to trade at its highest level in more than a year. 

While central bank rhetoric has remained very dovish - notably the testimony this week from Federal Reserve Chairman Jerome Powell, the rise in bond yields has indicated a growing belief that monetary policies will have to be tightened more quickly than originally envisioned.

“Risks are tilted towards a faster rise in yields. History has shown us that exiting from very easy central bank policies can be tricky,” said analysts at Nordea, in a research note. ”While Powell has for now promised that sizable bond purchases will continue, the time to start to tweak that communication may not be that far into the future.”

The bank says the dollar is at risk of wrong-footing the consensus once more, strengthening rather than weakening in 2021, and lowers its year-end forecast for EUR/USD to 1.16.

Currencies favored for leveraged carry trades all suffered, and in Europe USD/TRY rose 0.3% to 7.3561.