US dollar rallies as US yield curve steepens

The release of the Pfizer BioNTech news saw markets immediately price out further sizeable fiscal stimulus measures in the United States. The US yield curve steepened dramatically, particularly in 30-year tenor. Although the reasoning may be premature, the end effect is not, with little chance it will occur now if the Republicans win the Georgia runoff in January, and zero chance during the transition period.

The rise in US yields propelled the dollar higher, with the dollar index rising 0.54% to 92.75. The night’s biggest losers were the Japanese yen and the euro. The widening of the interest rate differential hit the yen particularly acutely. USD/JPY rose 1.93% to 105.35, a 200-point move.

Assuming the steepening of the US yield curve remains intact, USD/JPY may threaten its 100-day moving average at 105.87. Profit-taking this morning has seen USD/JPY retreat to 104.85 with no discernible support until 104.00, such was the scale of the rally overnight. It is likely to be a buy on dips for the rest of the week, with the Ministry of Finance mightily relieved, with Japan officials expressing concern about the rise in the yen only yesterday. What a difference a day makes.

The widening yield differential weighed on EUR/USD as well. It fell by 0.50% to 1.1815, just above support at 1.1795. A loss of 1.1795 could potentially open up further losses to 1.1700. Although there is noise already that Europe will be able to dial back its stimulus plans, I believe this is unlikely to happen. Covid-19 is rampaging across the continent with Portugal joining lockdowns overnight. That will weigh on Q4 growth, and much of Europe remains on fiscal and monetary life support, a potential vaccine won’t magically makes that go away. The ECB is also likely to enact new easing measures at their December meeting. EUR/USD had probably seen the best of its recent rally now, with 1.1900 and 1.2000 now formidable resistance.

Asian currencies faced an initial sell-off overnight, but across the region, today, have rallied against the US dollar. As the workshop of the world, Asian currencies have been carried along by the strength of China’s economy. With a glimmer of hope for the US and Europe now, thanks to a vaccine boost, Asia is well placed to benefit from potential economic upturns there as well. Any weakness in Asian currencies is likely to be a slow retreat and not a disorderly exit with the region set to outperform in 2021.

As far as the weaker US dollar premise I have been drumming for much of 2020, I am not yet convinced last night marked a secular turn in the fortunes of the dollar. If the yield curve continues to steepen, and if more vaccine candidates arrive, that may change. For now, central banks are continuing to pump money in the financial system, bar the PBOC. Interest rates will remain lower for longer as the recovery will be long and not instant. But most importantly, I am not going to let one night of ascendency from the FOMO gnomes of the stock market change a longer-term world view.