Buy the Long Bond?
I said my peace on global growth and EM currency crises last week, so I won’t belabour those here. I am struggling, however, to square the circle on the dollar and U.S. bonds. The story for the greenback appears simple; interest rate differentials suddenly matter again. The Fed is on the move, but expectations for tighter monetary policy elsewhere has been pushed back, especially in the U.K. and in the Eurozone. Even in Japan, few believe that the BOJ will do anything, anytime soon. HSBC’s FX Chief, David Bloom, does an admirable job explaining this in a recent segment on Bloomberg TV. By this account, the rout in EM is as much about a shift in G4 central bank expectations as it is about the lagged effect of higher short-term rates in the U.S. and structurally-vulnerable balance sheets. As long as European and Asian central banks drag their feet, and the Fed keeps going, the dollar will continue to rally; its simple. The problem with this story is that it assumes that the combination of a hawkish Fed and higher U.S. bond yields persists. Almost all my models are telling me to fade this story. For starters, the curve continues to lurk as the proverbial elephant in the room.
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