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US Dollar Rallies Despite Falling Treasury Yields - What Happened?

Wednesday, 24 October 2007 18:33:25 GMT  |  David Rodriguez, Currency Analyst

The US dollar rallied against major forex counterparts on renewed risk aversion across financial asset classes. Triple-digit losses in the Dow Jones Industrial Average forced traders to scale back dollar-short positioning despite strongly disappointing Existing Home Sales data. Outlook for the broader US economy continued to worsen on the dismal housing results, and speculators now price in a 100 percent likelihood that the Federal Reserve will cut interest rates on its October, 31 meeting.

The euro tumbled to lows of $1.4187 through earlier London trade, while the single currency later eased declines on a return to dollar selling. The day’s stock tumbles left the EUR/USD offered through the afternoon, however, and it remains off of yesterday’s close at $1.4237. Price action was predictably similar in the British Pound, which now trades at 2.0471 US dollars. The low-yielding Japanese Yen and Swiss Franc were the only major currencies to gain against the greenback, as it lost 0.80 yen to 113.93 and shed a very modest 6 points against the Swiss Franc.

Morning Existing Home Sales data initially led to an immediate dollar sell-off, but speculators eased off the throttle as the report led to similar tumbles in the US stock markets. Given the dollar’s sensitivity to risk sentiment, the currency found a soft bid despite falling yields and a worsened outlook on the domestic economy. In fact, the housing data was enough to lead implied Federal Reserve interest rate expectations significantly lower on the day’s trade. 

The closely-watched November Fed Funds Futures contract rallied a whopping 6.5 points to 95.54 for an implied yield of 4.46 percent. Such a shift tells us that markets predict with virtual certainty that the Federal Reserve will cut interest rates by 25 basis points in its October, 31 meeting. The implication should be enough to sink the dollar, but it remains clear that equity market performance remains a key factor in short-term currency trade.

The Dow Jones Industrial Average continued recent declines, losing a notable 148 points to 13,527 on the day’s trade. Tumbles were even more pronounced in other major indices, as the tech-heavy NASDAQ Composite shed a whopping 2.3 percent to 2,735. The highly diversified S&P 500 was likewise on offer, losing 1.5 percent to 1,497. 

US Treasury yields saw similarly pronounced tumbles on the day, with the key 2-year Note yield falling 12 basis points to 3.69 percent. The incredible downtrend in short-dated government debt underlines both bearish outlook for the economy and pronounced risk aversion across domestic asset classes. These dynamics have, perhaps counter-intuitively, led to a very short-term dollar rally.

Written by David Rodríguez, Currency Analyst for DailyFX.com

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