Fed Tapering, rising treasury yields seen boosting US dollar

December 27, 2013

Washington (Dec 27)  Rising US Treasury yields as the Federal Reserve scales back quantitative easing are expected to help boost the U.S. dollar against most of the world’s major currencies in 2014, strategists say. There are potential exceptions, with the British pound also expected to fare well. And, in some cases, strategists say the dollar’s gains could take a while to develop.

The greenback likely will start trading on monetary-policy outlooks more-so than the risk-on, risk-off moves of recent years, said Mark McCormick, forex strategist with Crédit Agricole. This, along with more capital inflows, is expected to generally favor the dollar if the US economy keeps improving

“The Fed is moving toward an exit from quantitative easing. It seems that a lot of the major central banks – barring the Bank of England – are moving toward looser policy, at least in our opinion,” McCormick said. “So the balance-sheet and interest-rate divergences should probably support the dollar.”

Barclays called for the dollar to rise against lower-yielding currencies such as the euro after outperforming in 2013 against higher-yielding currencies, especially those of emerging-market nations. However, Barclays also said, dollar strength could be delayed by the Federal Reserve’s forward guidance pledging to keep short-term interest rates low.

The impact of monetary-policy expectations could become more pronounced in the second half of the year, McCormick said. Initially, markets may accept the Fed’s notion that tapering of QE is not the same as monetary tightening. But eventually, if the economy keeps accelerating, markets may start to “challenge” the Fed’s forward guidance in which policy-makers have said short-term rates will remain low for some time after QE ends, he explained.

Yields on US 10-year Treasury notes have already risen. For now, McCormick said, the Fed emphasis on low short-term rates appears aimed at limiting yields in two- and five-year notes. But as 2014 and the economy progresses, there could be more movement in the shorter parts of the yield curve.

Chris Tevere, senior currency strategist with FOREX.com, described a “relatively mixed” outlook for the dollar in 2014. The Fed tapering “should be beneficial,” yet policy-makers suggested that the federal-funds rate could remain low even after the 6.5% unemployment threshold is reached. “For these reasons, the dollar is likely to remain range-bound and sideways throughout much of 2014,” Tevere said. “It will rally against some but weaken against others.”

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