We keep talking about ‘who is right and who is wrong’ maybe that mentality is actually wrong – maybe it more about your perception of time, and that actually both sides will be right in time.
That sounds philosophical for a reason as the final 48 hours of trade last week basically provide this idea.
First, let look at what was said and forecasted by the FOMC at its March meeting
Now let’s look at the reactions to this:
Initially USD lost its footing as yields fells – 10 year dropped 7 basis points in the first few hours of the FOMC release – the belief being that the Fed will ignore the short-term spikes in inflation and hold the line on its hugely accommodative programs.
However, that idea was very short lived as bond vigilantes came back with a vengeance leading to a very sharp and steep sell off. Yet how can that be when the FOMC has directly stated its not raising rates even with the astronomical economic growth and a substantial pick-up in inflation this year.
The conclusion has to be that there will be tighter policy over the coming years than would otherwise have been required to bring inflation back to the Committee’s target.
That conclusion is probably confirmed when you take a granular look are treasuries. If you take the implied real yields of US government bonds with five years or less to maturity these durations have actually fallen since the start of this year, those of longer-dated ones have risen sharply.
So, both parties are right, longer term inflation will drive tighter policy but for the short and medium term the needs getting through the pandemic takes precedence.
How do you trade this?
There is the year to date and 1-month chart of DXY versus the US 10-year yield.
It shows a fairly tight correlation between the 10-years rise and USD buying which you would expect.
However the pair that is most affected by this is USD/JPY seen in these chart.
This correlation is hard to ignore, its shows that USD/JPY and the 10-year yield are almost lock step. We continue to see this as the leading indicator for direction in the pair and have a long- term basis as yields are likely to hit 2% in the coming weeks taking the USD with it.
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