FX Markets React to Rising US Rates: Implications and Outlook
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FX Daily: Re-pricing for a world of higher US rates
FX markets are settling down after a big week of central bank policy announcements. Perhaps the biggest story is that the world's 10-year benchmark borrowing rate is pressing at 4.50% – seemingly on the view that a new neutral rate for Fed Funds may be 4%, not 2.5%. Expect the dollar to hold gains as Europe braces for another soft run of PMI data.
USD: 4.50% on the US 10-year yield could pressure risk assets
US interest rates continue to grind higher. Overnight, the US 10-year Treasury yield has edged up to 4.50% – the highest since 2007. Driving the move continues to be a re-assessment of the Fed's higher-for-longer policy. Looking out along the USD OIS curve, investors struggle to see short-term US rates (one month OIS) below the 4.00% area over the next 15 years. Our rates strategy team argues that it is fair to see a modest positively sloping yield curve over that period and the 10-year priced 50bp above this 4% low point.
This grind higher in US yields – marking higher risk-free rates – creates headwinds for risk assets such as equities, credit and emerging markets. Indeed, even the AI-powered S&P 500 is having a bad month, though it is still up 12.8% year-to-date. This equity correction is supportive news for the dollar, where any move to cash will mostly end up in the liquid dollar that pays 5.30% overnight rates.
For today, another bleak run of PMIs in Europe may well keep European currencies soft and the dollar bid. The US data calendar today sees the flash PMIs for September, where the composite PMI remains just above 50. This data has not been market-moving recently. More important was yesterday's release of the lowest weekly jobless claims since January which suggested there are very few signs of a robust US labour market turning.
Expect DXY to remain bid and there is a scenario where the dollar stays strong into mid-October, when large US corporates based in California need to pay their taxes.
