US Dollar: Higher yields and oil support – MUFG

MUFG’s Lloyd Chan notes that the US Dollar has strengthened modestly as US Treasury yields climb, with the US 10-year yield reaching 5.00% and the 2-year at 4.66%. He highlights that reports that markets assign over a 90% probability to a 25 bps Fed rate hike at the upcoming FOMC meeting and expect a cumulative two hikes by year-end. He stresses the Fed’s trade-off between persistent inflation pressures from high Brent Oil, gasoline and agricultural prices, and the impact of tighter policy on US debt servicing and housing.

Dollar underpinned by rising yields

"The US dollar strengthened modestly overnight, while US Treasury yields continued their march higher across the curve."

"The US 10y Treasury yield has now reached 5.00%, while the 2y yield climbed to 4.66%. Since the start of the year, US 10y yields have risen by more than 80bps, while Asian and European yields have also surged, amidst rising commodity prices."

"Market attention now turns to the FOMC meeting decision later today. Markets are pricing more than a 90% probability of a 25bps Fed rate hike, while expecting a cumulative two hikes by year-end. That said, the Fed faces a difficult trade-off."

"On one hand, inflation risks remain elevated, with Brent crude holding above US$100/bbl, US retail gasoline prices staying above USD4/gallon, and agricultural commodity prices moving higher."

"Escalating tensions in the Middle East continue to threaten energy supply chains, with attacks on Saudi energy infrastructure and disruptions to key transport routes adding upside risks to oil prices. "

"On the other hand, tighter monetary policy raises debt servicing costs for the US government and adds further strain on interest-rate-sensitive sectors such as housing."