Yields show dollar can gain as Fed prints money

The US bond market is giving dollar bulls more reason to be optimistic after driving the greenback higher against the other 16 major currencies since the first week of November.

Inflation-adjusted, or real, yields on benchmark 10-year Treasuries are higher than for similar-maturity notes in Germany, the UK and Japan, according to data compiled by Bloomberg. That may help the US lure foreign capital to finance the $1 trillion budget deficit even as Federal Reserve Chairman Ben S Bernanke floods the global financial system with cash by purchasing $600 billion of government debt.

“The yield story is important for the dollar,” said Derek Halpenny, European head of currency research at Bank of Tokyo- Mitsubishi UFJ Ltd. in London, who predicts a 9.3 per cent gain versus the euro next year and a 9.6 per cent advance against the yen. “If we continue to see an improvement in economic data, that’s going to push US yields higher.”

IntercontinentalExchange Inc’s US Dollar Index, which measures its performance against those of six trading partners, has risen 2.8 per cent since November 12, when the Fed began purchasing Treasuries in its second round of so-called quantitative easing. The US 10-year real yield was 2.15 per cent at the end of last week after averaging 1.74 per cent during the past decade.

The dollar is 3.4 per cent stronger against the euro in the period to $1.3226, 1.7 per cent higher versus the yen at 83.95 and up 1.9 per cent against the pound, trading at $1.5802. The dollar is the world’s most-traded currency, followed by the euro, yen and pound, according to the Bank for International Settlements in Basel, Switzerland.

A survey by Ried Thunberg ICAP Inc of 20 money managers controlling $1.34 trillion found that all forecast the dollar will be stronger or little changed versus the euro during the next three months and 90 per cent project the same against the yen. The poll by the Jersey City, New Jersey-based Reid Thunberg, a unit of ICAP Plc is dated December 13.

US 10-year real yields are more than a percentage point higher than the Japanese equivalent, approaching the most since October 2009. The Japanese yield ended last week at 1 per cent, down from this year’s high of 3.07 per cent on January 8. Euro real yields peaked at 2.49 per cent on January 4, before falling to 1.05 per cent last week. They are 0.32 per cent in the UK.

Higher yields may help the dollar the most versus the yen, according to Ronald Leven, executive director and currency strategist at Morgan Stanley in New York.

It tends to climb against the yen as US yields increase relative to Japanese rates. The correlation coefficient between dollar-yen and the spread between US and Japanese two-year yields averaged 0.52 since 2005, Bloomberg data show. A correlation of one means the pair move in lock step, while minus one means they move in opposite directions.

Even after rallying almost 6 per cent from an 11-month low on November 4, the dollar remains undervalued against 10 of the 16 most-traded currencies, according to a measure of purchasing- power parity compiled by the Organization for Economic Cooperation and Development in Paris that measures the relative prices of goods across countries.

The dollar is 27 per cent below fair value against the yen, 36 per cent undervalued versus the Swiss franc, 33 per cent against the Norwegian krone, 31 per cent versus the Danish krone and 30 per cent against the Australian dollar, the measure shows.