The U.S. Dollar And Rates: A Bearish Easter?

by: Hedge Insider

The U.S. dollar has recently risen against the Japanese yen; however, this move is not being confirmed by the EUR/USD pair (or DXY, the U.S. dollar index, more broadly).

The positive carry offered by U.S. dollars, versus other currencies, is falling. Markets have become less optimistic about U.S. rates.

I believe the run of USD/JPY to the 112 level is a mark of a run to liquidity, and not a sustainable move which will necessarily send the dollar higher.

As we approach Easter, and with U.S. stocks at near all-time highs and Japanese holidays approaching, I believe there is a high risk of a move down for the U.S. dollar. This could also cause, or even be caused by, a fall in U.S. stocks.

Markets appear to be risk-on for now, and I do not believe there are any imminent threats of chaos; yet, I do believe there is an increasing short-term risk of a measurable drop in the U.S. dollar for traders.

The dollar has been shifting and changing its trajectory; in particular, it has been rising against the Japanese yen and falling against the euro. In this short article, I will review the U.S. dollar's recent movements, paying extra attention to changing yield differentials and near-term downside risk.

In the chart below, we have the U.S. dollar price in terms of euros, pound sterling, Australian dollars, Swiss francs, Canadian dollars, euros, and Japanese yen. The prices are mapped using lines representing weekly closing prices (the chart is measures change in percentage terms).

Currency Movements

(Chart created by the author using The same applies to subsequent charts presented herein.)

As we can see, from top to bottom in the chart above, the U.S. dollar has (1) fallen against the pound sterling and Australian dollar, (2) risen against the Swiss franc, (3) fallen against the Canadian dollar and the euro, and finally (4) strengthened against the Japanese yen. These are certainly mixed results.

Proceeding from these exchange rate percentage changes, let us compare the short-term U.S. dollar yield (using the rate on one-year U.S. treasuries) with the equivalent yields of the currencies mentioned above. The chart below provides us with the interest rate differentials; the positive or negative differences between the one-year rate for the U.S. dollar and that of the currencies mentioned.

U.S. Dollar Yields

(The alternate currencies are depicted using the same colors as given in the chart above).

Note: the corresponding one-year yield (or interest rate) used for euros was the yield on German government bonds, as it is one of the largest economies in Europe. Also note, due to a lack of data on TradingView, the Swiss rate has been omitted, although USD/CHF remains the highest positive carry of all major currency pairs (i.e., excluding exotic and more volatile Forex pairs).

In the chart above, to make the moves of each line more apparent, I have grouped the differentials into three separate vertical axes, so that recent moves (shown on a rolling daily basis) are more visible.

Marked by the red line, the positive carry of USD/AUD (or, in other words, the negative carry if viewed as AUD/USD, the inverted and more traditional view of this pair) has shot up since the beginning of 2019. Additionally, while the positive carry of U.S. dollars over euros (using German government bond yields as proxies) is still strong at almost 3%, the net yield has notably fallen.

In terms of pound sterling, the yield differential has dropped significantly; it is still positive, but has dropped from 1.84% at the start of the year to 1.61%. Of course, Brexit is affecting the pound on an ongoing basis, but the change is still important with the pound sterling remaining a major global currency. And lastly, the U.S. dollar rate has moved adversely over the rate offered by Japanese yen; shown at 2.59% in the last chart presented above (despite being over 2.9% in November 2018 and 2.75% at the start of 2019).

Overall, the changes in carry for the U.S. dollar are adverse across the board. Clearly, the market is far less optimistic about U.S. rates; the yield differentials are mostly making lower lows and lower highs recently. It is interesting that despite this, the rate differential is still improving versus Australian dollars, which would signal a bearish AUD/USD (and I do believe the Australian dollar has room to fall).

However, even if the price of the U.S. dollar follows through to the upside in terms of Australian dollars (driven by increasingly favorable carry), the U.S. dollar's recent positive move against the Japanese yen (in terms of price) I do not believe to be sustainable. This is because despite the yield differential ticking up recently, it is still low (much lower than before) and the exchange rate move is simply approaching a key level (shown in the chart below).

USD/JPY Price and Yield Divergence

The move is not being confirmed by the EUR/USD. We can use the DXY (U.S. dollar index, whose weighting is heavily skewed to euros) in light of the above chart, to identify this divergence. The chart below shows USD/JPY with the 112 level intact (as illustrated also in the above chart), but on the four-hourly chart and with DXY added (blue line).


USD/JPY and DXY have been largely correlated recently, despite their oscillations. From February into March, USD/JPY appeared to lead DXY upwards, and as USD/JPY later dropped through early-to-mid March, DXY later dropped with it. Yet, DXY fell quite intensely, sending USD/JPY even further down.

From late March through mid-April, DXY rose to the upside, seemingly leading USD/JPY this time. They began to line up, yet over the most recent few days, USD/JPY has spiked while DXY has not confirmed this move, making lower highs and lower lows since the beginning of the month. In short summary, it appears the recent rise of USD/JPY to 112 looks less of a compelling breakout long opportunity and more of a short-term run for liquidity.

As touched upon earlier, the U.S. dollar's positive carry is waning in various currencies, making less and less of an attractive carry trade. And with U.S. stocks now moving to all-time highs, with optimism in the air, I would exercise caution.

I believe the USD/JPY pair (and, more broadly, the U.S. dollar) is at risk of succumbing to the adverse changes apparent in its short-term yield differentials. A sudden change in sentiment in U.S. stocks could quickly change the recent risk-on sentiment, which could easily precipitate a negative move for USD/JPY. Perhaps this is not imminent, but the risks are growing.

Furthermore, from April 29, 2019, the Japanese will be having one of the longest set of consecutive holiday days in a long time (April 29, 2019 through May 6, 2019). Japanese holidays are infamous for creating short-term dislocations in markets due to reduced trading volumes (liquidity). In fact, such events can be self-fulfilling, and we could see some risk-off moves made in advance of these dates. As we approach Easter: caveat emptor.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.