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Low US Rates May Lead To Usd Appreciation

The credit crisis proved to be a major shock for the financial markets, sending institutional investors into strong risk-aversion mode. This was reflected directly in the Treasury market, where investors bought the safety of the debt market, while shorting risky assets such equities and commodities as the 2009 and 2010 equity reversals unfolded.

With investors rallying into the Treasury market, the yield on US government debt fell to record low levels during the credit crisis. Since then, the market has made two returns to risk-tolerance, with equity market rallies in 2009 and 2010, that saw investors looking for higher yielding assets instead of the safety of Treasuries and bonds.

It seems that risk-tolerance does not mean anything at all for the Treasury market, since the debt market has continued to trade within the same tight range over the last half year. This was best seen in the short maturity bill market, where the market is trading close to the 0.0% benchmark level. The last time that short-term yields fell into negative territory was  after Lehman’s bankruptcy, in December 2008.

This points to something being wrong at one of the two ends of the interest rate equation. Either, the Treasury market is following the wrong event - most market participants say that the Fed’s pledge to maintain low interest rates for a long period has influenced the debt market – or that the equity and commodity markets are deeply overvalued.

Either way the story goes, two points are clear: the economy looks to be slowly recovering, thus pointing to higher yields, while the FOMC interest rates cannot go any lower from where they are currently standing; yet again pointing to higher yields.

Maybe the dollar will find buyers after all, as the market starts to price in global interest rate increases from most central banks, only to realize that the U.S. yields are already up there with the top end of the market, in regard to expectation and forward valuations. The last central bank to raise rates will likely be the same one that witnesses maximum appreciation in their currency values. It may then be no wonder that the dollar index cannot break 74.00 support, and could lead to the same bounce higher towards 82.00 that was seen in reaction to the 2009/2010 equity reversals.