The dollar is rallying and stocks aren’t getting killed. Maybe that’s because the up-move has nothing to do with the risk on/risk off paradigm.
Greg Anderson of Citi explains:
The proper explanation for EUR and JPY weakness overnight has nothing to do with domestic economic weakness, nor with risk appetite either. As has been the case for the past several months, the true underlying driver is US yields. US yields rose significantly on Friday, with the 10-year Treasury yield adding 13bp (to 2.79%) and the 2-year adding 3bp (to 0.50%). The rise in yields occurred in on a risk-off day in which the S&P 500 lost 1.18%, as previously noted. Today, US yields are higher, with the 10-year up another 9bp (to 2.88%) and the 2-year up another 5bp (to 0.56%) in what appears to be a risk-on environment, with S&P 500 futures up roughly 0.4%.
For the moment, US yields appear to be rising independent of what is happening in equity or commodity markets. Yields in the 2-10 range are now essentially the same as they were at the time of Bernanke’s Jackson Hole speech, which would suggest that the Fed’s QE2 measure has failed to have a permanent impact. Such a result would probably delight the EM central banks who are the biggest holders of US Treasury debt and who have been critics of QE2 at venues like the IMF and G20 meetings. If US yields continue to rise, they will drag the USD higher with them. However, it is important to note that the Fed’s QE2 purchases barely began last Friday. It will undoubtedly take time for those purchases to have an impact on yields, but to the extent they do, today’s USD strength will be undermined. We warn against getting too bulled up on the buck at this juncture. The USD needed to correct a bit higher, which it has, but the fundamentals for a bigger USD rally have yet to present themselves.
The good thing about his analysis, is that it will prevent you from lazily ascribing the euro weakness to “Ireland” or something similar. Bear in mind, too, that in May, the first time the PIIGS crisis really flared up, US yields compressed on a risk-off play, so while the current situation may rhyme with that, it’s not a replay.