There’s no obvious reason for the recent weakness in the US dollar, according to Capital Economics chief economist John Higgins.
The US dollar index has fallen by nearly 2% in November and is now trading below its 200 day moving average.
That followed a strong run in October as US economic data turned positive, while the US Fed continued on its path toward monetary policy normalisation.
And according to Higgins, the recent fall is “mystifying”, particularly in relation to recent moves in interest rates.
Higgins looked at the difference between the yield on benchmark US 10-year treasuries, and a trade-weighted basket of 10-year bonds of other advanced economies.
He noted that the strength of the US dollar has correlated closely to that spread this year — until November:
For most of 2017, the yield spread was declining as US 10-year government bond yields steadily fell from their March highs. The spread has subsequently increased but the US dollar hasn’t followed suit.
It’s a similar story in shorter-term debt, as US 2-year bonds yields climb with markets having locked in another interest rate hike by the US Fed in December.
Since the end of October, the spread between US 2-years and the short-term debt of other major economies has widened, but the greenback has declined against every currency except the AUD:
Higgins added that the impact of short-term yield differentials on currency markets has declined this year, as markets focus less on interest rates and more on how central banks plan to unwind their unprecedented monetary stimulus measures.
But the fact remains that broader correlations with interest rates have broken down, and the shift has Higgins stumped for now.
In considering what other factors are weighing on the greenback, Higgins cited the ongoing investigation into Russian election meddling.
But he concluded that so far markets seem much more alert developments in tax reform, adding that political concerns haven’t stopped the US stock market from reaching new record highs.
“The bottom line is that the dollar’s slide doesn’t make a lot of sense to us,” Higgins said.
“We might be missing something, but we don’t expect it to last next year, as rate expectations and bond yields both generally move further in favour of the US.”