Dollar up, Treasuries climb as Fed rates sentiment eases

Greenback gains alongside less risky assets ahead of Waller speech.

The dollar hit a one-month high as Treasury yields climbed on growing speculation that the Federal Reserve may be reticent about cutting interest rates as early as March.

The Bloomberg Dollar Spot Index rose 0.4% to its highest level since Dec. 13, as cooling demand for risky assets also boosted the greenback. Treasury yields advanced across the curve as trading resumed after a US holiday, catching up with rising yields on European debt after hawkish comments from European Central Bank policymakers. The US 10-year yield rose six basis points to 3.99%, and briefly topped 4%.

“We see the rebound in the dollar as a reflection of rates markets reducing their rate-cut expectations,” said Kristoffer Kjaer Lomholt, head of FX research at Danske Bank in Copenhagen. “The US economy looks to be on a stronger footing than most peers, which is also contributing to the investment case of being long US assets.” A possible pivot to rate cuts by the Fed has been the center of market attention after inflation slowed from its peak in mid-2022. This has ramped up bets for aggressive Fed easing this year, although a growing number of market participants believe this move may have been overdone.

In London trade, markets priced 159 basis points of Fed cuts by December, 2 basis points less than Monday.

Investors are awaiting a speech by Fed Governor Christopher Waller scheduled for Tuesday after Chair Jerome Powell gave a clear signal in December that a series of rate cuts was in the pipeline for 2024.

“There has been a chorus of Fed and ECB officials trying to tame market expectations for aggressive rate cuts,” said Prashant Newnaha, a senior Asia-Pacific rates strategist at TD Securities in Singapore. “For quite some time the market has ignored their utterances, but it does appear the market paid some attention to ECB comments overnight.”

Threats stemming from lingering inflation and geopolitical risks will prevent the ECB from lowering interest rates this year, Governing Council member Robert Holzmann said in an interview.

The dollar has gained around 1.5% since the start of 2024, but options traders are cautious when it comes to further greenback strength in the near-term. One-week risk reversals in the Bloomberg Dollar Index, a barometer of market positioning and sentiment, are at their most bearish levels in two weeks. Still, over a one-month horizon, risk reversals are trading near a one-month high.

Treasuries look vulnerable after traders priced in what looks like too many interest-rate cuts from central banks, said Kellie Wood, deputy head of fixed income at Schroders Plc in Sydney. Her firm recently took profit on long positions in bonds, while maintaining bets on a steeper curve and holding inflation-linked debt. “Close to seven cuts this year seems excessive,” Wood said, after traders priced in as much as 170 basis points of reductions in the Fed rate on Friday. “The front end is overbought on positioning and loaded with profit, so that could signal a reversal” is coming, she added.