US Treasury Yields Surge, What's Next for the US Dollar Index?

Last week (7/31-8/4), the US dollar index rose by 0.4%, while most other currencies experienced declines. The euro fell by 0.05%, and the yen dropped by 0.4%.

【Source: MacroMicro  Date2023/7/31-2023/8/4】

【Source: MacroMicro  Date2023/1/1-2023/8/4】

Benefiting from the rise in US bond yields following Moody's downgrade of the US rating, the US dollar index experienced a significant rebound in the first half of the week. However, on Friday, the US dollar index declined after the release of non-farm payroll data, which was below expectations. Nevertheless, it still ended the week with an overall gain of 0.4%.

【Source：MacroMicro 美元指数与国债利差正相关】

Some analysts believe that due to risk aversion, US bond yields may be overextended, with limited room for further upward movement at the current levels. There is a greater probability of US 10-year Treasury yields falling below 4% in the future.

The future trajectory of the US dollar index still depends primarily on the relative performance of the European and American economies and changes in expectations of interest rate hikes by central banks in both regions.

Last week, Eurostat released data showing that the euro area's initial estimate of Consumer Price Index (CPI) rose by 5.3% year-on-year in July, meeting expectations and lower than the previous value of 5.5%. Excluding volatile food and energy prices, the euro area's core harmonized CPI increased by 5.5% year-on-year in July, surpassing expectations of 5.4% and remaining unchanged from the previous value of 5.5%.

Until there is a downward trend in core inflation in the euro area, the European Central Bank (ECB) may still proceed with its final interest rate hike in September. This could provide some support for the euro in the medium term and consequently weigh on the US dollar.

Mitrade Analyst：

This week, the focus is on the US July CPI data. If US inflation continues its previous weakening trend, the US dollar may weaken again. Conversely, if the data exceeds expectations, the US dollar is expected to continue its rebound.

From a technical standpoint, bullish momentum in the US dollar has weakened, but buying signals remain strong. If it can break through the key level of 102.8 early this week, there is potential for further upside. On the other hand, the US dollar index would decline further, with support seen at 101.

【Source：TradingView】

Against the backdrop of a strengthening US dollar, the Japanese yen depreciated by around 0.4% against the US dollar last week.

Following the Bank of Japan's decision to pursue "greater flexibility" in yield curve control (YCC), analysts generally agree that the central bank is on the verge of a potential shift, and the market is preparing for this moment.

UBS suggests that if the United States does not enter a recession in the fourth quarter, the target for 10-year government bond yields may be raised. In particular, if forecasts indicate resilience in the US and global economies beyond this year and into next year, the Bank of Japan may make further adjustments to its YCC policy in October.

However, the Bank of Japan will maintain a wait-and-see approach until it can confirm the end of the US recession and global economic weakness. If the yen undergoes significant depreciation, the Japanese Ministry of Finance may stabilize the exchange rate through foreign exchange intervention.

Mitrade Analyst：

Currently, the concept of Yield Curve Control (YCC) still exists nominally, but its effectiveness in anchoring market expectations has significantly weakened. In the medium to long term, we maintain our view that the yen will appreciate. However, in the short term, with the Bank of Japan maintaining a wait-and-see approach, we anticipate the yen to continue fluctuating.

From a technical standpoint, the USD/JPY encountered resistance and retraced within a 2% range of the 20-day moving average. It is expected to fluctuate within the range of 140-144 this week.

【Source：TradingView】