The dollar risks falling because traders lack confidence in how the Federal Reserve will respond to an energy-price shock tied to the Middle East conflict, MUFG Bank says. Meanwhile, low foreign-exchange volatility is fueling fresh demand for yen-funded carry trades.
The dollar faces downside risk because markets have no clear read on the Federal Reserve's next move, MUFG Bank's Derek Halpenny says in a note. Fed Chairman Kevin Warsh has given no clear signals on potential interest rate rises, refraining from forward guidance even as an energy-price shock tied to the Middle East conflict clouds the outlook.
Traders worry the Fed could hold rates steady despite elevated underlying inflation, Halpenny says, and that concern is steepening the Treasury yield curve as long-term yields stay elevated relative to short-term ones. The DXY dollar index rose 0.1% to 99.895. The 10-year Treasury yield climbed to an 11-day high of 4.7354%, according to LSEG data.
The Japanese yen faces further underperformance as low currency-market volatility increases demand for carry trades, in which investors borrow in low-yielding currencies to invest in higher-yielding ones, Halpenny says. Even after another negative U.S. nonfarm payrolls print last Friday, risk appetite has held up. According to MUFG Bank's Derek Halpenny: "the appetite for risk remains solid", which is helping to depress broader G-10 currency volatility.
With volatility set to stay low, Halpenny says the outlook for carry trades remains attractive. The dollar traded flat at 159.34 yen after touching an 11-day high of 159.37 earlier, LSEG data show.
Source: The Wall Street Journal
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