This morning’s move in bonds might not rival the transition from Brosnan to Craig, but it has reordered the global currency landscape. Yields are lower across the curve, and the dollar is down against all of its rivals after a softer-than-anticipated October inflation print. The Federal Reserve is now expected to ease policy more quickly and dramatically than many of its major counterparts over the next year – with the European Central Bank standing as the lone exception.
But long-term yield differentials are still tilted overwhelmingly in the dollar’s favour. The difference between ten-year Treasury yields and our gross domestic product-weighted measure of industrialized-country equivalents remains extremely elevated, meaning that comparative return differences flatter US investments relative to their global alternatives, and dollar-denominated funding costs remain very high.
In our view, this differential is unlikely to collapse in the near term: a “soft landing” in the US economy won’t drive Fed officials into cutting rates dramatically, a “muddle through” might drive a more gradual decline, and a “hard landing” would force other central banks to match, or even exceed, its easing pace. The dollar could fall further – we’ve expected such a correction for many months now – but we would caution market participants against betting on a massive and sustained move lower.