US dollar struggles to hold onto gains despite rising yields

The US dollar is off the best levels of the day as we count down to the New Year.

This time of year is all about flows and tomorrow is the final day for US tax-loss selling in equities, so that’s an important factor to note. In the bigger picture, the market continues to recalibrate towards larger global rate cuts next year. Fed fund futures price in 155 bps of cuts but I don’t think many other markets have caught up to that level of interest rates.

Two spots where we’re seeing that unfold is the low-yielding Japanese yen and Swiss franc. Both have been extremely strong this week and USD/JPY hit the lowest since July earlier today at 140.66. USD/CHF has blown out over the past two days as well.

That reflects:

1) A market that’s increasingly convinced that interest rates will converge at low levels again, with Fed funds likely to head towards 2% and Japanese rates perhaps creeping up to 0.5%. That’s a much-narrower spread than was assumed even a few months ago. A low-rate world also diminishes risks around the enormous fiscal debt load that Japan continues to carry.

2) Dollar longs have been a crowded trade and that’s quickly unwinding. I also strongly suspect that the latest leg lower in Treasury yields is more of a short squeeze than a true fundamental reflection. But the dollar trade is taking longer in part due to the size of the FX market and partly due to the time of year.

Going forward, we still have one more day of year-end trading to go and New Years Day will also be a dud but I think there’s more dollar selling to come.