During the first half of the year, the US dollar soared against most of its major competitors. This was largely driven by increasing interest rate differentials between the United States and Japan. The dollar was also buoyed by the growing unrest in China. However, the dollar’s strength weighed heavily on emerging markets equities. It also reflected investor concerns about the outlook for global growth.
Inflation pressures began to mount as the United States and other major economies began to raise policy rates. This drove Treasury yields higher, mainly due to increases in real yields. Nominal yields on the 10-year Treasury rose to the highest levels since late 2007. The two-year Treasury yield climbed to a record high of 1.46%, its highest level since late 2007. However, the yield on the 30-year TIPS bond is at an all-time low, at -0.508%.
The 10-year breakeven inflation rate, which is the average of the nominal yields on a 10-year Treasury note and a 10-year Treasury Inflation Protection Security (TIPS), is rising. This is a widely-used measure of market-based inflation expectations. The core PCE deflator is expected to increase from 3.6% y/y in September to 4.3% y/y in October. It is important to note that this measure is not as accurate as the actual measure, which is the 5-Year Forward Inflation Expectation Rate.
The Federal Reserve delivered its fourth 75-basis point increase in a row. Although inflation pressures are weighing on markets, investors have begun to question the Fed’s ability to engineer a soft landing. This week will feature a slew of US economic releases, including the ISM manufacturing report and personal consumption data. Although these reports will highlight the US economy, their main impact will be on US inflation. A number of investors are betting on a 50-basis point rate hike in December.
Inflation compensation measures in foreign economies were generally little changed, although large swings in European natural gas prices contributed to volatility. However, investors were generally positive on the outlook for the US economy, suggesting the Fed’s decision to raise rates may not be as pronounced as originally thought. Similarly, the Bank of Japan reaffirmed its accommodative monetary policy stance.
Investors continue to closely monitor the economic and financial outlook for the United States and other key markets. The Fed’s meeting minutes showed that a majority of policymakers agreed to slow the pace of interest rate hikes. In addition, they pointed to increased risks to the global economy, including higher inflation and a potential recession in 2022. The US dollar continued to gain, reflecting investor concerns about the outlook for global growth. In addition, the dollar exchange value reached multi-decade highs, particularly against major currencies.
The United States Dollar Index measures the performance of the dollar against a basket of other currencies. It includes a number of currencies, including the Euro, British pound, Swiss franc, Japanese yen, Canadian dollar, Swedish krona, and Australian dollar. Although the Bloomberg U.S. agg index is unmanaged, it provides a good overview of how the dollar has performed against other currencies.