U.S. Dollar Decouples from Treasuries for a Simple Reason

The Dollar Index (DXY) is up +0.44% month-to-date

• U.S. Treasury yields are holding near their yearly highs, but the U.S. dollar has traded mostly lower this week.
• While Fed rate-cut odds have undergone a significant shift since the start of the month, other central banks are now just seeing their cut odds pushed back, helping catalyze other major currencies’ strength.
• Near-term U.S. dollar weakness may be worth fading longer-term.

Fed rate-cut odds for March and May are at their lowest levels of the year, helping push up U.S. Treasury yields to multi-month highs in recent days.

But the U.S. dollar is trading mostly lower this week, seemingly detached from a key fundamental driver. There is a reasonable basis for this divergence that may soon be resolved.

Since Jan. 31 Federal Open Market Committee (FOMC) meeting, Fed rate-cut odds have been on a steady trek lower. From Jan. 31 until the middle of February, the retreat in Fed cut odds was a singular effort. Rate-cut odds for the Bank of England, European Central Bank, Reserve Bank of Australia, etc. were little changed.

Investors reevaluate the odds

Starting on Feb. 14, traders began to reconsider their views on the timing of rate-cut cycles for all the other major central banks. Like with the Federal Reserve, traders began to speculate that rate-cut cycles would begin later in the year; declining cut odds from the BOE, ECB, RBA, etc. helped fuel a sell-off in overseas bond markets in what was effectively a ‘catchup trade’ to the move seen in U.S. Treasuries in the first half of February.

Given the economic trajectories of other major economies—Japan and the U.K. in technical recessions and the Eurozone not far behind—it still makes sense that the rest of the world will "out dove" the Fed for most of 2024. The short-term convergence between Fed and non-Fed rate cycle expectations has proved unfavorable for the U.S. dollar, but that catalyst may soon be exhausted.

Any additional weakness by the U.S. dollar may be setting up a "buy the dip" opportunity against a host of major currencies shortly.

/6B British pound technical analysis: daily chart (August 2023 to February 2024)

The British pound (/6BH4) has maintained a sideways consolidation that has been in place since mid-December 2023, ranging mostly between 1.2509 and 1.2833.

There’s little reason to think that the current range will break anytime soon, especially considering that /6BH4 finds itself directly situated between support and resistance. Range trading strategies like short strangles and iron condors remain appropriate, although given the lack of volatility (IV index: 6%; IV rank: 2.7), it’s understandable if traders look elsewhere.

/6E Euro technical analysis: daily chart (July 2023 to February 2024)

The euro (/6EH4) staged a modest rally off the swing lows established in early-November 2023, just north of 1.0700. In turn, it has also reclaimed the uptrend from the October and November 2023 swing lows, which initially provided support at the lows carved out at the start of February.

Does the turn higher constitute a bullish breaking from a falling wedge? It’s possible, and that would suggest that there remains significant space overhead for further gains in the short term. Any additional upside from here would be sought to be faded (perhaps via an ATM put spread).

\/6J Japanese yen technical analysis: daily chart (September 2023 to February 2024)

The Japanese yen (/6JH4) has been perhaps the most frustrating major currency in 2024, though hindsight offers clarity.

The Bank of Japan never delivered on hints that it would alter its policy stance while global bond yields ratcheted higher. While USD/JPY spot rates are hovering below the 2023 lows, /6JH4 has already breached the November 2023 low and has staged a feeble bounce off the lows established Feb. 13, the day the January U.S. inflation report was issued.

With /6JH4 continuing to track its daily five-day exponential moving average (one-week moving average) to the downside–it hasn’t closed above it since Feb. 1–it’s difficult to suggest that the currency has established a tradeable low.

Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multinational firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx

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