US dollar surprises | Treasury bonds tell a story

One could be forgiven for thinking that the New Zealand dollar / US dollar pair (NZDUSD) would be heading resolutely south after experiencing what could be described as a triple whammy over the last two days (Wednesday and Thursday Oct 29 and 30).

Firstly there was the FOMC monetary policy statement, which effectively reversed the committee’s previous concerns about employment and inflation expectations, leading to what was a far more hawkish stance than had been expected. QE is over and the prospect of sooner rate rises stateside has increased, which tends to strengthen the US dollar.

Then the Reserve Bank of New Zealand came out with its policy statement. Not only did they not increase rates, they made it clear that they were to stay flat for the foreseeable future, and also used language that intimated that the NZ dollar was way overpriced and expected to fall. So a dovish RBNZ, which should, in theory, weigh on the Kiwi.

Thirdly, US GDP figures were released, which revealed quarterly growth of 3.5% as against 3% expected. Again, bullish for the US dollar.

Now, while all of these things sent the pair in the indicated direction initially, the sentiment did not last. Immediately after the GDP announcement NZDUSD started to climb. As our US friends might say: “Go figure”.

Bonds tell a story

Under the conditions outlined above (Hawkish FOMC and good GDP growth) US treasuries, or government bonds, would be expected to fall in price, leading to a higher yield (we regard bond yield as a proxy for core interest rate expectations). But this did not happen. They rose instead. Some commentators put this down to the fine print of the GDP statement. This showed that a large part of the increase was made up of defence spending, which is known to be volatile. In addition, the consumer spending component of the GDP index rose at only a little more than half the rate of the previous release.

More significantly, perhaps, is the reality of low inflation at the present time, both in the US and in other major economies. This depresses expectations of core interest rate rises in a general way. So, against what might be expected from the released data, bond prices go up and the greenback weakens, relatively speaking - it is still in an overall uptrend.

And then there is the fact that we are in the end-of-month period, when there just might be a bit of re-alignment of portfolios going on.