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>>> Here's why the US dollar is 'priced to perfection' — and why it could move even higher
Yahoo Finance
by Alexandra Canal
January 8, 2025
https://finance.yahoo.com/news/heres-why-the-us-dollar-is-priced-to-perfection--and-why-it-could-move-even-higher-194141160.html
The US dollar (DX=F, DX-Y.NYB) extended its rebound on Wednesday, adding to gains after the currency was on track for a one-week low following a report from the Washington Post on Monday that suggested President-elect Donald Trump won't commit to an aggressive tariff plan.
But just two days later, CNN reported Trump could declare a national economic emergency to enact universal tariffs, pushing the dollar even higher as equities faltered.
The US dollar "is priced to perfection," Bank of America's global rates and currencies research team, led by FX analyst Athanasios Vamvakidis, wrote in a note published on Wednesday. "The USD has rallied strongly since the US election, from an already high level."
After hitting a September low, the US Dollar Index — which measures the dollar's value relative to a basket of six foreign currencies, including the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc — has rallied nearly 9%. Since the election, it has climbed by over 5%.
"In real effective terms, our estimates suggest that the USD ended 2024 at a 55-year high," Vamvakidis said. "This has been the longest USD uptrend in recent decades, which started in mid-2011."
The currency's price action has largely been driven by two main catalysts: Trump's election and the subsequent Republican sweep, along with the recalibration of future Fed easing in the face of strong economic data.
"American exceptionalism in terms of better economic growth, faster productivity growth, superior equity market performance, and higher yields all act as a collective magnet for attracting capital to the United States," wrote Blake Millard, director of investments at Sandbox Financial Partners.
Even data that's often viewed as not so good, like sticky pricing pressures, can be positive for the dollar.
The latest example: Data released on Tuesday showed prices paid in the services sector during the month of December jumped to a nearly two-year high, suggesting the inflation fight is not yet finished.
Traders scaled back rate cut bets as a result, placing a less than 50% chance the central bank cuts rates ahead of its June meeting, per the CME FedWatch Tool. That possibility spooked markets, with all three major indexes closing firmly lower. The dollar, though, instantly rebounded to end the session higher.
"With the Federal Reserve expected to cut rates less than most other major central banks, expected interest rate differentials favor the greenback," Millard wrote. "Also, tariffs will restrict the flow of goods leading to fewer dollars going abroad and reducing the demand for foreign currency."
And with most economists in agreement that Trump's proposed tariff plans will lead to higher inflation over time, the cycle surrounding bullish dollar sentiment remains intact.
The dollar's path forward
Of course, certain risks remain that could derail the dollar's positive path. And a lot depends on the unknowns of Trump 2.0.
"We expect the USD to remain strong in the short term on the back of US inflationary policies, and particularly tariffs, but to weaken later in the year, as these policies take a toll on the US economy while the rest of the world responds," BofA's Vamvakidis and his team wrote. "Policy uncertainty makes our baseline subject to substantial risks."
Some strategists believe markets have already overreacted to policy rumors that might not even come to fruition.
"I think we've got to take it all with a grain of salt," Tony Roth, chief investment officer at Wilmington Trust, told Yahoo Finance's Catalyst program on Wednesday. "I'm a little surprised, frankly, that the markets are ascribing as much importance to this sort of 24-hour rumor cycle mill on what he's going to be doing with tariffs."
But for now, the dollar is trading around a key inflection point, Millard said.
"Should the dollar continue its 3 to 4 month ascent higher, expect risk assets to remain under further pressure and a messy tape going forward," he said, referencing the historic negative correlation between the US dollar index and domestic equities.
A main reason for that is a strong US dollar can adversely impact companies that do business overseas, particularly due to slow earnings growth amid unfavorable foreign exchange conversions.
Per FactSet data, S&P 500 companies with international exposure drove the bulk of earnings growth during the third quarter. So a stronger dollar, coupled with blanket tariffs, could spell big trouble for stocks.
But "if the dollar stabilizes or breaks down from here," according to Millard, "then it should be party on for the bulls."
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>>> Trump’s Plan to End Currency War 3.0
By James Rickards
January 3, 2025
https://dailyreckoning.com/trumps-plan-to-end-currency-war-3-0/
Trump’s Plan to End Currency War 3.0
There has been a lot reported in recent days about the return of currency wars. With Trump 2.0 about to begin, let’s review his last term and what to expect in the second.
Trump badly bungled his transition after first being elected president in 2016. He was not ready with a long list of loyal appointees. Many of his senior appointments such as Rex Tillerson as Secretary of State, James Mattis as Secretary of Defense, and John Kelly as Chief of Staff secretly disliked Trump but accepted their roles as so-called “adult supervision” around the supposedly reckless Trump.
They thwarted his agenda. That backstabbing came on top of the large number of Obama holdovers in the Deep State who saw themselves as a “resistance” movement.
Trump is doing a better job of preparing for a second term as president, but the resistance is not sitting still either. As reported in The Washington Post, Politico, The Wall Street Journal, Yahoo Finance and other outlets, Trump is working on a secret plan to devalue the U.S. dollar. The goal would be to cheapen U.S. exports and thereby help the U.S. balance of trade and create exported-related jobs.
But critics say that this will only increase U.S. inflation as Americans have to pay more for their imported goods using cheaper dollars. The critics also say that other countries will retaliate against the U.S. by cheapening their own currencies (that’s the essence of a currency war) and no country will be any further ahead. In fact, the entire world will be worse off.
Rules of (Currency) War
Before looking more closely at what’s actually going on, some basics about a currency war should be explained. The first rule is that the world is not always in a currency war. The periods from 1944 to 1971 (the original Bretton Woods era) and from 1987 to 2010 (the period of the Washington Consensus) were times of currency peace. This contrasts with 1921-1936 (Currency War I), 1967-1987 (Currency War II), and the current period since 2010 (Currency War III).
The second rule is that when we are in a currency war, they can last for fifteen years or longer. It comes as no surprise that the currency war that commenced in 2010 is still going strong 14 years later in 2024. And that points to another key aspect of this debate.
The currency war being written about today by the media is not a new currency war. It’s the same one that has been going on since 2010. We’re simply in a new phase or a new battle.
It is true that cheapening your currency can import inflation. Sometimes that’s a legitimate policy goal if your country has been suffering from deflation. That’s obviously not the case in the U.S. today.
It’s also true that cheapening your currency can export deflation as trading partners pay less for your goods. That’s what China was doing to the entire world from 1994 to 2010 and that’s why the U.S. launched a currency war in 2010 – to fight back against disinflation and borderline deflation caused by cheap Chinese goods.
Currency wars can also shift jobs overseas and destroy domestic manufacturing as the terms of trade shift based on changing currency values. Retaliation is always waiting right around the corner in any currency war. The U.S. dollar hit an all-time low in August 2011, which was consistent with the U.S. goal of trying to import inflation.
But Europe struck back, and the EUR/USD cross-rate crashed from $1.60 to $1.04 as a result. So, it is correct that no one wins a currency war, and everyone is damaged in the process due to volatility, uncertainty, and the costs of conducting the war.
Trump’s Plan: Currency Peace
So, are the critics right that Trump has a secret plan to devalue the dollar? And are they right that this new stage in the currency war will bring inflation and hurt the U.S. economy?
The critics are wrong and don’t understand what Trump is actually trying to do. Trump is not trying to start a currency war; he’s trying to end it once and for all.
In the first place, no president has the power to unilaterally devalue the dollar. That might have been possible under the gold standard or some standard of fixed exchange rates, but that has not been the state of the world since 1973.
Exchange rates fluctuate based on a number of factors including interest rates, industrial growth, exchange controls, central bank interventions, capital flows, tax rates and many other macroeconomic variables. But the idea that the president can just wave his hand and devalue the dollar is false.
Far from the reckless, inflationary process the media claim, Trump’s actual plan is based on the highly successful model developed by James Baker for Ronald Reagan and implemented in the Plaza Accord of 1985 and the Louvre Accord of 1987.
After the severe economic recession of 1982 and Paul Volcker’s policy of moving interest rates to 20%, inflation in the U.S. was finally reigned in. Inflation dropped from 13.5% in 1980, to 6.1% in 1982, and then 3.2% in 1983. Investment in the U.S. went on a tear. U.S. real growth was 16% from 1983 to 1986. Everyone wanted dollars to invest in the U.S. and the dollar boomed reaching an all-time high in 1985.
Finally, the Reagan administration decided the U.S. dollar was too strong and was hurting U.S. exports and jobs. Treasury Secretary James Baker convened a meeting of the finance ministers of France, Germany, Japan, the UK, and the U.S. at the Plaza Hotel in New York City. The purpose was not to fight a currency war. The purpose was to create order in currency markets out of the chaos that had prevailed since 1973.
The parties reached a joint agreement that would devalue the U.S. dollar in an orderly fashion versus the French Franc, Japanese Yen, UK pounds sterling, and the German Deutschemark. Once the targeted level for the dollar was achieved, the parties would use their best efforts, including market intervention as needed to maintain those levels within narrow bands.
A separate meeting in Paris at the Louvre in 1987 agreed that the devaluation phase was over, and the dollar would be maintained at the new parities. This was not currency war; it was currency peace achieved by agreement and implemented in a cooperative fashion. The Louvre Accord (this time including the U.S., UK, France, Germany, Japan and Canada) ushered in a period of global prosperity that lasted twenty years until the Global Financial Crisis of 2008.
Trump’s goal is to repeat the success of the Plaza and Louvre Accords. Trump’s advisor on this is Robert Lighthizer, who is one of the most brilliant financial minds around and was Trump’s U.S. Trade Representative (2017-2021).
Lighthizer was also USTR for Ronald Reagan from 1983 to 1985 so he’s a veteran of prior currency wars and was in the administration around the time the Plaza Accord was being developed. Lighthizer is the perfect individual to help Trump achieve the kind of success that Reagan and Baker had in the 1980s.
The media are trying to portray Trump as reckless when in fact he’s proposing something highly beneficial for U.S. jobs and U.S. industry. Don’t be fooled by false claims of new currency wars. Trump is trying to achieve a new era of currency stability and lasting prosperity.
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>>> Treasury Market Gets First 5% Yield in Sign of What Could Come
Bloomberg
by Sydney Maki and Alice Gledhill
January 8, 2025
https://finance.yahoo.com/news/key-us-treasury-yields-approach-134001674.html
(Bloomberg) — The 20-year Treasury bond offered a grim warning as a selloff fueled by inflationary angst gripped global debt markets: 5% yields are already here.
The 20-year yield, a laggard on the US government debt curve since its re-introduction in 2020, topped 5% Wednesday for the first time since 2023. The move, fueled in part by concern that President-elect Donald Trump’s policies will rekindle price pressures and lead to wider deficits, indicates what’s potentially next in the $28 trillion Treasury market.
The 30-year yield topped 4.96%, while the 10-year rose as much as four basis points to nearly 4.73% — just shy of its highest level since November 2023. The moves echoed the run-up in yields seen in the UK and across emerging markets.
“The US market is having an outsized effect as investors grapple with sticky inflation, robust growth and the hyper-uncertainty of incoming President Trump’s agenda,” said James Athey, a portfolio manager at Marlborough Investment Management.
Treasury yields have been climbing since the Federal Reserve in September kicked off its interest-rate cutting cycle with an outsized half-point move. A resilient US economy and Trump’s White House victory less than two months later fueled the moves further, leaving the 10-year yield more than 100 basis points higher than it was before the Fed’s debut rate reduction.
“Treasury yields at 5% is definitely on the cards,” said Lilian Chovin, head of asset allocation at Coutts. “There’s a risk premium, a term premium going on with the very large fiscal deficits.”
From Amundi SA and Citi Wealth to ING, firms are increasingly acknowledging a new era of higher yields, and options traders are targeting the 5% level. It’s a rude awakening for a market that had broadly expected yields to fall as central banks pivoted from aggressive rate hikes to cuts.
New Era
The 20-year bond yield, though an outlier on the curve because it’s a relatively new tenor, is subject to the same pressures as the others. Yields retreated slightly from the day’s highs after the ADP gauge of private-sector hiring was weaker than anticipated for December.
All that has forced bond investors to contend with the possibility that the benchmark yield could soon return to 5% — a level that has been breached only a handful of times over the past decade, most recently in late 2023.
The level has also come into focus as the US government issues a whopping $119 billion worth of new debt this week. A sale of 30-year bonds lies ahead at 1 p.m. New York time and stands to draw the highest yield since 2007 — like the 10-year auction did on Tuesday. The Treasury also sold three-year notes on Monday.
Shifts in open interest data on US 10-year note futures indicate that traders have added to bets on higher yields every day so far this year, likely helping to exacerbate the yield’s move closer to 5%. The data also offered evidence that traders had strong appetite for new bearish wagers.
Such a rapid build-up of short positions in the first days of 2025, of course, stands to potentially spur volatility around upcoming economic data releases. That puts bond investors on high alert ahead of readings of the US labor market on Friday and consumer price inflation next Wednesday.
Higher yields also raise the stakes as Fed officials — who’ve cut borrowing costs three times this cycle — aim to get inflation under control without triggering a downturn of the economy. Projections updated last month showed the median policymaker expects two additional cuts in 2025.
Fed Governor Christopher Waller on Wednesday said he believes inflation will continue to cool toward the central bank’s 2% target, offering support for additional cuts this year.
Traders, meanwhile, are pricing in a cumulative 36 basis points of easing this year — implying no more than one quarter-point reduction. The first such move isn’t fully priced in until July.
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>>> Trump’s first year will be filled with fiscal follies
Yahoo Finance
Rick Newman
December 24, 2024
https://finance.yahoo.com/news/trumps-first-year-will-be-filled-with-fiscal-follies-155611389.html
Relief swept Washington, D.C., after Congress ended a budget standoff and passed a short-term spending bill on Dec. 21, averting a government shutdown. But that year-end legislative battle may foretell further fiscal chaos in 2025, including the risk of another downgrade of US debt.
Donald Trump will take office on Jan. 20 with his fellow Republicans running both houses of Congress. That Republican “trifecta”— full control of the legislative and executive branches — has boosted hopes that Trump will be able to extend a huge set of tax cuts due to expire at the end of 2025 and perhaps rein in government spending.
The Trump agenda, however, now looks a lot shakier, and the recent funding battle demonstrates why.
Though Republicans control the House, the party is split into factions, including a group of budget hawks that numbers more than 30. Those Republicans are dead set against tax cuts or spending hikes that add substantially to the national debt, now more than $36 trillion.
The Dec. 21 spending bill passed the House by a comfortable 366-34 margin, but that’s because every Democrat voted for it. Democrats were willing to join most Republicans in voting for the bill so President Biden doesn’t have to manage an unpopular shutdown during his final days in office. Once the House voted, the Senate passed the funding bill without any problem.
But minority Democrats aren’t likely to vote for Republican priorities once Trump takes office. And once the next Congress convenes on Jan. 3, Republicans will have just a five-seat majority, which is even thinner than the current GOP breakdown. That means partisan legislation will require virtually every Republican vote, a feat that has become notoriously difficult in the fractious GOP during the last several years.
Republican lawmakers are already working on a huge set of tax cuts meant to be the capstone for the first year of Trump’s second term. That includes an extension of all the individual tax cuts enacted in 2017, which expire at the end of 2025. Republicans also hope to include new measures Trump has proposed, such as eliminating the income tax on tips.
But the latest revenue fight raises fresh doubts about whether Republicans can get it done.
“Our discussions with Republican staff on Capitol Hill have increasingly suggested that a partisan bill that addresses the expiring [tax cuts] will be inordinately difficult, if not impossible, to pass next year,” Henrietta Treyz, co-founder of Veda Partners, wrote in a recent analysis. “The government funding debate neatly illustrates why Republican staff is feeling anxious about their prospects next year.”
The basic problem is that extending the 2017 tax cuts would add about $4 trillion to the national debt, with the bill even higher if Congress lards in additional tax breaks. Republicans will try to cut spending to offset some of that, but most spending goes toward defense, which most Republicans support, plus politically popular programs such as Medicare and Social Security. Major spending cuts would outrage voters, including many Republicans, which means there’s no real way to prevent tax cuts from ballooning the debt even more.
When Congress first passed the Trump tax cuts in 2017, 12 House Republicans voted against the bill. But Republicans had a far larger majority then and could afford to lose some internal support. In 2025, just two or three defections will be enough to sink GOP legislation. And there seem to be more than two renegade Republicans.
The most telling moment in the recent funding dispute wasn’t the vote tally on the final bill but the vote on an earlier bill Trump urged all Republicans to vote for. Thirty-eight Republicans bucked Trump, dooming that bill. Their main objection was that the bill would have suspended the debt limit, the law that limits the total amount of money the US government can borrow.
The bill Congress finally passed on Dec. 21 did not address the debt limit, which means Trump is going to have to tangle with that, which he was hoping to avoid. During the last big spending fight in 2023, Congress suspended the debt limit, but only until Jan. 1, 2025. That means it will have to raise the debt limit again next year, saddling Trump with what has routinely become an ugly political fight.
The next 12 months, in fact, are going to be filled with fiscal fireworks. There will be another funding fight in March, which is when the current temporary spending expires. Around that time, the deadline may be drawing near for when Congress has to raise the borrowing limit. Then there will be another spending battle in September, which is when the government’s fiscal year ends and Congress needs to approve the next year’s funding.
Markets usually survive government shutdowns without much bruising. But debt ceiling fights can get harrowing because there’s an implicit threat that the US will default on some payments if Congress doesn’t raise the limit.
S&P downgraded the US debt rating for the first time ever in 2011 following a congressional standoff that left the Treasury days away from a default. Fitch cut the US debt rating after the 2023 showdown, while Moody’s changed its US outlook from stable to negative. All three agencies cite political dysfunction as their main concern.
Since the US fiscal situation gets progressively worse, those concerns are likely intensifying. In 2023, when Fitch cut the US rating, the national debt was $32 trillion. Eighteen months later, it’s $4 trillion higher. Plus, there have been some signs that endless US borrowing is beginning to rattle bond markets, which is how a US debt crisis would likely begin.
Trump may still get his tax cuts. But the political brawls it will take to get there will leave the United States in even shakier fiscal shape than it's in now.
Somebody, at some point, is going to have to say no more.
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>>> Stocks Like Trump. Bonds Like Bessent Better.
The Wall Street Journal
by Sam Goldfarb
December 9, 2024
https://finance.yahoo.com/news/stocks-trump-bonds-bessent-better-103000503.html
Things are getting political in the $28 trillion U.S. Treasury market.
Treasury yields, a crucial driver of borrowing costs across the economy, typically fluctuate with traders’ bets on short-term interest rates set by the Federal Reserve. But their biggest moves lately have been sparked by election results and President-elect Donald Trump’s pick of Scott Bessent as Treasury secretary.
The Dow Jones Industrial Average soared more than 1500 points the day after Trump’s election win, and the S&P 500 rose Friday to close at a record, its 57th of the year. Treasurys, by contrast, started to rally only after the Bessent nomination.
Here’s a look at what’s been driving the swings in Treasury yields and what that could mean about the road ahead:
Out with inflation, in with jobs
As of Friday, the yield on the benchmark 10-year Treasury note was 4.150%, in the middle of a range that has prevailed since late 2022. That is when the Fed was raising interest rates aggressively to tame inflation.
That range, however, is large. Yields, which move in the opposite direction of bond prices, have swung sharply this year as economic-data releases have sent traders shifting between worries about inflation and fears of a recession.
More recently, inflation has faded as a concern for investors, often doing little to move yields.
Jobs data have remained important. A strong report released in October eased concerns about a recession and sparked a rebound in yields. The latest report, on Friday, showed a small uptick in the unemployment rate and had a more modest impact.
Enter Trump
Now traders say Trump’s agenda of mass deportations, higher tariffs, lower taxes and looser regulations could put upward pressure on inflation and interest rates, driving down bond prices and sending yields higher.
Bond-market bets on a Trump victory intensified after a series of good polls for the former president. Yields peaked after the election, but reversed after Trump’s pick of the longtime investor Bessent as Treasury secretary.
Wall Street generally views Bessent as a safe pair of hands who could temper Trump’s populist impulses.
The path ahead
Treasury yields have climbed since September, despite the fact that the Fed has started to cut interest rates.
The main reason: Treasury yields are heavily influenced by investors’ expectations for short-term rates going forward. The cuts that the Fed has made so far were already baked into Treasury yields, and investors are now anticipating fewer cuts in the future than they had previously.
Higher Treasury yields mean steeper borrowing costs for businesses and consumers. But yields often rise because investors are optimistic that a strong economy can withstand high rates.
Potentially more destabilizing would be a climb caused by a rising term premium—Wall Street lingo for the component of Treasury yields that reflects everything other than investors’ expectations for short-term rates. That can include anything from the supply of bonds to hard-to-pin-down variables such as uncertainty about the long-term inflation outlook.
Various models show the term premium climbing sharply around the election. But those estimates fell after Trump’s pick of Bessent, underscoring the faith that investors currently have in the Treasury nominee.
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Atlantic Council / IMF - >>> Going for gold: Does the dollar’s declining share in global reserves matter?
Econographics
By Hung Tran
August 27, 2024
https://www.atlanticcouncil.org/blogs/econographics/going-for-gold-does-the-dollars-declining-share-in-global-reserves-matter/#:~:text=Its%20latest%20COFER%20report%20shows,been%20reported%20to%20the%20IMF.
Going for gold: Does the dollar’s declining share in global reserves matter?
Over the past twenty-three years, the US dollar (USD) has declined gradually as a share of global foreign exchange reserves, according to the International Monetary Fund (IMF). The shift has not benefited any other major currency viewed as a potential competitor to the USD, like the Euro, the Great British pound (GBP), or the yen. It has instead favored a group of lesser-used currencies, including the Canadian dollar, the Australian dollar, the Renminbi, the South Korean won, the Singaporean dollar, and the Nordic currencies. If gold—which has recently experienced a surge in purchases by many central banks, as well as the general public—is included in reserve asset portfolios, the share of the USD is smaller than what the IMF has highlighted. As geopolitical confrontations deepen, the share of the USD in global reserves is likely to continue declining in the future, eventually diminishing the dominant role of the dollar and the US in the international financial system.
The declining share of the USD in global reserves
The IMF conducts a regular survey of Currency Composition of Official Foreign Exchange Reserves (COFER). Its latest COFER report shows that in the first quarter of 2024, the share of USD sits at $6.77 trillion—54.8 percent of the total official foreign exchange (FX) reserves of $12.35 trillion, or 58.9 percent of allocated FX reserves where currency breakdowns having been reported to the IMF. This is a noticeable fall from the 71 percent share for USD in 2001. Basically, the decline in the USD share has been driven by efforts by central banks to diversify their reserves into a wider range of currencies—a move facilitated by improvements in financial markets and payment infrastructures in many countries. It is important to note that the share of USD would be lower if gold were included in global reserves.
Since the global financial crisis in 2008, the world’s central banks have increased their gold purchases in an attempt to manage heightened financial system uncertainty. Doing so has pushed gold prices up by 138 percent over the past sixteen years to reach the current record highs of over $2,600 per ounce. Gold buying has accelerated further in recent years as part of a growing popular demand. In 2022 and 2023, central banks purchased more than one thousand tons of gold per year, more than doubling the annual volume of the previous ten years. Purchases have been spearheaded by the central banks of China and Russia, followed by several emerging market countries including Turkey, India, Kazakhstan, Uzbekistan, and Thailand. In particular, the People’s Bank of China has raised the share of gold in its reserves from 1.8 percent in 2015 to a record 4.9 percent at present. At the same time, it has cut its holding of US Treasuries from $1.3 trillion in the early 2010s to $780 billion in June 2024.
Gold holdings, valued at market prices, account for 15 percent of global reserves. As a consequence, the share of the USD in total global reserves including gold would fall to 48.2 percent—instead of 54.8 percent of global foreign exchange reserves. The declining USD share suggests that while the USD is still the preferred currency most used by central banks for their reserves, it has been losing market share. It is not as dominant in the global reserves arrangement as it still is in trade invoicing, international financing, and FX transactions, according to the Atlantic Council’s Dollar Dominance Monitor.
Implications of the declining share of the USD in global reserves
Several reasons have been advanced to explain the growing demand for gold. For the general public, factors including hedging against inflation and/or against political and geopolitical risks, as well as positioning for expected US Federal Reserve rates cuts, appear reasonable. The central banks buying gold have also mentioned their desires to diversify their reserves portfolios, de-risking from vulnerability to sanctions risk from the United States and Europe. This sense of vulnerability has become acute for some countries in conflict or potential conflict with the US/Europe, after the West imposed substantial sanctions on Russia following its invasion of Ukraine. Decisions to immobilize overseas reserve assets of the Bank of Russia, subsequently appropriate the interest earnings of those assets, and threats to seize assets outright to help pay compensation to Ukraine proved especially unsettling.
In response, central banks have moved into gold in a way to diminish sanction risks. They can take physical possession of the gold they have bought and kept it in domestic vaults—instead of leaving it at Western financial institutions such as the US Federal Reserve, the Swiss National Bank, or the Bank for International Settlements, where gold is subject to Western jurisdiction. If the likelihood of geopolitical confrontation heightens, it follows that the declining trend in the share of the USD in global reserves will persist. This is consistent with the de-dollarization trend whereby a growing number of countries have developed ways to settle their cross-border trade and investment transactions in local currencies. Doing so chips away at the USD’s dominant role in the international payment system, as well as motivating countries to hold some reserves in each other’s currencies.
While the declining share of the USD in global reserves could continue to unfold gradually, as in the past two decades, central banks’ demand for USD for their reserves would eventually fall to a critical threshold. The US national saving rate is also likely to stay low and remain insufficient to cover domestic investment, leading to persistent US current account deficits. The combined effect of these trends in addition to falling foreign central bank demand for USD would constrain the US government’s ability to issue debt to finance its budgetary needs.
This constraint could become binding, a turning point heralded by sharp reductions in foreign official demand for US Treasuries. In that case, USD exchange rates would have to fall and interest rates to rise, simultaneously and in sufficient magnitude, to improve the risk-return prospects of US government debt and attract international investors. Any increase in US interest rates would be very problematic as interest payments on government debt have already become a burden, and are estimated to take up more than 20 percent of government revenue by 2025. They are threatening to crowd out other necessary public priorities including national defense, dealing with climate change, infrastructure, and human services. These developments would make the political fight over budgetary resources for competing needs even more antagonistic, and the important task of getting government deficits and debt under control more intractable. Both factors would ultimately put the US fiscal trajectory on an unsustainable path and threaten global financial stability—a risk not easily addressed given the deepening geopolitical contention.
Hung Tran is a nonresident senior fellow at the Atlantic Council GeoEconomics Center, a former executive managing director at the Institute of International Finance and former deputy director at the International Monetary Fund.
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>>> UK gilt market faces worst week in months as budget rattles investors
Reuters
By Yoruk Bahceli, Amanda Cooper and Harry Robertson
November 1, 2024
https://www.reuters.com/world/uk/uk-gilt-market-faces-worst-week-year-budget-rattles-investors-2024-11-01/
Summary
UK yields set for big weekly jump
Sterling lower even as traders pare back rate-cut bets
Scale of bond, pound moves still far short of Sept 2022 rout
Markets calmer on Friday, some investors see opportunities
LONDON, Nov 1 (Reuters) - Short-term British government borrowing costs headed for their biggest weekly jump in over a year on Friday, while the pound faced its longest stretch of weekly losses in six years as Labour's tax-and-spend budget raised inflation expectations.
Two-year gilt yields , which led the selloff as investors pared back rate cut expectations, have risen 26 basis points on the week, set for their biggest weekly increase since June 2023.
Benchmark 10-year yields were up 21 bps, the biggest weekly move this year, having touched their highest in a year on Thursday at 4.526%.
Yields however dipped on Friday and sterling edged higher, suggesting investor sentiment was calming.
While the surge in government borrowing costs and the drop in the pound are sizable, the speed and scale are far short of the crisis that rocked markets in September 2022 following then-Prime Minister Liz Truss's budget of billions in unfunded tax cuts.
"2022 was something really quite off the scale. But that doesn’t mean that what we saw this week wasn’t important," City Index market strategist Fiona Cincotta said.
Yields have jumped as markets digest the government's plans, which will add nearly 70 billion pounds a year to the public spending bill, according to Britain's fiscal watchdog, with just over half covered by higher taxes and the rest by increased borrowing.
The UK's Office for Budget Responsibility now expects inflation will average 2.6% next year, compared with a previous 1.5% forecast.
Traders expect less than 90 bps of rate cuts by the end of next year, having priced in well over a percentage point prior to the budget.
They still expect a rate cut at the Bank of England's meeting next Thursday but have reduced the chance of a December cut to less than 50%.
Some investors said the moves may be exacerbated by positioning shifts, with many investors having favoured gilts before the budget.
BNP Paribas Asset Management told Reuters it had closed its overweight position in gilts, while Artemis is selling 10-year gilts following the budget.
BUYING OPPORTUNITY
Investors including Lazard Asset Management and AXA Investment Managers reckon gilts look attractive with higher yields.
"It doesn't strike us as an irresponsible budget," said AXA's head of total return and fixed income Nick Hayes.
"When I speak to the investment banks, they talk about decent buyers of gilts across the curve... you're not seeing any panic selling."
Rabobank said on Friday the market reaction had been "overdone," with the OBR expecting Britain's deficit, based on current spending and revenue, to turn to a surplus in four years.
Sterling edged up 0.3% against the euro on Friday, though it was still headed for its biggest one-week slide against the single European currency in more than a year, down by 1%.
Against the dollar , it was steady on the day at $1.291, but down 0.4% on the week, set for its fifth weekly decline - the longest such stretch since late 2018.
The currency falling as markets reduce rate cut bets shows the budget is not being seen as good for growth, City Index's Cincotta said.
The OBR revised up growth projections modestly for this year and next, but lowered them for 2026-2027.
Investors are sitting on one of the largest bullish positions in sterling on record. , worth $6.05 billion and the biggest bet against the dollar among the major currencies, according to the most recent weekly data from the U.S. markets regulator, making it vulnerable to further drops.
The derivatives market shows traders are more willing to pay more for options to sell sterling rather than buy it than at any time in the last 16 months.
"We like short GBP even more given its limited move so far," Neil Mehta, portfolio manager at BlueBay Asset Management, said.
For the time being, UK bonds were likely to remain jittery, with the U.S. presidential election taking place next week.
"We anticipate high volatility in global rates markets next week, which could be even more pronounced in gilts," Lazard Asset Management's co-head of global fixed income Michael Weidner said.
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