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The major difference from the long-term rate increase episode of 2013: the dollar

Bond sell-offs are often associated with a radical change in expectations. In May 2013, the fact that Ben Bernanke was, for the first time, talking about the possibility of a reduction of the Fed's asset purchases (QE3 tapering) had given rise to the idea that the fed funds policy was going to be tightened very quickly. The US 10-year yield went from 1.60% to 3% in early September 2013. While there was a virtual market consensus that the Fed would announce its tapering at the FOMC on 18 September 2013, the Fed had sidestepped the decision by saying that "the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market." A two-year long decline of long-term rates followed.

The “Trump tantrum” comes from the idea that fiscal stimulus measures taken by the future administration will substantially improve the prospects for growth and inflation. First, rising expectations of inflation will please FOMC members, who have been bemoaning their weakness for about two years (and, by the way, if the scope of budget measures disappoints, inflation expectations could suffer once again). Second, Janet Yellen said on Thursday that the next fed funds increase would come "relatively soon" (read "December").

But one of the biggest differences between the "taper tantrum" and the Trump tantrum lies with the US dollar. During the “taper tantrum”, the ECB and the BoJ were not aggressive, and Chinese authorities still agreed on the fact that that the US dollar and renminbi could move in tandem. Today, the monetary policies of the ECB and the BoJ are very aggressive (and will remain so), and these central banks will not tolerate a further rise of long-term rates rise (in any case, the Japanese 10Y is targeted at 0% by the BoJ). Furthermore, Chinese authorities no longer tolerate any rise in the renminbi's effective exchange rate (so the renminbi is gradually depreciating against the US dollar, and this week went even lower than the levels of the peg of 2008-2010).

And so, the theme of monetary policy divergence and rate divergence is resurgent. The rise in US long-term rates coincides, then, with a sharp rise in the US dollar in effective terms, unlike during the taper tantrum: despite all the fuss in 2013 (particularly over the depreciation of the "fragile five" currencies), the effective exchange rate had stayed virtually stable (stable against the euro and the yen, down against the renminbi). The dollar's rise will be a recurring problem for the Fed in 2017 (in addition to the fact that the dollar's appreciation will weaken imported inflation), and a message from the Fed about this tightening of monetary conditions via the currency's appreciation could be what prompts the end of the Trump tantrum. By all appearances, though, this won't happen before December's FOMC (the FOMC will not miss its chance to raise fed funds while such an increase is almost fully anticipated by the markets).




2016-11-18-key focus
DRUT Bastien , Fixed Income and FX Strategy
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The major difference from the long-term rate increase episode of 2013: the dollar
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